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84-64 Securities and Exchange Commission Interpretation of Application of Rule 15c2-4 to Direct Participation Program Offerings

TO: All NASD Members and Other Interested Persons

Attention: Direct Participation Programs Department

The NASD is publishing a letter issued by the Securities and Exchange Commission, providing interpretive advice with respect to the application of Rules 15c2-4 and 15c3-l to public and private offerings of direct participation programs. Rule 15c2-4 applies to offerings of securities being made on an "all-or-none" basis or on another basis pursuant to which payment will not be made to the issuer until a particular contingency occurs (best efforts distributions). Pending occurrence of the contingency, Rule 15c2-4 requires each participating broker-dealer either to (1) promptly deposit investors' funds into a separate bank account, if the broker-dealer is required to maintain minimum net capital of $25,000 and is not affiliated with the issuer or general partner 1/ or (2) promptly transmit such funds to a bank escrow agent, if the broker-dealer is required to maintain minimum net capital of $5,000 or is a $25,000. broker-dealer affiliated with the issuer or general partner.

The interpretive advice of the Commission staff relates to the term "promptly transmitted** in Rule 15c2-4. In Notice to Members 84-7, dated January 30, 1984, the Commission staff interpreted the term "promptly transmitted" to mean:

Absent unusual circumstances, funds should be.. .transmitted as soon as practicable after receipt. In contingent offerings not requiring suitability determinations by the issuer or the general partner, funds should be ... transmitted by noon the next business day. In contingent offerings requiring suitability determinations by the issuer or general partner (for example, most direct participation programs) where investors' checks are made payable solely to the bank escrow agent but delivered to the broker-dealer, prompt transmittal may be accomplished by forwarding the checks to the escrow agent by noon of the next business day or by noon of the second business day after receipt of the subscription by the issuer or general partner. If the latter option is used, the subscription must be forwarded to the issuer or general partner by noon of the next business day after receipt of the funds.

In discussions between the NASD and the Task Force of the American Bar Association Federal Regulation of Securities Committee, Subcommittee on Partnerships, Trusts and Unincorporated Associations with the Commission staff, it was represented that the above interpretation in the context of direct participation program offerings, prevented some broker-dealers from adequately performing the complex suitability determinations required in such offerings and that it also required the premature separation of investor checks from subscription documents resulting in processing errors, risk of loss as well as causing loss of control of the offering.

As a result of these discussions and a request for interpretive advice, the Commission staff has indicated that compliance with certain new procedures would satisfy the "promptly transmitted" requirement of Rule 15c2-4 for direct participation programs. Following is an excerpt of the Commission staff interpretive letter containing those new procedures.

I. Format of Checks/Escrow Agent
Investors will be instructed to make their checks payable to a bank escrow agent ("Escrow Agent"), as agent for the issuer. Any soliciting broker-dealer receiving a check not conforming to the foregoing instructions shall return such check directly to such subscriber not later than the end of the next business day following its receipt. Checks received by soliciting broker-dealers which conform to the foregoing instructions shall be transmitted for deposit by any soliciting dealer pursuant to one of the methods described below under "Transmittal Procedures."
II. Transmittal Procedures
Transmittal of received investor funds will be made in accordance with the following procedures:
(a) Off-Site Supervisory Review
Where, pursuant to a soliciting broker-dealer's internal supervisory procedures, internal supervisory review is conducted at the same location at which subscription documents and checks are received from subscribers, checks will be transmitted by the end of the next business day following receipt by the soliciting broker-dealer for deposit to the Escrow Agent or to the broker-dealer registered under the Exchange Act (the "Processing Broker-Dealer") whose responsibilities in the offering include handling, reviewing investor suitability, processing and documentation of subscriptions and investor funds received.
(b) On-Site Supervisory Review
Where, pursuant to a soliciting broker-dealer's internal supervisory procedures, final internal supervisory review is conducted at a different location, checks will be transmitted by the end of the next business day following receipt by the soliciting broker-dealer to the office of the soliciting broker-dealer conducting such final internal supervisory review (the "Final Review Office"). The Final Review Office will in turn, by the end of the next business day following receipt of the Final Review Office, transmit such checks for deposit to the Escrow Agent or to the Processing Broker-Dealer.
(c) Processing Broker-Dealer
Where a Processing Broker-Dealer is involved in the distribution process, checks will be transmitted by such Processing Broker-Dealer for deposit to the Escrow Agent as soon as practicable, but in any event by the end of the second business day following receipt by the Processing Broker-Dealer. Checks of rejected subscribers will be promptly returned to such subscribers.

A reprint of the Commission staff interpretive letter is attached.

Any questions regarding this Notice should be addressed to Harry E. Tutwiler, Associate Director, or Suzanne E. Rothwell, Assistant Director, Corporate Financing Department, at (202) 728-8258 or William Schief, Director of Regional Attorneys, Surveillance Department, at (202) 728-8229.

Sincerely,

Frank J.Wilson
Executive Vice President
Legal and Compliance

Attachment

DIVISION OF MARKET REGULATION

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON. D.C. 20549

October 16, 1984

Linda A. Wertheimer, Chairman
Subcommittee on Partnerships, Trusts and Unincorporated Associations
Federal Regulation of Securities Committee
American Bar Association
4300 InterFirst One
Dallas, Texas 75202

Re: Task Force of the American Bar Association Federal Regulation of Securities Committee, Subcommittee on Partnerships, Trusts and Unincorporated Associations: Compliance with Rule 15c2-4 in the context of direct participation program offerings File No. TP 85-3

Dear Ms. Wertheimer:

In your letter dated October 8, 1984, as supplemented by telephone conversations with the staff, you request on behalf of the Task Force of the American Bar Association Federal Regulation of Securities Committee, Subcommittee on Partnerships, Trusts and Unincorporated Associations (the "Task Force") interpretive advice under Rules 15c2-4 and 15c3-l under the Securities Exchange Act of 1934 ("Exchange Act") with respect to the treatment of subscription documentation and checks received by certain broker-dealers in the context of direct participation program offerings, as more fully described below.

Background

Rule 15c2-4 under the Exchange Act, 17 CFR 240.15c2-4, provides, in pertinent part:

It shall constitute a "fraudulent, deceptive or manipulative act or practice" as used in Section 15(c)(2) of the Act, for any broker, dealer or municipal securities dealer participating in any distribution of securities, other than a firm-commitment underwriting, to accept any part of the sale price of any security being distributed unless:
•••
(b) If the distribution is being made on an "all-or-none" basis, or on any other basis which contemplates that payment is not to be made to the person on whose behalf the distribution is being made until some further event or contingency occurs, ... (2) all [money or other consideration received from investors is] promptly transmitted to a bank which has agreed in writing to hold all such funds in escrow for the persons who have the beneficial interests therein and to transmit or return such funds directly to the persons entitled thereto when the appropriate event or contingency has occurred. [Emphasis supplied.]

Rule 15c3-l(a)(2) under the Exchange Act, 17 CFR 240.15c3-l (a)(2), permits a broker-dealer to maintain net capital of not less than $5,000 if he does not hold funds or securities for, or owe money or securities to, customers and does not carry accounts of, or for, customers (with limited exceptions not pertinent here), and limits his business to one or more specified securities activities, including satisfaction of the following condition:

(ii) He participates, as broker or dealer, in underwritings on a "best efforts" basis or "all or none" basis in accordance with the provisions of 17 CFR 240.15c2-4(b)(2) and he promptly forwards to an independent escrow agent customers' checks, drafts, notes or other evidences of indebtedness received in connection therewith which shall be made payable to such escrow agent;... [Emphasis supplied.]

In Notice to Members 84-7 (January 30, 1984) ("Notice 84-7") issued by the National Association of Securities Dealers, Inc. ("NASD"), the Commission's staff addressed, inter alia, the interpretation of the term "promptly transmitted" in the context of Rule 15c2-4.

Absent unusual circumstances, funds should be ... transmitted as soon as practicable after receipt. In contingent offerings not requiring suitability determinations by the issuer or the general partner, funds should be ... transmitted by noon of the next business day. In contingent offerings requiring suitability determinations by the issuer or general partner (for example, most direct participation programs) where investors checks are made payable solely to the bank escrow agent but delivered to the broker-dealer, prompt transmittal may be accomplished by forwarding the checks to the escrow agent either by noon of the next business day or by noon of the second business day after receipt of the subscription by the issuer or general partner. If the latter option is used, the subscription must be forwarded to the issuer or general partner by noon of the next business day after receipt of the funds. See SEC Interpretive Letter issued to Lowell H. Listrom & Company, Inc. (April 27, 1983).

You make the following representations:

The Task Force includes members who represent or are affiliated with entities which conduct offerings of direct participation programs, as such term is defined in Section 34(d) (2) of the NASD's Rules of Fair Practice. These offerings either are registered with the Commission or are conducted in reliance upon the availability of exemptions from registration under Sections 3(a)(11), 3(b) and 4(2) of the Securities Act of 1933, as amended (such offerings being collectively referred to herein as "DPP Offerings").

With respect to such DPP Offerings, the Task Force is concerned that compliance with the interpretation of "promptly transmitted" in Rule 15c2-4(b)(2) as expressed in Notice 84-7 would prevent some broker-dealers from adequately performing the complex suitability determinations required in such offerings and would require premature separation of investor checks from subscription documentation, thereby increasing processing errors and risk of loss, as well as causing loss of control by broker-dealers of the mechanics of the offering for which they are responsible. This may occur because the present interpretation of "promptly transmitted" does riot take into account the number of steps frequently involved in DPP Offerings where one broker-dealer receives the investor's documentation which must then be reviewed at one or two additional locations before the suitability determination is concluded. This process requires more time than the current staff interpretation permits. Moreover, the requirement that the initial broker-dealer in such circumstances retain custody of the investor's check until it is transmitted to the escrow account results in separation of the subscription agreement and the check and has contributed to delays and errors in the overall process.

Task Force proposal for procedures which will satisfy the "promptly transmitted" requirement of Rule 15c2-4(b)(2)

In order to alleviate these problems, the Task Force proposes that the staff interpret "promptly transmitted" in Rule 15c2-4(b)(2) to permit the following procedures to be used in DPP Offerings.

I. Format of Checks/Escrow Agent
Investors will be instructed to make their checks payable to a bank escrow agent ("Escrow Agent"), as agent for the issuer. Any soliciting broker-dealer receiving a check not conforming to the foregoing instructions shall return such check directly to such subscriber not later than the end of the next business day following its receipt. Checks received by soliciting broker-dealers which conform to the foregoing instructions shall be transmitted for deposit by any soliciting dealer pursuant to one of the methods described below under "Transmittal Procedures."
II. Transmittal Procedures
Transmittal of received investor funds will be made in accordance with the following procedures:
(a) On-Site Supervisory Review
Where, pursuant to a soliciting broker-dealer's internal supervisory procedures, internal supervisory review, is conducted at the same location at which subscription documents and checks are received from subscribers, checks will be transmitted by the end of the next business day following receipt by the soliciting broker-dealer for deposit to the Escrow Agent or to the broker-dealer registered under the Exchange Act (the "Processing Broker-Dealer") whose responsibilities in the offering include handling, reviewing investor suitability, processing and documentation of subscriptions and investor funds received.
(b) Off-Site Supervisory Review
Where, pursuant to a soliciting broker-dealer's internal supervisory procedures, final internal supervisory review is conducted at a different location, checks will be transmitted by the end of the next business day following receipt by the soliciting broker-dealer to the office of the soliciting broker-dealer conducting such final internal supervisory review .(the "Final Review Office"). The Final Review Office will in turn, by the end of the next business day following receipt by the Final Review Office, transmit such checks for deposit to the Escrow Agent or to the Processing Broker-Dealer.
(c) Processing Broker-Dealer
Where a Processing Broker-Dealer is involved in the distribution process/checks will be transmitted by such Processing Broker-Dealer for deposit to the Escrow Agent as soon as practicable, but in any event by the end of the second business day following receipt by the Processing Broker-Dealer. Checks of rejected subscribers will be promptly returned to such subscribers.

In conjunction with all of the foregoing procedures, investor checks and subscription documentation delivered on " Saturdays, Sundays and holidays will be treated as not having been received by a broker-dealer until the first business day thereafter.

Staff Response:

On the basis of your representations and the facts presented, noting particularly the condition that investor checks which are not properly made out to the bank escrow agent will be returned to the investor by the end of the next business day following receipt by the soliciting broker-dealer, this Division has concluded that transmission of checks under the circumstances described above is not likely to result in any of the abuses that Rules 15c2-4 and 15c3-l were designed to prevent. Accordingly, this Division takes the position that such procedures, if otherwise employed in compliance with Rule 15c2-4, would satisfy the "promptly transmitted" requirement of Rule 15c2-4(b)(2). The Division also takes the position that these procedures, if otherwise employed in compliance with Rule 15c3-l, would constitute participation in a "best efforts" or "all or none" offering in accordance with the provisions of Rule 15c2-4(b)(2) within the meaning of paragraph (a)(2)(ii) of Rule 15c3-l. Nothing herein, however, shall limit the ability of a broker-dealer complying with Rule 15c3-l(a)(1) ("$25,000 broker-dealer") not affiliated with the issuer or the general partner to avail itself of the procedures afforded by Rule 15c2-4(b)(1). The foregoing interpretive advice is based solely on your representations and the facts you have presented to the staff, and is strictly limited to the .application'-of Rules 15c2-4 and 15c3-l to the procedures described above.


1/ SEC staff has previously provided advice that ". . . where an issuer and a broker-dealer are affiliated, the broker-dealer should not act as agent or trustee for the funds." See NASD Notice to Members 84-7 (January 30, 1984), Question 7.



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