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95-73 NASD Requests Comment On Member Obligations To File Certain Exchange Offers That Result In Public Distributions;

Comment Period Expires October 15, 1995

SUGGESTED ROUTING

Senior Management
Corporate Finance
Legal & Compliance
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Executive Summary

The NASD® is proposing to amend the Corporate Financing Rule, Article III, Section 44, of the NASD Rules of Fair Practice (Rule) to require that certain registered and unregistered exchange offers and related information must be filed with the NASD Corporate Financing Department (Department) when members are engaged in "solicitation activities" in connection with such transactions. The NASD has determined that the Rule should provide guidance to members in determining when their exchange-offer activities result in their "participation in a public distribution," and thus become subject to NASD rules and oversight. In view of the record amount of merger and acquisition activity that has occurred in the past two years, the NASD believes that the proposed amendments to the Rule will provide certainty and eliminate confusion regarding the application of the Rule to exchange offers. The proposed amendments describe member participation in certain types of exchange offers that must comply with the substantive provisions of the Rule, including those that relate to underwriting compensation and other distribution terms and arrangements.

The Corporate Financing Committee (Committee) has considered whether certain types of merger and acquisitions transactions should be subject to NASD regulation and believes that the Rule should apply only to exchange offers in which a member firm engages in solicitation activities of security holders on behalf of the issuer when securities are issued. With regard to exchange offers, the Rule is applicable only to members acting as financial advisors to the issuer of securities, but not to those that are advisors to the target company or to any shareholder group. Thus, the Rule will apply to exchange offers registered on SEC Form S-4 where the member is acting as dealer/ manager to solicit consents to the proposed business reorganization, and to a member that solicits security holders in exchange offers exempt from registration under Section 3(a)(9) of the Securities Act of 1933. The Committee also determined that the Rule should not apply to exchange transactions where the member does not engage in solicitation activities on behalf of the issuer, or to mergers, particularly those that involve stock-for-stock exchanges, or spin-offs of any type.

The NASD realizes the time-sensitive nature of many exchange offers and thus has instructed the staff to expedite their review of any such filings made with the Department. Generally, the staff can be expected to issue a comment letter within 48 hours of receipt of the filing of an exchange offer.

Analysis Of Provisions Of Proposed Rule Change

Following is an analysis of how the proposed amendments will modify the provisions of the Rule.

Filing Requirements For Exchange Offers

The NASD has determined to add new Subsections (b)(9)(H) and (b)(9)(I) to the Rule to specify that members that participate in specified exchange transactions must file them with the Department for review. Transactions subject to the Rule would be exchange offers that are either:

  • exempt from registration under Section 3(a)(9) of the Securities Act of 1933, when the member's participation involves solicitation activities to facilitate the exchange of securities; or

  • registered on Form S-4 with the Securities and Exchange Commission (SEC), when the member is acting in the capacity as dealer/manager to facilitate the exchange of securities by soliciting investors (collectively, Exchange Offers).

However, notwithstanding these criteria, any exchange offer or merger and acquisition transaction that falls under the provisions of Schedule E to the NASD By-Laws, will continue to be subject to filing with the Department. Specifically, the Rule is being amended to state clearly that filing is required for distributions of securities where Schedule E applies. The SEC and NASD have long held the view that pre-offering review is vital to protect investors when the member and issuer are in a control relationship or have a conflict of interest that is addressed through the application of Schedule E. Furthermore, all of the conditions in Notice to Members 88–100 would require filing of the merger with the NASD. Specifically, in that Notice, the NASD expressed its special concerns regarding the merger of blank-check companies in the penny stock market with privately held holding companies of members, indirectly creating a publicly held NASD member without having to fully comply with Schedule E to the By-Laws.

All exchange offers exempt from registration under Section 3(a)(9) wherein the member is engaged in solicitation activities must be filed with the Department and are fully subject to the Rule. Solicitation activities by a member include solicitation of or other forms of direct contact with security holders, including these activities:

  • being named as a dealer/manager;

  • performing tasks that are permitted to be performed by investor relations firms (i.e., ascertaining what action security holders intend to take with respect to the exchange offer);

  • contacting security holders to inquire whether they have received the offering materials or answering unsolicited contacts; or

  • participating in meetings with security holders or their advisors before or after an exchange offer begins.

If the member's "participation" however, does not involve solicitation activities, but is limited to functions that may include, among other things, delivery of a "fairness opinion," advising the issuer as to the structure and terms of the exchange offer, assisting the issuer in the preparation of the offering documents to be sent to security holders, or other functions that do not include direct solicitation of or other forms of direct contact with security holders, the transaction would be exempt from filing and compliance with the Rule.

The application of the Rule to offerings of securities registered on Form S-4 is expressly limited to only those distributions where the member is engaged by the company to act as dealer/manager and solicit consents on behalf of the company to the proposed reorganization and to otherwise facilitate the exchange of securities. In such exchange offers, the member generally acts as a financial advisor to help structure the transaction and will receive a fee, as well as distribution-related compensation for services rendered. The NASD believes that when a member is retained to act as a dealer/manager by a company to solicit consents, the member is then involved in distribution-related activities in connection with registered exchange offers which should be regulated under the Rule. As is set forth below, all other transactions that require securities to be registered on Form S-4 are exempt from the Rule.

Exemptions From The Provisions Of The Rule

The NASD also proposes to adopt new Sections (C)(8)(I) and (C)(8)(J) to clarify that there are exemptions from the filing requirements and compliance with the other provisions of the Rule for certain merger and acquisition transactions in which the role of the member is to act as financial advisor to the board of directors of the acquirer, or the target company, including providing general financial advice on the structure of the transaction, and under certain circumstances, issuing a fairness opinion. Thus, in transactions where the securities to be issued are registered with the SEC on Form S-4 in connection with a merger or similar form of business combination, the members' activities are exempt from the Rule.

The proposed amendments also provide for an exemption from compliance with the Rule for spin-off transactions. In the case of a typical spin-off, reverse spin-off, or similar transaction of a subsidiary company to existing security holders, the security holders receive shares of the subsidiary as a dividend or distribution. These transactions involve no investment decision by the shareholders and, consequently, the parent's financial advisor is not generally involved in any public solicitation in connection with the spin-off.1

Transactions Subject To The Rule But Exempt From Filing

Proposed new Section (b)(7)(F) to the Rule provides for an exemption from the filing requirements for Exchange Offers where the securities to be issued or being acquired are listed on the Nasdaq National Market®, the New York Stock Exchange (NYSE), or the American Stock Exchange (AMEX), or for securities distributions of certain seasoned companies. These transactions are exempt from the filing requirements only, and not from compliance with the Rule.

Exemption For Securities Listed On Nasdaq National Market, NYSE, Or AMEX

The NASD believes that it is appropriate to exempt from the filing requirements Exchange Offers where securities to be issued, or are being acquired, are listed on the Nasdaq National Market, the NYSE, or AMEX, thereby permitting the shareholder to readily obtain an alternative marketable investment.2 The NASD believes that this situation is analogous to a cash tender offer, which is outside the scope of the Rule, where the outstanding shares are purchased for cash. Further, the listing standards for Nasdaq National Market-, NYSE-, and AMEX-listed companies ensure that independent directors of the board will evaluate the offer, and that sufficient information will be distributed to shareholders and made available to the markets so investors can make a decision regarding whether to sell or hold the securities it holds or will receive.

Exemption For Seasoned Securities

The NASD also believes that an exemption from the filing requirements should be available for Exchange Offers by seasoned issuers that would qualify to register securities on Forms S-3, F-3, or F-10 as those forms were in effect prior to October 21, 1992, (for Forms S-3 and F-3) and June 21, 1991, (for Form F-10). This provision would generally require that the company have a three-year history as a public-reporting company, and be in compliance with the current year's periodic reporting requirements of the Securities Exchange Act of 1934 (relating to timely filing of 10-Qs and 10-Ks). In addition, to qualify for this exemption from filing, the minimum required market value of a company's voting stock must be as follows: Form S-3 $150 million (or $100 million market value of voting stock and three million shares annual trading volume); and Form F-3 $300 million (held worldwide). For Form F-10, Canadian issuers must have (CN) $360 aggregate value of voting stock and a public float of (CN) $754 million.

Regulation Of Financial Advisory "Tail Fee" Arrangements

The proposed amendments to the Rule include new Section (c)(6)(B)(xiii) that provides that it is an unreasonable term and arrangement when proposed in connection with an Exchange Offer for any agreement or arrangement between a member and a company to contain a "tail fee," if the tail fee has a duration of more than two years from the date the member's services are terminated. However, a member may demonstrate, on the basis of information satisfactory to the NASD, that an arrangement of more than two years is not unfair or unreasonable under the circumstances.

A tail fee is an arrangement or agreement in which the company is obligated to compensate a member in the event the Exchange Offer is not completed and the company subsequently consummates a similar transaction. The NASD evaluated the appropriateness of such an arrangement and agreed to adopt the common industry practice that tail fees should generally be permitted, but limited to a two-year period, calculated from the date the member's services were terminated. The NASD believes that a shorter period of time does not adequately protect a member that may have expended considerable time and effort working on an exchange offer, when a company determines to terminate the services of the member, and nonetheless completes the Exchange Offer. In Exchange Offers, unlike traditional corporate underwritings, the real benefit derived by the company is the creativity of the strategic advice given by the member for the particular transaction that may include, among other things, assisting the company in defining objectives, performing valuation analyses, formulating restructuring alternatives, and structuring the Exchange Offer. Also, a member providing financial advice in the case of an exchange offer will generally have provided considerable ongoing financial advisory services to the company.

The NASD believes, however, that NASD staff should be able to grant exceptions to the two-year limitation upon demonstration of fairness of the arrangements. The Committee determined, therefore, that the provision should give the staff authority to grant such exceptions upon request, and under circumstances where the member can demonstrate that the creativity of the strategic advice has a potential benefit to the company for more than two years. In the case of offerings exempt from filing but subject to compliance with the Rule where the tail fee arrangement is longer than two years, the member must still comply with this provision of the Rule and, therefore, must request an opinion of the staff as to whether a tail fee with a longer arrangement is permissible under the Rule, even though it is not required to make a formal filing.

Interpretation Regarding Reimbursement Of Certain Expenses In Exchange Offers

Certain types of fees and expense reimbursement arrangements typically negotiated for or received in connection with Exchange Offers are not deemed to be inconsistent with or prohibited by Subsection (C)(6)(B)(iii) of the Rule. With regard to fees, the only compensation that is permitted under this provision of the Rule relates to situations where a member acting as a financial advisor receives a "time and efforts" or similar fee for the services it rendered in connection with an Exchange Offer that is not completed, and the financial advisor does not, therefore, receive the agreed upon success fee. Reimbursement of certain expenses, including, but not limited to, travel costs, document production, and legal fees of the financial advisor, are also typically provided for in the agreements, whether or not the transaction is consummated. The NASD does not believe that these and similar types of reimbursement arrangements in Exchange Offers should be prohibited by the Rule, since their arrangements are not viewed to be directly connected with the issuance of securities.

Request For Comments

The NASD asks members and other interested parties to comment on the proposed modifications to the Rule. Comments should be addressed to:

Joan C. Conley Corporate Secretary National Association of Securities Dealers, Inc. 1735 K Street, NW Washington, DC 20006–1500

Questions concerning this Notice may be directed to Charles L. Bennett, Director, or Carl R. Sperapani, Assistant Director, NASD Corporate Financing Department, at (301)208–2700.


1 If, however, a spin-off is followed by a traditional public offering by the spun-off company to raise capital, the company's initial public offering would be subject to the Corporate Financing Rule's filing requirements.

2 In developing the definition of "limited partnership roll-up transaction" in Article III, Section 34, the SEC approved a similar exemption for freely tradable securities.


Text Of Proposed Amendments To The Corporate Financing Rule

Underwriting Terms and Arrangements

(Note: New text is underlined.) Sec. 44

(a) Definitions No change.
(b) Filing Requirements
(1) through (6) No change.
(7) Offerings Exempt From Filing

Notwithstanding the provisions of paragraph (1) above, documents and information related to the following public offerings need not be filed with the NASD for review, unless subject to the provisions of Schedule E to the By-Laws. However, it shall be deemed a violation of this Section or Article III, Section 34 of these Rules of Fair Practice, for a member to participate in any way in such public offerings if the underwriting or other arrangements in connection with the offering are not in compliance with this Section or Section 34, as applicable:
(A) through (E) No change.
(F) exchange offers (as defined in subparagraph (9)(H) below) where:
(i) the securities to be issued or the securities being acquired are listed on the Nasdaq National Market, the New York Stock Exchange or the American Stock Exchange: or
(ii) the company issuing securities qualifies to register securities with the Securities and Exchange Commission on Forms S-3. F-3 or F-10. under the requirements for those forms set forth in subparagraph (C) of this paragraph.
(8) Exempt Offerings

Notwithstanding the provisions of paragraph (1) above, the following offerings are exempt from this Section, Schedule E to the By-Laws, and Article III, Section 34 of the Rules of Fair Practice. Documents and information relating to the following offerings need not be filed for review:
(A) through (F) No change.
(G) tender offers made pursuant to Regulation 14D adopted under the Securities Exchange Act of 1934, as amended; [and]
(H) securities issued pursuant to a competitively bid underwriting arrangement meeting the requirements of the Public Utility Holding Company Act of 1935, as amended;
(I) securities of a subsidiary or other affiliate distributed by a company in a spin-off, reverse spin-off or similar transaction to its existing security holders exclusively as a dividend or other distribution: and
(J) securities registered with the Securities and Exchange Commission on Form S-4 in connection with a merger or similar form of business combination.
(9) Offerings Required to be Filed

Documents and information relating to all other public offerings including, but not limited to, the following must be filed with the NASD for
(A) through (F) No change.
(G) securities offered pursuant to Regulation A or Regulation B adopted under the Securities Act of 1933, as amended; [and]
(H) exchange offers, exempt from registration under Section 3fa)(9) of the Securities Act of 1933 (if the member's participation involves active solicitation activities) or registered with the Securities and Exchange Commission on Form S-4 (if the member is acting as a dealer-manager) (collectively, "exchange offers"):
(I) any exchange offer or. merger and acquisition transaction which involves offerings of securities subject to Schedule E of the By-Laws, including but not limited to any such offerings and any corporate reorganization involving a member or its parent that results in the direct or indirect public ownership of a member and offerings required to be filed pursuant to sub-paragraph (H) of this paragraph: and
(J) any offerings of a similar nature that are not exempt under paragraphs (7) or (8) of this Subsection.
(c) Underwriting Compensation and Arrangements
(1) through (5) No change.
(6) Unreasonable Terms and Arrangements
(A) No member or person associated with a member shall participate in any manner in a public offering of securities after any arrangement proposed in connection with the public offering, or the terms and conditions relating thereto, has been determined to be unfair or unreasonable pursuant to this Section or inconsistent with any By-Law or any Rule of Fair Practice, or other rule or regulation, of the NASD.
(B) Without limiting the foregoing, the following terms and arrangements, when proposed in connection with the distribution of a public offering of securities, shall be unfair and unreasonable:
(i) through (x) No change.
(xi) for a member or person associated with a member to accept, directly or indirectly, any non-cash sales incentive item including, but not limited to, travel bonuses, prizes and awards, from an issuer or an affiliate thereof in excess of $50 per person per issuer annually. Notwithstanding the foregoing, a member may provide non-cash sales incentive items to its associated persons provided that no issuer, or an affiliate thereof, including specifically an affiliate of the member, directly or indirectly, participates in or contributes to providing such non-cash sales incentive; [or]
(xii) for a member to participate with an issuer in the public distribution of a non-underwritten issue of securities if the issuer hires persons primarily for the purpose of distributing or assisting in the distribution of the issue, or for the purpose of assisting in any way in connection with the underwriting, except to the extent in compliance with 17 C.F.R. ยง240.3a4-l and applicable state law: or
(xiii) when proposed in connection with an Exchange Offer, any agreement or arrangement in which the issuer grants to the member the right to receive a "tail fee" in the event that the Exchange Offer is not completed and the company subsequently consummates a similar transaction if the tail fee arrangement has a duration of more than two (2) years from the date the member's services are terminated; provided, however, that a member may demonstrate on the basis of information satisfactory to the NASD that an arrangement of more than two (2) years is not unfair or unreasonable under the circumstances.

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