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95-27 NASD Introduces Revised Free-Riding Questionnaire And Form FR-1

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Executive Summary

As a result of recent amendments to the Free-Riding and Withholding Interpretation of the NASD Board of Governors under Article III, Section 1 of the NASD Rules of Fair Practice, the NASD revised the questionnaire that is used to review whether an offering was distributed according to the Interpretation. Revisions also were made to NASD Form FR-1, which may be used by members in their dealings with non-

U.S. broker/dealers or banks. Copies of the revised forms follow this Notice.

Background

The NASD adopted the Interpretation based on the premise that members are obligated to make a bona fide public distribution at the public offering price of securities of a public offering that trade at a premium in the secondary market whenever such secondary market begins (a hot issue), regardless of whether such securities are acquired by the member as an underwriter, as a selling group member, from a member participating in the distribution as an underwriter or a selling group member, or otherwise. The Interpretation includes specific prohibitions and restrictions as a guide for members participating in an offering of hot-issue securities.

On December 7, 1994, the Securities and Exchange Commission (SEC) approved several amendments to the Interpretation. Notice to Members 95-7 describes the amendments in detail. These changes necessitated revisions to the questionnaire used by the NASD in reviewing offerings for compliance with the Interpretation and to NASD Form FR-1, which may be used by members to obtain assurances from non-U.S. broker/ dealers or banks that no sales will be made by them in contravention of the Interpretation.

Free-Riding Questionnaire

In its review for compliance with the Interpretation, the NASD issued a questionnaire to the managing underwriter and to members participating in the distribution of the hot issues. Members must complete the questionnaire and forward it to the appropriate NASD District Office. The revised questionnaire is divided into four sections:

  • Section I, overall figure from the managing underwriter;

  • Section II, overall figures from all other underwriters, selling group members, and participants in the distribution;

  • Section III, breakdown of the distribution by the participant; and

  • section IV, detailed information on sales to restricted accounts.

Sections I And II

In the first two sections, a member must indicate the total number of securities that have been confirmed by the firm. For this questionnaire, "confirmed" means the number of hot-issue securities allocated to the firm for distribution and for which the firm has issued a confirmation/ comparison reflecting the full details of such sales to retail customers, institutional accounts, or other broker/dealers. When participating in a distribution of hot-issue securities, broker/dealers are responsible for ensuring compliance with the Free-Riding and Withholding Interpretation for all securities allocated and confirmed by that broker/dealer, including shares billed and delivered on behalf of others, such as designated orders, group sales, and directed sales.

A member completes Section I or Section II of the questionnaire. Section I is completed by the managing underwriter only. Section II is completed by all underwriters, selling group members, and other participants in the distribution, except for the managing underwriter.

Section III

All members must complete Section III. In this section, a member indicates the total number of securities distributed in each of 10 categories. The categories are addressed in the questionnaire in the same basic order in which they are addressed in the Interpretation. Unless otherwise noted, a member must provide detailed information on these sales in Section IV.

The figures reported in Section III are final figures after a member makes any cancellations and reallocations. Members should note that the total figure in Section III should equal the total number of securities confirmed in Section I or Section II.

Section IV

Section IV requires a member to provide detailed information on sales that were made to restricted accounts. The Interpretation includes specific circumstances in which it is permissible to sell to a restricted account, provided the member demonstrates compliance with the applicable provisions of the Interpretation.

NASD Form FR-1

For sales to a non-U.S. broker/dealer or bank, which is not participating in the distribution as an underwriter, the selling member must make an affirmative inquiry regarding the ultimate purchasers and comply with certain recordkeeping requirements. However, the Interpretation provides that a member may fulfill these obligations by having the non-U.S. broker/dealer or bank execute Form FR-1, or a reasonable facsimile of it.

In completing Form FR-1, the non-U.S. broker/dealer or bank gives the selling member a blanket assurance that no sales will be made in contravention of the provisions of the Interpretation. This form, which also was revised to conform with the recent amendments, is reprinted following this Notice. Members may reproduce copies of it or, as provided in the Interpretation, obtain other written assurance from the non-U.S. broker/dealer or bank.

* * *

Questions about the amendments to, or other provisions of, the Interpretation, should be directed to the NASD Office of General Counsel at (202) 728-8953. Questions regarding the Free-Riding Questionnaire or NASD Form FR-1 may be directed to Erin Gilligan, District Coordinator, Compliance Department, at (202) 728-8946.

Free-Riding Questionnaire

3/95

NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.

DATE

KEYBOARD()

RE: KEYBOARD()

Offering Date: KEYBOARD()

INSTRUCTIONS: Each member is required to complete either Section I or Section II based upon the capacity in which they acted in the distribution of the new issue. Sections III and IV must be completed by all firms for their " confirmed" * securities. It is the executing broker/dealer's responsibility to ensure that securities were distributed in compliance with the Free-Riding and Withholding Interpretation.

SECTION I. TO BE COMPLETED BY THE MANAGING UNDERWRITER ONLY

A. Total number of securities offered for public distribution:

(Include any additional shares received from the issuer as part of any over-allotment provision.)
B. Total number of securities allocated to other underwriters and selling group members:
C. Total number of securities confirmed* by your firm to retail and institutional customers, including all shares billed and delivered on behalf of others, designated orders, group sales, directed sales, etc.:

SECTION II. TO BE COMPLETED BY ALL UNDERWRITERS, SELLING GROUP MEMBERS AND OTHER PARTICIPANTS IN THE DISTRIBUTION

A. Total number of securities confirmed* by your firm to retail and institutional customers. (Do not include shares billed and delivered on your behalf by the managing underwriter, designated orders, group sales, directed sales, etc.):
B. Indicate capacity in which your firm participated in the offering:

Underwriter

Selling group

Other (define)

* For purposes of this questionnaire, "confirmed" means the number of new issue securities allocated to the firm for distribution purposes and for which the firm has issued a confirmation/comparison reflecting the full details of such sale to retail customers, institutional accounts or other broker/dealers. When participating in a distribution of new issue securities, broker/dealers are responsible for ensuring compliance with the Free-Riding and Withholding Interpretation for all securities allocated and confirmed by that broker/dealer.

SECTION III. BREAKDOWN OF SECURITIES DISTRIBUTED BY YOUR FIRM

INSTRUCTIONS: Indicate total number of securities distributed in each category and, unless otherwise noted, provide detailed information in Section IV, "Sales to Restricted Accounts". This breakdown should contain the final figures after giving effect to all cancellations and reallocations. For additional information regarding categories, please refer to the Board of Governors Interpretation "Free-Riding and Withholding" under Article III, Section I, of the Rules of Fair Practice.

1. Securities held in a firm account.
2. Sales to any officer, director, general partner, employee or agent of the member or any other broker/dealer, or to persons associated with the member or with any other broker/dealer, or to a member of the immediate family of such person.

Indicate the number of shares/units that were sold pursuant to the following provisions:
(A) Sales to persons associated with broker/dealers whose business is limited to investment company/variable contract securities or direct participation programs.

Number of shares/units _________
(B) Sales to a member of the immediate family of a person associated with a member who is not supported directly or indirectly by that person if the sale is by a broker/dealer other than that employing the restricted person and the restricted person has no ability to control the allocation of the hot issue.

Number of shares/units _________
It is not necessary to complete Section IV for items 2(A) and (B).
3. Sales to a person who is a finder with respect to the public offering or to any person acting in a fiduciary capacity to the managing underwriter, including among others, attorneys, accountants and financial consultants, or to any other person who is supported directly or indirectly, to a material extent, by any person specified in this paragraph.
4. Sales to any senior officer of a bank, savings and loan institution, insurance company, investment company, investment advisory firm or any other institutional type account, (including, but not limited to hedge funds, investment partnerships, investment corporations, or investment clubs) domestic or foreign, or to any person in the securities department of, or to any employee or any other person who may influence or whose activities directly or indirectly involve or are related to the function of buying and selling securities for any bank, savings and loan institution, insurance company, investment company, investment advisory firm, or other institutional type account, domestic or foreign, or to any other person who is supported directly or indirectly, to a material extent, by any person specified in this paragraph.
5. Sales to any account in which any person specified under paragraphs (1), (2), (3), or (4) has a beneficial interest.
6. Sales to other domestic broker/dealers for bona fide public customers, other than those enumerated in paragraphs (1)(2)(3)(4) or (5) above.
Name of Broker/Dealer No. of Shares/Units Written Representation Received (pursuant to paragraph 6)
    Yes No
    Yes No
    Yes No
It is not necessary to complete Section IV for item 6.
7. Sales to any domestic bank, domestic branch of a foreign bank, trust company or other conduit for an undisclosed principal.
(A) Indicate the number of shares/units that were sold based upon assurances obtained that ultimate purchasers were not restricted persons.

Number of shares/units ___________
It is not necessary to complete Section IV for item 7 (A).
8. Sales to a foreign broker/dealer or bank.

Indicate the number of shares/units that were sold pursuant to the following conditions.
(A) Sales by a foreign broker/dealer or bank participating in the distribution as an underwriter were made in accordance with provisions of underwriting agreement.

Number of shares/units ___________
(B) Affirmative inquiry was obtained that ultimate purchasers were not restricted persons.

Number of shares/units ___________
It is not necessary to complete Section IV for items 8(A) and (B).
9. Sales to an investment partnership or corporation, domestic or foreign (except companies registered under the Investment Company Act of 1940) including but not limited to hedge funds, investment clubs, and other like accounts.

Indicate the number of shares/units that were sold pursuant to the following conditions:
(A) "Carve out" mechanism was utilized.

Number of shares/units ___________
(B) Determination was made based upon file containing information on all persons having a beneficial interest or the opinion of counsel or accountant was obtained.

Number of shares/units ___________
It is not necessary to complete Section IV for items 9 (A) and (B).
10. Sales to public customers.

It is not necessary to complete Section IV for item 10.

TOTAL (1 through 10)

Please note that the total should be equal to total securities confirmed by your firm as noted in Section I or II.

Indicate the number of shares/units that were originally sold to a restricted account and were subsequently cancelled prior to the end of the first business day after the date on which secondary market trading begins and were reallocated to an unrestricted account. ___________

  Not applicable
________________________________ __________________________________
Signature of Principal Title

NOTE: Questionnaires should be returned to your District Office by the date specified.

SECTION IV. SALES TO RESTRICTED ACCOUNTS

PLEASE NOTE THAT IN CERTAIN CIRCUMSTANCES AS SET FORTH IN THE INTERPRETATION, IT IS PERMISSIBLE TO SELL TO A RESTRICTED ACCOUNT. HOWEVER, IT IS THE OBLIGATION OF THE MEMBER TO DEMONSTRATE COMPLIANCE WITH THE APPLICABLE PROVISIONS OF THE INTERPRETATION.

REPORTING MEMBER ______________________________________________________

ISSUE:_____________________________________________________________________

DATE OF PUBLIC OFFERING_________________________________________________

NUMBER OF SHARES /UNITS NAME OF PURCHASER NAME OF REGISTERED REPRESENTATIVE (HANDLING A/C) CATEGORY REPORTED IN SECTION III INDICATE EMPLOYMENT CLASSIFICATION, FAMILY MEMBER RELATIONSHIP, ETC. OF PURCHASER 1/ INDICATE WHETHER ISSUER-DIRECTED SALES, STAND-BY ARRANGEMENT SALES, OR SALES TO VENTURE CAPITAL INVESTORS 2/

1/ SALES ARE PERMITTED TO MEMBERS OF THE IMMEDIATE FAMILY PROVIDED THAT SUCH PERSONS DO NOT CONTRIBUTE DIRECTLY OR INDIRECTLY TO THE SUPPORT OF SUCH MEMBER OF THE IMMEDIATE FAMILY, SECURITIES WERE SOLD TO SUCH PERSONS IN ACCORDANCE WITH THEIR NORMAL INVESTMENT PRACTICE AND THAT THE AGGREGATE OF THE SECURITIES SO SOLD IS INSUBSTANTIAL AND NOT DISPROPORTIONATE. TO DEMONSTRATE INVESTMENT HISTORY AT YOUR FIRM OR ANOTHER BROKER/DEALER, PLEASE SUBMIT A TRANSCRIPT OR OTHER EVIDENCE FOR EACH ACCOUNT. TRANSCRIPT SHOULD INCLUDE ACCOUNTS PRACTICE PRIOR TO OFFERING (I.E., 1 YEAR).

2/ SALES OF ISSUER-DIRECTED SECURITIES, SALES PURCHASED PURSUANT TO A STAND-BY ARRANGEMENT AND SALES TO VENTURE CAPITAL INVESTORS. ARE NOT SUBJECT TO PROVISIONS OF THE INTERPRETATION PROVIDED THE CONDITIONS STIPULATED IN THE INTERPRETATION ARE MET.

NASD FORM FR-1

Representation from Non-United States Broker/Dealers or Banks regarding NASD Board of Governors Interpretation with respect to "Free-Riding and Withholding" under Article III, Section I, of the Rules of Fair Practice.

Date __________________

Name of Non-United States Broker/Dealer or Bank _________________________________

Address ____________________________________________________________________

Pursuant to the obligations imposed upon members in their dealings with Non-United States broker/dealers or banks under paragraph 8 (b) of the Interpretation, this form gives assurances to (selling member name) ___________________________________________ that no sales will be made in contravention of the provisions of this Interpretation.

It is our understanding that the securities falling within the scope of the Interpretation are those of an issue which trade at a premium in the secondary market whenever such secondary market begins. We further understand that the Interpretation prohibits:

1. Sales to any broker/dealer, including a member of the National Association of Securities Dealers, Inc. (NASD); provided, however, a purchasing firm may sell all or part of the securities acquired as described above to another member broker/dealer upon receipt from the latter, written assurance that such a purchase would be made to fill orders from bona fide public customers, other than those enumerated in paragraphs (2), (3), (4) or (5) below, at the public offering as an accommodation to them and without compensation for such.
2. Sales to any officer, director, general partner, employee or agent of the member or any other broker/dealer, or to persons associated with the member or with any other broker/dealer, or to a member of the immediate family of any such person. This provision does not apply to:
1. Sales to persons associated with broker/dealers whose business is limited to the purchase or sale of either investment company/variable contract securities or direct participation programs.
2. Sales to a member of the immediate family of a person associated with a member who is not supported directly or indirectly to a material extent by such person if the sale is by the broker/dealer other than that employing the restricted person and the restricted person has no ability to control the allocation of the hot issue.
3. Sales to a person who is a finder with respect to the public offering or to any person acting in a fiduciary capacity to the managing underwriter, including among others, attorneys, accountants and financial consultants, or to any other person who is supported directly or indirectly, to a material extent, by any person specified in this paragraph.
4. Sales to any senior officer of a bank, savings and loan institution, insurance company, investment company, investment advisory firm or any other institutional type account, (including, but not limited to hedge funds, investment partnerships, investment corporations, or investment clubs) domestic or foreign, or to any person in the securities department of, or to any employee or any other person who may influence or whose activities directly or indirectly involve or are related to the function of buying and selling securities for any bank, savings and loan institution, insurance company, investment company, investment advisory firm, or other institutional type account, domestic or foreign, or to any other person who is supported directly or indirectly, to a material extent, by any person specified in this paragraph.
5. Sales to any account in which any person specified under paragraphs (1), (2), (3), or (4) has a beneficial interest provided that:
1. Sales to members of the immediate family of persons enumerated above in paragraph (2), may be made if such persons do not contribute directly or indirectly to the support of such member of the immediate family; and
2. Sales may be made to persons specified under paragraphs (3) and (4), if the firm is prepared to demonstrate that the securities were sold to such persons in accordance with their normal investment practice, that the aggregate of the securities so sold is insubstantial and not disproportionate in amount as compared to the sales to members of the public and that the amount sold to any one of such persons is insubstantial in amount.

We understand that by providing Form FR-1 to the aforementioned NASD member we are asserting that no sales were made in contravention of the provisions of the Interpretation.

   


Signature of Executive
Title

*The term immediate family shall include parents, mother-in-law or father-in-law, husband or wife, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-law, children, and any other person who is supported directly or indirectly, to a material extent by the member or other person specified above.

Form FR-1 3/95


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