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88-89 Amendment to Schedule E of the NASD By-Laws Re: Definition of Qualified Independent Underwriter - Effective December 1, 1988
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The SEC has approved an amendment to the definition of qualified independent underwriter contained in Section 2(l) of Schedule E to the NASD By-Laws. The amendment, which becomes effective December 1, 1988, precludes a member from acting as a qualified independent underwriter if any of its associated persons having supervisory responsibility for organizing, structuring, or performing due diligence with respect to corporate public offerings of securities have within the previous five-year period been convicted or enjoined or have been the subject of disciplinary action by the NASD, the SEC or any self-regulatory organization for distribution-related activities resulting in a suspension or bar from a self-regulatory organization.
Additionally, the amendments would require a qualified independent underwriter to have experience in managing or co-managing public offerings of a size and type similar to the proposed offering. They also would restrict the qualified independent underwriter's direct or indirect ownership of the issuer's equity securities. The text of the amendment is attached.
The Securities and Exchange Commission approved an amendment to Schedule E to the NASD By-Laws regarding the definition of qualified independent underwriter. The amendment to the definition is intended to clarify and enhance the current criteria and to ensure that the purposes of Schedule E will be achieved.
Schedule E contains a number of requirements intended to address conflicts of interest experienced by a member that engages in a public offering of its own securities or the securities of the member's parent or affiliate. One of the major conflicts arises when a member participates in establishing the public offering price of the securities and conducts due diligence with respect to the registration statement. Schedule E addresses these conflicts by requiring that a member, independent of the issuer, with a background in underwriting, a track record of profitable operations, and experienced management conducts due diligence, participates in the preparation of the registration statement and offering documents, and provides an opinion on the price of an equity issue or the yield of a debt issue. Such member is termed a qualified independent underwriter and must satisfy the objective criteria contained within the definition of that term in Section 2(1) of Schedule E.
The Corporate Financing Committee and the Board of Governors have determined that it is necessary to amend the current criteria to ensure that the purposes of Schedule E will be achieved. Therefore, Schedule E has been amended to enhance and clarify the existing experience requirement contained in Subsection 2(1)(4) of Schedule E, specify the level at which a member's direct or indirect ownership of the issuer's equity securities would disqualify the member from acting as a qualified independent underwriter and to add restrictions that would disqualify members because of disciplinary histories of certain of their associated persons.
Prior to the amendment, Section 2(1)(4) stated that a qualified independent underwriter must be actively engaged in the underwriting of public offerings for at least the five-year period immediately preceding the filing of the registration statement. The NASD believes that the phrase "actively engaged in the underwriting of public offerings" should be amended to ensure that the qualified independent underwriter is sufficiently experienced to perform the due diligence and pricing functions with respect to the proposed public offering. Therefore, the Section has been amended to require that the member have experience in "managing or co-managing" public offerings of a "size and type similar to the proposed offering." The requirement that the qualified independent underwriter have managed or co-managed public offerings ensures that the member has had previous experience in performing the functions of due diligence and pricing that are functions traditionally fulfilled by managers and co-managers.
This requirement is coupled with the requirement that the member also have experience in offerings which are of similar size and type. The similar size and type requirement is intended to prevent, for example, a member with experience as an underwriter of small equity offerings from acting as a qualified independent underwriter for a large firm-commitment offering of high-risk, high-yield debt. As a result, subprovisions (a) and (b) of Section 2(1 )(4) include specific parameters relating to the size and type of previous offerings managed or co-managed by the member. In debt offerings, the member must have managed or co-managed other debt offerings, each with gross proceeds of not less than 25 percent of the gross proceeds of the proposed offering. In equity offerings, the member must have managed or co-managed other equity offerings, each with gross proceeds of not less than 50 percent of the gross proceeds of the proposed offering. In addition, if the member has acted as manager or co-manager of public offerings, each with gross proceeds of at least $50 million, it is believed that managing such offerings demonstrates due diligence and pricing experience that qualifies the member for any type or size offering.
The experience requirement also contains alternative criteria that would permit a member to demonstrate that it has acquired the requisite experience through means other than acting as a manager or co-manager. The Association does not wish to preclude members from acting as qualified independent underwriters if they have extensive experience in performing due diligence and rendering fairness opinions in connection with corporate financing activities such as mergers and acquisitions but have no comparable experience as a manager or co-manager. Therefore, a member can satisfy the requirements if it can demonstrate that it has experience within the previous five years involving the pricing and due diligence functions that is comparable to the experience of a manager or co-manager of public offerings of securities of the size set forth in the first three criteria.
DISCIPLINARY HISTORY REQUIREMENTS
The amendment adopts a new Subsection 5 to Section 2(1) of Schedule E. The new Subsection precludes a member from acting as a qualified independent underwriter if any person associated with the member in a supervisory capacity responsible for structuring corporate public offerings or conducting due diligence has been convicted, enjoined, suspended, or barred within the previous five years for a violation of federal, state, or self-regulatory organization anti-fraud rules in connection with the distribution of securities.
Subsection (a) would disqualify a member if any of the supervisory personnel referred to above have been convicted within five years prior to the filing of the registration statement of a violation of the anti-fraud provisions of federal or state laws or rules or regulations promulgated thereunder in connection with the distribution of a registered or unregistered offering of securities. Subsection (b) would disqualify a member if any of such supervisory personnel have been subject to any order, judgment, or decree of any court entered within five years prior to the filing of the registration statement, and if the order, judgment, or decree permanently enjoins or restrains such person from engaging in or continuing any conduct or practice in violation of the anti-fraud provisions of federal or state securities laws or any rules or regulations promulgated thereunder in connection with the distribution of a registered or unregistered offering of securities. Subsection (c) would disqualify a member if any of such supervisory personnel have been suspended or barred from association with any member by an order or decision of the Securities and Exchange Commission, any state, the NASD, or any self-regulatory organization within five years prior to the filing of the registration statement for any conduct or practice found to be in violation of the anti-fraud provisions of federal or state laws or rules or regulations promulgated thereunder or the anti-fraud rules of any self-regulatory organization in connection with the distribution of a registered or unregistered offering of securities.
The amendment redesignates present Subsection 5 as new Subsection 6, which restricts to less than 5 percent the beneficial ownership of the outstanding voting securities of a corporate issuer or partnership issuer by the qualified independent underwriter. Previously, Section 2(1)(5) provided that the qualified independent underwriter could not be an "affiliate" of the issuer. The definition of affiliate as contained in Section 2(a) of Schedule E involves the concept of control of the issuer and presumes affiliation when a member owns at least 10 percent of the voting stock of the issuer. Therefore, under the provisions of the old section, a qualified independent underwriter could, for example, own 8 percent of the outstanding securities of the issuer and meet the criteria of a qualified independent underwriter. The NASD determined that the affiliation standard did not provide for sufficient objectivity. The amendment provides that a member may not beneficially own 5 percent or more of the outstanding voting securities of a corporate issuer or beneficially own a partnership interest in 5 percent or more of the distributable profits or losses of an issuer which is a partnership.
The amendment becomes effective December 1, 1988. Therefore, all offerings declared effective by the SEC, or if SEC-exempt, by another reviewing regulatory authority on or after December 1, 1988, are required to comply with the new definition of qualified independent underwriter.
Questions regarding this notice should be directed to Charles L. Bennett, Assistant Director, NASD Corporate Financing Department at (202) 728-8258.
AMENDMENT TO SCHEDULE E TO THE BYLAWS
(Note: New language is underlined.)
Section 2 — Definitions