FINRA Manual: Contents
|View Whole Section||Text only||Print Manager||Link|
88-33 Adoption of Amendments to Schedule E to the NASD By-Laws Effective Immediately
TO: All NASD Members and Other Interested Persons
The SEC has approved amendments to Schedule E to the NASD By-Laws governing the public offering of securities issued by a member, the parent of a member, or an affiliate of a member. With the exception of an exemption from Schedule E for investment grade securities, eollateralized by financing instruments, the remaining changes to Schedule E involve clarifying amendments.
The text of the amendments is attached.
On March 29, 1988, the Securities and Exchange Commission (SEC) approved amendments to Schedule E to the NASD By-Laws (see SEC Release No. 34-25525 (March 29, 1988)) that are intended to clarify the scope and application of the Schedule. 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 participates in a public offering of securities of an affiliate. The major conflicts of interest addressed relate to the conduct of due diligence with respect to the offering document, the pricing of the securities offered, and the suitability of investors. Most of the amendments merely clarify certain provisions and incorporate interpretations of Schedule E. However, one substantive amendment exempts investment grade financing instrument backed securities from compliance with Schedule E.
EXPLANATION OF AMENDMENTS
Exemption for Financing Instrument-Backed Securities
The NASD amended Subsection 2(a)(3) to exempt from Schedule E distributions by members of securities issued by affiliates of members, regardless of the form of legal entity of the affiliate, organized solely for the purpose of offering investment grade securities to the public eollateralized with a specified portfolio of financing instruments. Although such securities are generally backed by mortgage obligations, public offerings have also occurred of securities backed by loan obligations for automobiles, boats, and credit card receivables.
When an offering of financing instrument-backed securities rated investment grade is not issued by a member's affiliate, such offering is currently exempt from NASD review pursuant to an exemption incorporated in the Interpretation of the Board of Governors—Review of Corporate Financing, under Article III, Section 1 of the NASD Rules of Fair Practice (Corporate Financing Interpretation). This exemption reflects the NASD's view that competitive market forces that ordinarily affect investment grade debt can be relied upon to ensure the fairness and reasonableness of underwriting compensation. In reviewing whether offerings of financing instrument-backed securities issued by a member's affiliate should be subject to Schedule E, the NASD determined that the conflicts of interest experienced by the affiliate member that are addressed by Schedule E, related to the pricing of the offering, the member's due diligence obligation, and the suitability of investors, are absent in distributions of financing instrument-backed securities that have received an investment grade rating. Such rating reflects the confidence of the rating agency regarding the ability of the issuing entity to pay dividends and to redeem the obligation. In addition, the investment grade rating of securities usually results in their sales to investors that are of an institutional or financially sophisticated nature.
Section 1 — General
The NASD amended Section 1 to clarify that Schedule E applies to offerings by a parent of a member, as defined in Subsection 2(h)* of Schedule E, regardless of whether the member participates in the offering. Further, this provision has been amended to clarify that Schedule E applies to both debt and equity public offerings of securities.
Section 2 — Definitions
Affiliate. Section 2(a) defines when an issuer is considered to be an affiliate of a member firm. The NASD is concerned that members and their counsel may look to the presumptions contained in Subsection 2(a) as the sole bases upon which affiliation may be found. Therefore, the NASD amended the introductory language of Subsection 2(a)(2) to clarify that the term "affiliate" is presumed to include, but is not limited to, those situations described in the enumerated presumptions.
Beneficial Ownership. For purposes of determining affiliation, Subsection 2(a)(2) bases a presumption of affiliation on the beneficial ownership of 10 percent or more of the outstanding voting securities of one entity by the other entity. The NASD amended Schedule E to include in new Subsection 2(b) a definition of the term "beneficial ownership" that provides that beneficial ownership is based on the "right to the economic benefits of a security."
Immediate Family. The NASD amended the term "immediate family" in Subsection 2(g) to include the son-in-law or daughter-in-law and any other person who is supported, directly or indirectly to a material extent by an employee of, or person associated with, a member, to incorporate language similar to that contained in the Interpretation of the Board of Governors—Free-Riding and Withholding, under Article III, Section 1 of the NASD Rules of Fair Practice (Free-Riding and Withholding Interpretation).
Public Offering. The NASD amended the definition of "public offering" in current Subsection 2(k) to reflect exemptions from Schedule E for offerings pursuant to Section 4(6) of the Securities Act of 1933, Rule 504 (unless considered a public offering in the states where offered), Rule 505, and Rule 506 of Regulation D adopted by the SEC.
Section 3 — Experience, Pricing, and Due Diligence
The NASD amended this section by deleting Subsection 3(d) and amended Subsection 3(a) in coordination therewith. Subsection 3(d) is now unnecessary as Subsection 3(e) was previously modified to require the participation of only one qualified independent underwriter and to permit the affiliated member to participate to an unlimited extent in the offering.
Section 4 — Escrow of Proceeds
Subsection 4(b) requires disclosure in the offering document of the date when a member expects to complete its offering of a security and the terms under which the proceeds will be released from escrow. The NASD amended Section 4 to redesignate Subsection (b) as Subsection (a) and to add new Subsection (b) to clarify disclosure requirements with respect to all offerings subject to Schedule E. The new provision requires disclosure in the offering document that the offering is of a member's securities or those of an affiliate, that the offering is being made pursuant to Schedule E, the name of the qualified independent underwriter, if any, and that such underwriter has assumed the responsibility of pricing and due diligence. Finally, the title of Section 4 has been changed to "Disclosure."
Section 5 — Net Capital Computation
The NASD amended this section to include as new Subsection (a) the provision previously in Subsection 4(a) that requires a member issuing its own securities to place the offering proceeds in an escrow account. The current language of Section 5 is being retained in new Subsection 5(b). Finally, the NASD has changed the title of Section 5 to "Escrow Proceeds; Net Capital Computation."
Section 9 — Offerings Resulting in Affiliation or Public Ownership of a Member
Section 9 currently provides a basis for applying Schedule E to an offering by an issuer that is not an affiliate of a member at the time of filing the offering, but as a result of the offering will be a member's affiliate. In addition, Section 9 requires compliance with Schedule E when the offering would result in the public ownership of a member. The NASD amended Section 9 to provide that Schedule E applies to those situations where the issuer proposes to utilize the proceeds from an offering to become a member or to form a broker-dealer subsidiary to become a member and where a member would become an affiliate of the issuer as the result of a transaction with the issuer or its affiliate that occurs simultaneously or subsequent to the public offering. This amendment codifies the NASD's current interpretation of Section 9.
In addition, the NASD amended Section 9 to clarify that an offering within that section is subject to Schedule E "to the same extent as if the transaction had occurred prior to the filing of the offering." Thus, if a transaction occurs simultaneously with an offering that results in the issuer becoming a parent of a member, the offering would be subject to Schedule E as if the offering were by a parent of a member. In comparison, if the issuer proposes to utilize the proceeds of the offering to become a member of the NASD, the offering would be subject to Schedule E as if by a member firm.
Section 13 — Sales to Employees — No Limitations
Section 13, which provides an exemption from the NASD's Free-Riding and Withholding Interpretation for sales to employees of a member, is amended to clarify that employees of a member are only permitted to purchase securities of the member or those of the member's parent. In addition, Section 13 has been amended to reduce from six to five months, following the effective date of the offering, the lock-up period on securities acquired by a person associated with a member when an independent market does not exist for such securities.
Section 14 — Filing Requirements
The NASD adopted new Subsection 14(c) to clarify that members are required to file public offerings subject to Schedule E with the NASD for review, notwithstanding the fact that such offerings may not be required to be filed pursuant to an exemption from filing under the Corporate Financing Interpretation.
* * * * *
Questions regarding this notice can be directed to either Suzanne E. RothwelL, NASD Associate General Counsel, at (202) 728-8247, or the NASD Corporate Financing Department at (202) 728-8258.
Frank J. Wilson
Executive Vice President
and General Counsel
AMENDMENTS TO SCHEDULE E TO THE NASD BY-LAWS*
Distribution of Securities of Members and Affiliates
No member or person associated with a member shall participate in the distribution of a public offering of debt or equity securities issued or to be issued by the member, the parent of the member, or an affiliate of the member and no member or parent of a member shall issue securities except in accordance with this Schedule.
For purposes of this Schedule, the following words shall have the stated meanings:
Section 3—Participation In Distribution of Securities of Member or Affiliate
Section 4—[Escrow of Proceeds] Disclosure
Section 5—Escrow of Proceeds; Net Capital Computation
Section 6—Audit Committee[s]
Any member or parent of a member which makes a public offering of an issue of its securities shall be required to establish within twelve months of the effective date of said offering an audit committee composed of members of the board of directors (except that it shall not include the chief accounting or chief financial officer of the member or its parent) and the functions of the audit committee shall include the following:
Section 7—Public Director
Any member or parent of a member which makes a public offering of an issue of its securities shall cause to be elected to its board of directors within twelve months of the effective date of said offering a public director who shall serve as a member of the audit committee.
Section 8—Periodic Reports
Any member who makes a distribution to the public of an issue of its securities pursuant to this Schedule, shall send to each of its shareholders or, in the case of debt offerings, to each of its investors:
Section 9—Offerings Resulting in Affiliation or Public Ownership of Member
If an issuer proposes to direct all or part of the proceeds from a public offering to a member or exchange securities by means of a public offering for an interest in a member, and the member is, or as a result of the proposed transaction would be, an affiliate of the issuer, or if an issuer proposes to engage in any offering which results in the public ownership of a member, or if an issuer proposes to utilize the proceeds from a public offering to become a member or form a broker-dealer subsidiary to become a member, or if a member proposes simultaneously or subsequent to a public offering to enter into a transaction with the issuer or an affiliate of the issuer and as a result of the transaction would be an affiliate of the issuer, the offering shall be subject to the provisions of this Schedule [E] to the same extent as if the [offering were of securities issued by the member] transaction had occurred prior to the filing of the offering.
Section 10—Registration Statements for Intrastate Offerings
Any member offering its securities pursuant to an exemption under Section 3(a)(ll) of the Securities Act of 1933 shall disclose in the registration statement at a minimum that information suggested by the Securities and Exchange Commission in Securities Act Release No. 5222 (January 3, 1972).
Every member underwriting an issue of its securities, or securities of an affiliate, pursuant to the provisions of Section 3 hereof, who recommends to a customer the purchase of a security of such an issue shall have reasonable grounds to believe that the recommendation is suitable for such customer on the basis of information furnished by such customer concerning the customer's investment objectives, financial situation, and needs, and any other information known by such member. In connection with all such determinations, the member must maintain in its files the basis for its determination.
Section 12—Discretionary Accounts
Notwithstanding the provisions of Article III, Section 15 of the Corporation's Rules of Fair Practice, or any other provisions of law, a transaction in securities issued by a member or an affiliate of a member shall not be executed by any member in a discretionary account without the prior specific written approval of the customer.
Section 13—Sales to Employees — No Limitations
Notwithstanding the provisions of the Board of Governors' Interpretation With Respect To "Free-Riding And Withholding," a member may sell securities issued by a member [or an affiliate] a parent of a member, or by an issuer treated as a member or parent of a member under [which is subject to] Section 9 hereof to the member's employees; potential employees resulting from intended mergers, acquisitions, or other business combination of members resulting in one public successor corporation, or persons associated with it; and the immediate family of such employees or associated persons without limitation as to amount and regardless of whether such persons have an investment history with the member as required by that Interpretation; provided, however, that in the ease of an offering of equity securities for which a bona fide independent market does not exist, such securities shall not be sold, transferred, assigned, pledged or hypothecated for a period of [six] five months following the effective date of the offering.
Section 14—Filing Requirements; Coordination with Corporate Financing Interpretation
Section 15—Predominance of Schedule E
If the provisions of this Schedule E are inconsistent with any other provisions of the Corporation's By-Laws, Rules of Fair Practice or Uniform Practice Code, or of any interpretation thereof or resolution of the Board of Governors, the provisions of this Schedule shall prevail.
Section 16—Requests for Exemption from Schedule E
The Corporate Financing Committee of the Board of Governors, upon written request, may in exceptional and unusual circumstances, taking into consideration all relevant factors, exempt a member unconditionally or on specified terms from any or all of the provisions of Schedule E which it deems appropriate. Unless waived by the party requesting an exemption, a hearing shall be held upon a request before the Corporate Financing Committee, or a Subcommittee thereof designated for that purpose.
Section 17—Violation of Schedule E
A violation of the provisions of this Schedule shall constitute conduct inconsistent with high standards of commercial honor and just and equitable principles of trade and a violation of Article III, Section 1 of the Corporation's Rules of Fair Practice and possibly other sections, especially Sections 2 and 18, as the circumstances of the case may dictate.
*All references to subsections of Section 2 are to the amended subsection designations.
*New language is underlined; deleted language is in brackets.
*In the opinion of the National Association of Securities Dealers, Inc., and the Securities and Exchange Commission, the full responsibilities and liabilities of an underwriter under the Securities Act of 1933 attached to a "qualified independent underwriter" performing the functions called for by the provisions of Section 3 hereof.