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93-41 SEC Approves Schedule D Amendments Permitting Excused Withdrawal or Passive Market-Making Status for Distribution Participants That Are Nasdaq Market Makers

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Executive Summary

On May 28, 1993, the Securities and Exchange Commission (SEC) approved amendments to Part VI, Section 8 of Schedule D to the NASD® By-Laws that will assist members in meeting their obligations under SEC rules 10b-6 and 10b-6A. The amendments require that the manager of a secondary offering of Nasdaq securities assume the responsibility for asking Nasdaq Operations to withdraw the quotations of Nasdaq market makers that are distribution participants or to identify the quotations as those of a passive market maker.

The amendments take effect June 22, 1993. The text of the amendments follows this Notice.

Background

On May 28, 1993, the SEC approved amendments to Part VI, Section 8 of Schedule D to the NASD By-Laws. The amendments were initially prompted when the SEC staff alerted the NASD that, on occasion, members engaged in the distribution of securities of companies listed in The Nasdaq Stock MarketSM are, through inadvertence or otherwise, not complying with the provisions of the two-and nine-business day cooling-off periods provided for in Rule 10b-6 adopted by the SEC under the Act.1

Previously, Section 8(b), as clarified in Notice to Members 88-69 (September 1988), required each market maker to submit a written request for an excused withdrawal as a market maker to Nasdaq Operations when the market maker intended to participate in a secondary offering subject to SEC Rule 10b-6.

The NASD found that if a market maker participating in a distribution fails to withdraw its quotations from Nasdaq on a timely basis before a secondary offering, the market maker will ask the SEC staff to provide relief from the cooling-off provisions of Rule 10b6 to enable the offering to commence on the scheduled date rather than delay the offering to comply with the rule. The market makers in these situations may argue that the violation is inadvertent and present information demonstrating that the market making by the member does not indicate a manipulative pattern. Further, SEC failure to provide relief may disrupt the offering by changing the composition of the underwriting syndicate. The NASD found that such requests for relief are a continuing problem; more so during periods of increased corporate financing activity.

The amendments are also the result of the SEC's approval of a new exception to Rule 10b-6 and new companion rule, Rule 10b-6A (passive market making rule) on April 8, 1993, to permit "passive market making" in connection with certain distributions of securities quoted in The Nasdaq Stock Market during the period when Rule 10b-6 would otherwise prohibit such activity.2 Rule 10b-6A is only available for registered firm commitment offerings that qualify for the two-day cooling-off period under Rule 10b-6(a)(4)(xi).3 Under 10b-6A, a passive market maker's bid is limited by the level of bids of market makers who are not participating in the distribution. One of the terms of the passive market making rule is that each market maker participant deciding to engage in passive market making must "notify the NASD in writing in advance of its intention to engage in passive market making."4

Description of Amendments

In order to address the problem of inadvertent violations of Rule 10b6 and to implement the notification requirements of Rule 10b-6A, the NASD has adopted a new procedure that requires the manager of a secondary distribution subject to Rule 10b-6 to assume responsibility for requesting excused withdrawal or passive market maker status for the underwriting syndicate and selling group members known to the manager on the day before the cooling-off period under Rule 10b6 begins.5 The title of Section 8 is being modified to reflect that the section applies to the withdrawal of quotations and passive market making. Subsection 8(a) now encompasses requests for passive market maker status.6

Under new subparagraph 8(d)(1)(A), the first phase of the excused-withdrawal and passive-market-maker-status process obligates the manager of the distribution or a member acting in a similar capacity7 to notify Nasdaq Operations in writing of the prospective distribution. The manager must supply such notification within five days of the filing of the offering documents either with the NASD's Corporate Financing Department or, if exempt from filing with the Department, within five days of filing with the appropriate regulatory authority. The manager must provide notice of the prospective distribution, indicate to Nasdaq Operations that it will manage the distribution, and identify the Nasdaq security or securities that are the subject of the distribution.

The second phase of the excused withdrawal process has two parts. Subparagraph 8(d)(1)(B) requires the manager, not later than noon Eastern Time of the business day before the cooling-off period commences8, to notify Nasdaq Operations in writing of the contemplated date and time that the cooling-off period begins, the identity of the participants in the distribution, and the identity of the distribution participants that intend to act as passive market makers. This authorizes Nasdaq Operations to automatically withdraw the market makers' quotations or identify the specified market makers' quotes as passive and fulfills the obligations of the market makers pursuant to Rule 10b-6(a)(4)(xi) and Rule 10b-6A to request withdrawal of their quotations or provide notification to Nasdaq Operations of their intent to engage in passive market making.

In addition, subparagraph 8(d) (1)(B) also requires the manager to inform each market maker that Nasdaq Operations is aware of the firm's status regarding the prospective distribution to permit a market maker that does not intend to participate in the distribution or act as a passive market maker to prevent its quotes from being deleted or identified as passive. Subparagraph (d)(3) requires a market maker, identified to Nasdaq Operations as a distribution participant, to notify Nasdaq Operations and the manager by 4:00 PM Eastern Time on the day before the cooling-off period begins that it does not intend to participate in the distribution or to engage in passive market making.

The NASD anticipates that all members of the underwriting syndicate would be known to the manager on the day before the cooling-off period begins. The foregoing procedure, however, would only cover those members of the selling group actually known to the manager on the day before the cooling-off period commences. Under Rule 10b-6, the cooling-off period commences on the later of the applicable time period (two- or nine-business days before the distribution starts) or the time the member becomes a distribution participant. Therefore, if a member receives an invitation to be a member of the selling group after the cooling-off period has commenced or if the member is an affiliated purchaser9 of a distribution participant, a member that wishes to comply with Rule 10b-6(a)(4)

(xi) or Rule 10b-6A must timely initiate its own request for excused withdrawal of its quotations or for designation as a passive market maker pursuant to Subsection 8(b).

The NASD has also amended Subsection 8(b) to provide that it cannot be relied on if the request for excused withdrawal status or passive market maker status should be made under Subsection 8(d) to comply with SEC Rules 10b-6 or 10b-6A. Previously, Subsection 8(b) permitted excused withdrawal to comply with Rule 10b-6 pursuant to the second sentence which refers to "legal or regulatory requirements." Amended subsection 8(b) provides that members can also obtain passive market maker status under that provision; however, market makers should not rely on Subsection 8(b) to obtain excused withdrawal status or passive market maker status in circumstances where Subsection 8(d) provides a procedure for notification to Nasdaq Operations.

New paragraph 8(d)(2) provides that for an offering with no registration statement filing requirement, market makers that are distribution participants must notify Nasdaq Operations of the date and time the cooling-off period begins and request withdrawal of their quotations or designation as passive market makers. This separate provision is made for unregistered offerings because it is unlikely that offering documents will be filed with any regulatory authority triggering initial notification. Further, such offerings often arise on short notice, and generally there is only one or a very few distribution participants. Imposing the full notification provisions of subparagraphs 8(d)(1)(A) and (B) for these offerings could impede capital raising through private placements and would not serve a substantial regulatory interest.

Finally, while it is anticipated that virtually all offerings of companies trading in The Nasdaq Stock MarketSM will be managed by a member firm which is also making a market in the issuer's securities, to the extent that the manager is not a market maker, new paragraph 8(d)(4) obligates each market maker that is a distribution participant to file the required notice unless another market maker assumes the compliance obligation on its behalf. This provision is intended to permit the market makers to act either independently or in concert to comply with the notice provisions where the manager is not a market maker. The NASD anticipates that, under normal circumstances, the non-market maker distribution manager will advise the NASD of the pendency of a distribution in the manner specified in paragraph 8(d)(1).

The amendments take effect June 22, 1993. Questions concerning this Notice may be directed to Charles L. Bennett, Director, or Richard Fortwengler, Associate Director, NASD Corporate Financing Department at (202) 728-8258.

Specific questions on the identification of market makers as passive market makers and other market-maker procedures may be directed to Nasdaq Operations at (202) 5093618 or (800) 635-6485.


1 SEC Rule 10b-6 prohibits persons engaged in the distribution of securities from bidding for or purchasing any security that is the subject of the distribution or related securities. The rule generally requires market makers in the security who are also participants in the distribution or affiliated purchasers to withdraw from market making, (1) two business days before commencement of offers or sales in the distribution if the securities are priced at $5 per share or more and the public float is 400,000 shares or more (10b-6(a)(4)(xi) (A)), or (2) nine business days before commencement of offers or sales in the distribution in the case of all other securities (10b-6(a)(4)(xi)(C)). See also, Rule 10b-6: Interpretation of "Business Day" (July 29, 1991) [1991 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶79,751 (Business Day letter).

2 Securities Exchange Act Release No. 32117 (April 8, 1993); 58 F.R. 19598 (April 15, 1993). The SEC's approval of Rule 10b-6A was in response to a Petition for Rulemaking filed with the SEC by the NASD.

3 Pursuant to exception (xi)(A) to Rule 10b-6, market makers that intend to participate in the distribution of securities are prohibited from making bids or purchases of outstanding securities of the same class as the securities to be distributed commencing two days before commencement of offers or sales of the securities to be distributed (or, for market makers that are members of the selling group, commencing at the time such market maker becomes a participant in the distribution) for securities with a minimum price of $5 per share and a minimum public float of 400,000 shares, with such prohibition continuing until the termination of the offering.

4 Subsection (c)(7) to Rule 10b-6A. 58 F. R. 19598 (April 15, 1993), at 19607.

5 The amendments announced in this Notice supercede prior amendments to Part VI, Section 8 of Schedule D that were approved by the SEC on a temporary basis for 60 days to provide a procedure for individual market makers to comply with the notification requirement in Rule 10b6A. Securities Exchange Act Release No. 34-32159 (April 16, 1993); 58 F.R. 21613 (April 22, 1993).

6 The obligation to determine whether Rule 10b-6 or Rule 10b-6A applies to the particular offering remains with the member participating in the offering. Rule 10b-6 applies to issuances of securities that meet the definition of "distribution" contained in Rule 10b-6(c)(5). Such a distribution can include a registered or unregistered offering of securities, a private placement, rights offering, or securities issued in a merger or acquisition.

7 An offering may not have a designated manager; however, any member performing some or all of the functions of a manager, and/or who agrees to perform the notification function for the distribution participants would be a member acting in a "similar capacity" to a manager for purposes of this proposed rule change.

8 Pursuant to the SEC's Business Day letter, cited above in footnote 1, "a business day should generally be interpreted as a twenty-four hour period determined with reference to the principal market for the securities to be distributed, and that includes a complete trading session for that market." [1991 Transfer Binder] Fed. Sec. L. Rep. (CCH) at p. 78,394.

9 Rule 10b-6 defines the term "affiliated purchaser" to include an entity acting in concert with a distribution participant in making purchases of the securities or an entity in a control relationship.


Text of Amendments to Part VI, Section 8 of Schedule D

(Note: New text is underlined; deleted text is in brackets).

Part VI

* * * * *

Sec. 8.Withdrawal of Quotations and Passive Market Making

(a) A market maker that wishes to withdraw quotations in a security or have its quotations identified as the quotations of a passive market maker shall contact [NASDAQ] Nasdaq Operations to obtain excused withdrawal status prior to withdrawing its quotations. [Excused withdrawals] Withdrawal of quotations or identification of quotations as those of a passive market maker shall be granted by [NASDAQ] Nasdaq Operations only upon satisfying one of the [demonstration of the existence of one of the circumstances set forth in paragraph (b) of] conditions specified in this S[s]ection.
(b) Excused withdrawal status based on physical circumstances beyond the market maker's control may be granted for up to five (5) business days, unless extended by [NASDAQ] Nasdaq Operations. Excused withdrawal status and passive market maker status based on demonstrated legal or regulatory requirements, supported by appropriate documentation and accompanied by a representation that the condition necessitating the withdrawal of quotations is not permanent in nature, may, upon written request, be granted for not more than sixty (60) days (unless such request is required to be made pursuant to paragraph (d) below). Excused withdrawal status based on religious holidays may be granted only if notice is received by the Association five business days in advance and is approved by the Association. Excused withdrawal status based on vacation may be granted only if: (1) the request for withdrawal is received by the NASD twenty (20) business days in advance, and is approved by the NASD; (2) the request includes a list of the securities for which withdrawal is requested; and (3) the request is made by a market maker with three (3) or fewer [NASDAQ] Nasdaq Level 3 terminals. Excused withdrawal status may be granted to a market maker that has withdrawn from an issue prior to the public announcement of a merger or acquisition and wishes to reregister in the issue pursuant to the same-day registration procedures contained in Section 1, above, provided the market maker has remained registered in one of the affected issues. The withdrawal of quotations because of pending news, a sudden influx of orders or price changes, or to effect transactions with competitors shall not constitute acceptable reasons for granting excused withdrawal status.
(c) Excused withdrawal status maybe granted to a market maker that fails to maintain a clearing arrangement with a registered clearing agency or with a member of such an agency and is withdrawn from participation in the Automated Confirmation Transaction service, thereby terminating its registration as a market maker in [NASDAQ] Nasdaq/NMS issues. Provided however, that if the Association finds that the market maker's failure to maintain a clearing arrangement is voluntary, the withdrawal of quotations will be considered voluntary and unexcused pursuant to Part VI, Section 9 of this Schedule and the Rules of Practice and Procedures for the Small Order Execution System.
(d) Excused withdrawal status or passive market maker status may be granted to a market maker that is a distribution participant in order to comply with Rule 10b-6 or Rule 10b-6A adopted under the Securities Exchange Act of 1934, as amended, on the following conditions:
(1) A market maker acting as a manager (or a similar capacity) of a distribution shall:
(A) provide written notice to Nasdaq Operations of the prospective distribution and the fact that the market maker is a manager of the distribution and of the Nasdaq security or securities that are subject to Rule 10b-6 no later than 5 business days following the filing of a registration statement with the Association pursuant to the Corporate Financing Rule, Article III, Section 44 of the Rules of Fair Practice, or, if the member is not required to file the registration statement with the Association, no later than 5 business days following the filing of offering documents with the appropriate regulatory authority; and,
(B) no later than noon Eastern Time on the business day prior to the beginning of the cooling-off period;
(i) request withdrawal of the market makers' quotations or identification of the market makers' quotations as those of a passive market maker by providing written notice to Nasdaq Operations of the identity of the market makers that are distribution participants, the contemplated date and time of the commencement of the cooling-off period, and the identity of the market makers that intend to act as passive market makers; and (ii) advise the market makers that they have been identified as distribution participants to Nasdaq Operations and that their quotations will be automatically withdrawn or identified as passive market maker quotations upon the request made by the manager unless they submit to Nasdaq Operations the notice specified in paragraph (3), below.
(2) If the security is being distributed pursuant to an offering for which no registration statement or offering document is required to be filed, adopted each market maker that is a distribution participant shall, no later than noon Eastern Time on the business day prior to the beginning of the cooling-off period, provide written notice to Nasdaq Operations of its participation in the distribution, the contemplated date and time of the commencement of the cooling-off period, the Nasdaq security or securities that are subject to Rule 10b-6, and request withdrawal of its quotations or identification as a passive market maker.
(3) A market maker that has been identified to Nasdaq Operations as a distribution participant shall provide written notice to Nasdaq Operations and the manager of its intention not to participate in the prospective distribution or act as a passive market maker no later than 4:00 PM Eastern Time on the business day prior to the beginning of the cooling-off period in order to avoid having its quotations withdrawn or identified as the quotations of a passive market maker.
(4) In the event the manager of a distribution is not a market maker, each market maker that is a distribution participant shall comply with Subsection (d)(1) unless another market maker has assumed responsibility for compliance.
For purposes of this section, the term "cooling-off period" refers to the periods specified in Rule 10b-6(a)(4)(xi) adopted under the Securities Exchange Act of 1934, as amended, the terms "distribution" and "distribution participant" refer to these terms as defined in Rule 10b-6(c)(5) and (c)(6) adopted under the Securities Exchange Act of 1934 and the term "passive market maker" refers to this term as defined in Rule 10b-6A under the Securities Exchange Act of 1934.

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