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85-5 Follow-up to NASD Notice to Members 84-48 Dealing with Concessions Receivable and Related Commissions Payable

IMPORTANT

PLEASE DIRECT THIS NOTICE TO ALL FINANCIAL AND OPERATIONAL OFFICERS AND PARTNERS

TO: All NASD Members and Other Interested Persons

Since the issuance of Notice to Members 84-48, requests for clarification have been received concerning that portion of the Notice dealing with the treatment to be accorded commissions payable.

After further discussion with the staff of the SEC's Division of Market Regulation, the following explanation sets forth the proper method for the handling of commissions payable pursuant to SEC Rule 15c3-l:

A broker-dealer should include in the calculation of aggregate indebtedness that portion of the liability which is payable within twelve months from the net capital computation date and in addition the firm's net capital requirement shall be increased by an amount equal to one percent of the remaining commission payable. (Emphasis added)

Example

Facts;

 

Total commissions payable related to concessions receivable

$ 500,000

Current year portion of commissions payable to be included in aggregate indebtedness

$ 100,000

Aggregate Indebtedness Calculation:

 

Other items of aggregate indebtedness

$ 1,000,000

Add: Current year portions of commissions payable

100,000

Total aggregate indebtedness

$ 1,100,000

Net Capital Computation:

 

Net Capital requirement before 1% additional requirement (6 2/3% of aggregate indebtedness of $1,100,000)

$ 73,334

Add: 1% of portion of commissions payable due after current year (1% of $400,000)

4,000

Required net capital

$ 77,334

Questions concerning this notice may be directed either to I. William Fishkind, Assistant Director, Surveillance Department, at (202) 728-8405 or your local District Office.

Sincerely,

John E. Pinto, Jr
Senior Vice President
Compliance

National Association of Securities Dealers, Inc.
1735 K street, N.W.
Washington, D.C, 20006
(202) 728-8000

January 18, 1985

IMPORTANT

PLEASE DIRECT THIS NOTICE TO ALL FINANCIAL, OPERATIONAL AND COMPLIANCE OFFICERS AND PARTNERS

TO: Selected NASD Members For Which the Association is the Designated Examining Authority and Other Interested Persons

RE: British Telecommunications plc American Depositary Receipts

BACKGROUND

The initial public offering of Ordinary Shares of British Telecommunications plc was made by the Government of the United Kingdom on December 3, 1984. American Depositary Shares (ADS) representing interests in Ordinary Shares were offered by several United States and Canadian underwriters. Upon full payment of the purchase price, each American Depositary Share will represent ten presently outstanding ordinary shares of 25 pence each of British Telecommunications pic. Prior to full payment, the ADS will be evidenced by First and then Second Interim American Depositary Receipts (Interim ADRs). Upon full payment, they will be evidenced by ADRs in definitive form. The Interim ADRs began trading "regular way" on the New York Stock Exchange on December 3, 1984.

The original offering price for the ADS is payable in three installments (approximately 40% due upon delivery of the Interim ADRs, approximately 30% due June 21, 1985, and the remaining 30% due April 8, 1986).

Holders of the Interim ADRs are responsible for payment of the second and final installments. The Interim ADRs provide that registered holders agree to pay any remaining installments of the purchase price. Trades between NASD members are to be handled in a manner which requires members purchasing Interim ADRs to assume such payment obligations from the selling broker-dealer, regardless of whether or not the purchasing firm has the Interim ADRs transferred to its name. The amount of each installment in U.S. dollars will be based upon exchange rates prevailing at the time the installment is due.

In view of the many unique aspects of this offering, there have been a number of meetings and discussions held with the staff of the Securities and Exchange Commission. Certain special requirements which have been adopted, as well as the applicability of existing regulations, are discussed below.

Margin Requirements

Federal Reserve Board Regulation T - In its relevant parts, Regulation T provides that any security that is registered on or has unlisted trading privileges on a national securities exchange is a "margin security" and may be purchased or carried in a margin account. The margin required on a "margin security" is 50% of the current market value. Since the ADRs are listed and traded on the New York Stock Exchange, they are eligible for margin privileges. However, members of the underwriting and selling group, under SEC Rule ll(d)(l) of the Securities Exchange Act of 1934, are subject to certain restrictions before they can extend credit on the ADR.

Securities Exchange Act Rule ll(d)(l) - This rule prohibits a person who is both a broker and a dealer from extending credit to a customer on any security which is part of a new issue where the broker-dealer is a member of a selling syndicate or underwriting group for such new issue. In addition to prohibiting the extension of credit in connection with the original sale of the security, the rule also prohibits the security from being used as collateral in connection with other transactions that the broker-dealer may effect for the customer. This prohibition is in effect for 30 days commencing as follows:

(1)

Underwriters

from the date when both the distribution is completed and the underwriting agreement is terminated.

(2)

Selling Group Participants

from the date on which the broker dealer completes its distribution

Section 4 of Appendix A, Article III, Section 30
of the Association's Rules of Fair Practice

Under NASD rules, the initial and maintenance margin requirements for customers are: 25% of the current market value of all ADRs "long" in the account; $5 per ADR or 30% of the current market value of the ADRs, whichever is greater, of each ADR "short" in the account selling at $5 per ADR or above; and $2.50 per ADR or 100% of the current market value of the ADRs, whichever is greater, of each ADR "short" in the account selling at less than $5 per ADR. In addition, on new transactions, the rule requires a minimum equity in margin accounts of at least $2,000, except that cash need not be deposited in excess of the cost of any ADRs purchased.

Members may of course decide to impose higher "house" maintenance requirements in order to maintain sufficient equity in customers' margin accounts because of the installment payment method of the British Telecommunications Interim ADRs.

SEC Capital and Reserve Formula Requirements

Due to the unusual installment payment aspects of the offering, the Securities and Exchange Commission has approved special net capital, and Rule 15c3-3 Reserve Formula and possession and control of securities requirements until April 15, 1986, as summarized below.

Capital Requirements (SEC Rule 15c-l)

Underwriting Positions - Underwriters were subject to a capital charge equal to 15% of the total offering price (based upon prevailing exchange rates) on the day registration of the Interim ADRs became effective (For example, an offering price which based on the prevailing exchange rates on December 3, 1984, would be the equivalent of $16.40 per definitive ADR would result in a charge of $2.46 per Interim ADR.) This charge would apply to members computing net capital under the standard or alternative methods. The initial capital charge on the total offering could be subsequently reduced to the extent that sales were confirmed to customers.

Proprietary Positions - Members computing net capital under the standard or alternative methods are subject to a net capital charge equal to 15% of the sum of the market value of the Interim ADRs plus the estimated contractual liability (based on prevailing exchange rates) for any unpaid installments. By way of illustration:

Example 1
If after payment of the first installment, the Interim ADRs are selling at $10, the deduction under the basic and alternative methods would be $10 + $9.84 (estimated cost of second and final installments) x .15 = $2.97 per Interim ADR.
Example 2
If after payment of the second installment, the Interim ADRs are selling at $15, the deduction under the standard and alternative methods would be $15 + $4.92 (estimated cost of final installment) x .15 - $2.99 per Interim ADR.

Reserve Formula (SEC Rule 15c3-3) - Credit balances and adequately secured debits relating to customers' transactions in the ADRs are to be included in the Reserve Formula computation. For example, in December 1984, customer debits and credits relating to the first Interim ADRs should have been included in the reserve computation. When the second Interim and definitive ADRs are traded regular way in June 1985 and April 1986, respectively, customer debits and credits relating to those ADRs must be included in the Reserve Formula computation.

Possession and Control of Securities (Rule 15c3-3) - The adjusted ledger debit used for the purpose of calculating the value of excess margin securities based on 140% should not include the liability to pay the second and third installments, respectively, until the second Interim or definitive ADRs, as the case may be, are traded regular way.

Disclosure of Customer's Liability

Members should take extraordinary measures to ensure that customers are aware of the installment nature of payment for the ADRs, and the obligation of the holder of Interim ADRs to make payment of future installments. The SEC has determined that Rule 10b-10 be applied in the following manner. Confirmations sent to customers purchasing Interim ADRs must set forth the price which shall include the amount, in pounds sterling, of the installment obligations that will become due on such Interim ADRs. Further, to ensure that the obligation to pay such installments is enforceable against the customer, the full price, i.e., the total amount of installment payments, should be set forth on the confirmation.

It is strongly suggested that members, at a minimum, make appropriate disclosure to all customers who purchase Interim ADRs and the amount of the remaining installments payable in British pounds sterling. Such disclosure should be made at or before the completion of the transaction as part of the trade confirmation (either by imprinting or stamping).

An industry operations task force has suggested the following language be imprinted on trade confirmations:

FOR FIRST INTERIM ADRs:

BUYER ASSUMES OBLIGATIONS TO PAY SECOND AND FINAL INSTALLMENTS OF 4 POUNDS STERLING EACH

FOR SECOND INTERIM ADRs:

BUYER ASSUMES OBLIGATION TO PAY FINAL INSTALLMENT OF 4 POUNDS STERLING

This language may be abbreviated due to limitation of available space on, and computer processing of, confirmations as follows:

FOR FIRST INTERIM ADRs:

BUYER ASSUMES OBLIG
TO PAY 2D&FNL INSTL
OF 4 PDS. STLG, EACH

FOR SECOND INTERIM ADRs:

BUYER ASSUMES OBLIG
TO PAY FINAL INSTL OF
4 PDS. STLG.

Members that stamp confirmations should use language less abbreviated than that suggested above.

The Association suggests that after each purchase of Interim ADRs, the first statement of account be sent to customers, or a separate notice sent at or about the same time, fully disclosing: (1) the customer's liability for, and the amount of, remaining installments payable in British pounds sterling; and (2) that part or all of their position in Interim ADRs may be liquidated in the event of nonpayment of installments or other remedies may be pursued by Her Majesty's Government. Members are also encouraged to send such disclosure with all statements of account sent to customers so long as the customer holds Interim ADRs.

Because the above-noted disclosures may not be all-inclusive, the Association recommends that members consult with counsel on the exact disclosure language to be used and the manner in which such disclosure should be made.

Bonus Shares

Pursuant to the prospectus, the natural persons purchasing ADS in the initial public offering who continue to hold an interest in these shares through November 30, 1987, will be entitled to receive from Her Majesty's Government the equivalent of one tenth of an ADS for each ADS so held (up to a maximum of 400 ADS) without any additional payment. In order to be entitled to receive bonus shares, such purchasers must register their interest no later than January 31, 1985, and have their continuous holding certified no later then January 15, 1988. Members must maintain records which will allow identification of customers entitled to these shares.

* * * *

Questions concerning this matter may be directed to I. William Fishkind, Assistant Director, Surveillance Department, at (202) 728-8405.

Sincerely,

John E. Pinto,
Senior Vice President
Compliance


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