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85-81 Request for Comments on Proposed Exemption from Free-Riding Interpretation for Conversions of Savings and Loan Associations
TO: All NASD Members and Other Interested Persons
LAST DATE FOR COMMENT: JANUARY 2, 1986
The National Association of Securities Dealers, Inc., (NASD) is requesting comments on a proposed amendment that would exempt certain persons purchasing securities in connection with the conversion of a savings and loan association or other organization from mutual to stock ownership from the restrictions of the Interpretation of the Board of Governors, Free-Riding and Withholding (the "Free-Riding Interpretation") under Article III, Section 1 of the NASD Rules of Fair Practice. The proposed amendment, and the history and background leading to its proposal, are discussed in this notice. The text of the amendment is attached.
HISTORY AND BACKGROUND
The Free-Riding Interpretation restricts certain persons from purchasing securities in a public offering if those securities trade at a premium in the immediate aftermarket. The Interpretation prohibits member firms, persons associated with members, immediate family members of such associated persons and other specified persons from purchasing or retaining securities that are part of a "hot" issue. It also requires members to make a bona fide public offering of such securities. To assure compliance with the Interpretation, most firms establish procedures to monitor purchases of new issues. As a practical matter, application of the Interpretation generally restricts the ability of members and their associated persons to purchase new issues.
In recent years, a growing number of savings and loan associations have converted from the mutual form of ownership to stock ownership, issuing securities in the process. Under the rules of the Federal Home Loan Bank Board (FHLBB), federally chartered institutions usually offer their depositors, borrowers and community residents the opportunity to subscribe to their securities prior to any under-written public offering. In some cases, an association's entire offering will be sold through this subscription process, without participation by a broker-dealer. More commonly, the issuing institution will sell a portion of the offering during the subscription period, with the remaining securities being underwritten and distributed by a broker-dealer. The point at which the broker-dealer becomes involved, and the role performed, varies.
With the proliferation of savings and loan conversions, numerous questions have arisen concerning the ability of persons subject to the Free-Riding Interpretation to purchase securities directly from a savings and loan association during its subscription period. These questions involve several complex issues, especially when a restricted person is entitled under FHLBB rules to purchase securities in the capacity of a depositor or borrower, or when it is unclear whether a broker-dealer will be involved in the offering.
In view of these numerous issues, the National Business Conduct Committee (NBCC) of the NASD Board of Governors has reviewed the FHLBB rules, the practices involved in savings and loan conversions and the policy considerations behind the restrictions of the Free-Riding Interpretation. On the basis of this analysis, the NBCC concluded that it is appropriate to exempt certain persons from the Free-Riding Interpretation under specified conditions. In doing so, the NBCC also concluded that it is appropriate to make a distinction between member firms, their associated persons and immediate family members on the one hand and all other restricted persons covered under the Interpretation on the other hand.
The proposed amendment would define "conversion offering" as an offering that is part of a plan whereby a savings and loan association or other organization converts from the mutual form to the stock form of ownership. The definition includes offerings by other organizations and would make the language applicable, for example, to conversions by mutual insurance companies.
The amendment would define "eligible purchaser" to mean a person who is eligible to purchase securities directly from the issuer in a savings and loan conversion offering under FHLBB rules and who has a direct relationship with the issuer as a depositor, borrower, officer, director or employee, or serves in a similar capacity.
The terms of savings and loan conversions specify those persons eligible to purchase directly from the issuer in transactions that are not handled by the underwriter. Often, persons eligible to make such purchases can do so prior to the public, underwritten offering. In some cases, the entire offering is distributed to such purchasers. Under FHLBB rules, eligibility to purchase may be extended to residents of the community in which the converting association is located. After careful consideration, the NBCC concluded that it is appropriate to extend the proposed exemption from the Free-Riding Interpretation only to those purchasers who have a direct relationship with the issuer. Thus, depositors, borrowers, officers, directors or employees could claim the exemption (assuming they meet all other criteria), but persons who are eligible under FHLBB rules solely due to their residence could not.
Sales by the Issuer
The proposed amendment provides an exemption from the Free-Riding Interpretation in two different situations:
In the first situation, the amendment must address sales by the issuer because the Interpretation otherwise would indirectly prohibit some such sales. When a member or associated person participates in an offering, all transactions that are part of the offering are scrutinized for compliance with the Interpretation. In a typical savings and loan conversion, therefore, sales made directly by the issuer to restricted persons may constitute violations of the Interpretation by NASD members participating in the offering.
The amendment would permit members and associated persons to participate in a conversion offering notwithstanding the fact that the issuer may have sold, or may sell, securities of the offering to persons restricted by the Interpretation. For the exemption to be available, however, any such sales by the issuer must be made only to eligible purchasers as defined. Those purchasers may not be members, their associated persons or immediate family members of associated persons, and the sales must be effected without any direct or indirect participation by a member or associated person. In a savings and loan conversion, therefore, a member could participate in the offering even though the issuer has directly sold shares to restricted persons as long as no sales were made to a member, associated person or immediate family member.
Sales to Members, Associated Persons and Their Immediate Families
The proposed amendment would deal separately with sales to member firms, their associated persons and members of their immediate families and would impose more stringent conditions on the exemption. The NBCC believes there are inherent conflicts of interest between participation in the securities industry and the purchase of "hot" issues, even in the context of the conversion of a savings and loan association. The NBCC concluded that it is necessary to require persons in this category to satisfy additional conditions beyond those previously mentioned for non-securities industry persons.
Subsection (c) would permit members and associated persons to sell securities as part of a conversion offering to members and associated persons and their immediate families if seven conditions are met:
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All members and other interested persons are invited to submit comments on the proposed rule. Comments should be received no later than January 2, 1986, and should be directed to:
Mr. James M. Cangiano, Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006
Comments received by the indicated date will be considered by the NBCC and the NASD Board of Governors. Any rule change approved by the Board must be filed with and approved by the Securities and Exchange Commission before becoming effective.
Questions concerning this notice may be directed to Dennis C. Hensley, Vice President and Deputy General Counsel, at (202) 728-8245.
Frank J. Wilson
Executive Vice President and General Counsel
TEXT OF PROPOSED AMENDMENT
Amend the Interpretation of the Board of Governors, Free-Riding and Withholding under Article III, Section 1 of the Rules of Fair Practice by adding at the end thereof the following language: