TO: All NASD Members and Other Interested Persons
The NASD is publishing Suggested Escrow Agreement Provisions and Suggested Language for Selected Dealer Agreements to assist members and their counsel in complying with SEC Rule 15c2-4.
BACKGROUND AND SUMMARY
Through its review of public offerings of securities conducted by the Corporate Financing Department, the NASD has the responsibility to ensure compliance by members with Securities and Exchange Commission Rule 15c2-4. This rule applies to public and private offerings of securities that are distributed by members on a best-efforts basis. Subsection (b) of Rule 15c2-4 applies to those best-efforts offerings that include a contingency that may result in the return of investors' funds if the contingency is not met. In such contingent offerings, Rule 15c2-4 requires that a $5,000 broker-dealer or a $25,000 broker-dealer affiliated with the issuer may only deposit investors' funds in an escrow account with a bank independent of the issuer and broker-dealer.
The NASD is aware of problems experienced by members in determining whether the form of escrow agreements proposed by banks meets the requirements of Rule 15c2-4. To assist members and their counsel in complying with Rule 15c2-4, the NASD is publishing suggested escrow provisions in the form of an escrow agreement and is publishing suggested language for inclusion in selected dealer agreements used in connection with public and private offerings, along with comments explaining the provisions.
Attached are Suggested Escrow Agreement Provisions and Suggested Language for Selected Dealer Agreements. Please note that they are intended only to provide assistance and guidance to members and their counsel in complying with SEC Rule 15c2-4 in public and private offerings of securities. Neither the Suggested Escrow Agreement Provisions nor the Suggested Language is intended to be a required model. They were drafted for an offering underwritten on a best-efforts part-or-none basis. Therefore, the Suggested Escrow Agreement Provisions do not specifically address a best-efforts all-or-none offering, arrangements for a $25,000 broker-dealer to "sweep" customer accounts into the escrow, or state requirements for establishing an escrow account. Thus, certain provisions that are generally found in escrow agreements, but are unrelated to compliance with Rule 15c2-4, such as liability and indemnification, are not included. Members should consult with counsel to ensure that any escrow agreement is in compliance with applicable state requirements.
Finally, the NASD Corporate Financing Department will continue to accept escrow agreements and selected dealer agreements with other provisions, a different structure, and different language, so long as such provisions comply with SEC Rule 15c2-4.
Questions concerning this notice may be directed to either Charles L. Bennett or Richard J. Fortwengler, NASD Corporate Financing Department, at (202)728-8258.
Frank J. Wilson
Executive Vice President
Legal and Compliance
SUGGESTED ESCROW AGREEMENT PROVISIONS
This agreement is made and entered into as of __, 19__, by and among [INSERT NAME OF BANK] (the "Escrow Agent"), [INSERT NAME OF BROKER-DEALER] (the "Underwriter"), and [INSERT NAME OF ISSUER] (the "Company" or the "Partnership").
This introductory paragraph sets forth the date as of which the agreement is entered into and the name of the parties. SEC Rule 15c2-4(b) under the Securities Exchange Act of 1934 (the "Rule") requires that when an escrow account is used for distributions conducted on a contingency basis (e.g., best-efforts all-or-none or part-or-none offerings), the escrow agent must be a commercial bank that is unaffiliated with either the issuer or the underwriter. A "bank" is defined in Section 3(a)(6) of the Securities Exchange Act of 1934, to include a U.S. chartered bank, a bank that is a member of the Federal Reserve System, or a bank examined by a state or federal authority. In addition, pursuant to SEC staff interpretation, a savings and loan institution that is FSLIC-insured and FHLBB-regulated may act as an escrow agent under Rule 15c2-4(b). Further, since Rule 15c2-4(b) applies only to broker-dealers, the underwriter must be one of the contracting parties. It is not necessary for the issuer to be a contracting party to the escrow agreement to meet the requirements of Rule 15c2-4.
The Company/Partnership proposes to offer for sale to investors through one or more registered broker-dealers up to______shares of common stock/units of limited partnership interest (the "Securities") at a price of $______per share/unit (the "Proceeds").
The Underwriter intends to sell the Securities as the Company's/Partnership's agent on a best-efforts part-or-none basis for ______shares/units and on a best-efforts basis for the remaining Securities in a public/private offering (the "Offering").
The Company and the Underwriter desire to establish an escrow account in which funds received from subscribers will be deposited pending completion of the escrow period. [INSERT NAME OF BANK] agrees to serve as Escrow Agent in accordance with the terms and conditions set forth herein.
The term Selected Dealer as used herein shall include the Underwriter and other co-underwriters and/or other selected dealers as part of the selling group. All Selected Dealers shall be bound by this Agreement. However, for purposes of communications and directives, the Escrow Agent need only accept those signed by [INSERT NAME OF BROKER-DEALER].
Now therefore, in consideration of the foregoing, it is hereby agreed as follows:
This paragraph focuses on two important aspects of Rule 15c2-4: (1) the type of account that must be established to hold subscribers' funds and (2) to whom subscribers' checks should be made payable. The second and third sentences of this paragraph are optional depending on the category of broker-dealers participating in the distribution of the offering. Under Rule 15c2-4, a broker-dealer's obligation with regard to funds received from an investor depends on whether it is a "$5,000 broker-dealer" or a "$25,000 broker-dealer" under the SEC's net capital rules and whether the broker-dealer is affiliated with the issuer.
A $5,000 broker-dealer is required to establish an escrow account to hold subscriuers' funds until the contingency occurs, may only receive investors' checks payable to an unaffiliated bank acting as escrow ngent, and may not receive cash or checks payable to the issuer or the broker-dealer.
As an alternative to establishing an escrow account, $25,000 broker-dealers unaffiliated with the issuer may act as agent or trustee for a separate bank account until the offering contingency occurs. A "separate bank account" is one which is independent of the broker-dealer's operating account and is specifically identified as being for the benefit of a particular offering. If the "separate bank account" method of holding customer funds is elected by a $25,000 broker-dealer, a separate account at a bank must be maintained by the firm for each offering in which it is acting as an underwriter or selected dealer; funds of different offerings may not be commingled.
A $25,000 broker-dealer is permitted to receive cash and checks payable to the broker-dealer. Therefore, if all members of the selling group are $25,000 broker-dealers, it is not mandatory to have checks made payable to the Escrow Agent. However, pursuant to SEC staff interpretation of Subsection (b)(2) of Rule 15c2-4, a $25,000 broker-dealer affiliated with the issuer must forward checks to an escrow account and may not act as agent or trustee for a separate bank account. Further, any checks received by an issuer affiliated with a broker-dealer are considered received by the broker-dealer and must be forwarded to an escrow account.
During the escrow period, the Company/Partnership is aware and understands that it is not entitled to any funds received into escrow and no amounts deposited in the Escrow Account shall become the property of the Company/Partnership or any other entity, or be subject to the debts of the Company/Partnership or any other entity.
Pursuant to Rule 10b-9 of the Securities Exchange Act of 1934, the escrow period may only be extended beyond the latest period disclosed in the offering document if the escrow period has not yet terminated and either investors' funds are returned to them or the investors affirmatively confirm in writing their decision to continue their investment before the expiration of the latest disclosed escrow period.
Under Rule 15c2-4 and pursuant to the SEC net capital rules, a $5,000 broker-dealer may not receive cash from its customers. Only $25,000 broker-dealers may accept customers' cash or checks payable to the broker-dealer. All $5,000 broker-dealers whose customers tender cash or incorrectly drawn checks, i.e., checks not payable to the Escrow Agent, must return such payment to the customers and request that payment be made in the proper form.
In the event the Escrow Agent does receive the Minimum prior to termination of the Escrow Period, in no event will the Escrow Amount be released to the Company/Partnership until such amount is received by the Escrow Agent in collected funds. For purposes of this Agreement, the term "collected funds" shall mean all funds received by the Escrow Agent which have cleared normal banking channels and are in the form of cash.
Pursuant to the requirements of both Rules 15c2-4 and 10b-9, the SEC requires that in the event the agreed-upon contingency is not met, all or a specified amount of the consideration paid must be promptly returned to each individual subscriber. Funds are not to be returned to the Selected Dealer for delivery to its customers or to the issuer for return to subscribers in the event the contingency is not met. It is the Escrow Agent's duty to directly return such funds to the subscribers. Furthermore, the Escrow Agent may not attach or place a lien on the escrowed funds for its fees until the Minimum is met.
In offerings where an interest-bearing escrow account has been established, refunds to subscribers may, but are not required to, include each subscriber's pro-rata share of any interest earned while the subscriber's funds were on deposit. Such interest may properly be paid to the broker-dealer, the issuer, or the purchaser. However, appropriate disclosure should be made in the offering document as to whom any interest will be paid. It should be noted that if the interest is to be paid to the broker-dealer, the NASD will consider such payment additional underwriting compensation.
The Minimum may be met by funds that are deposited from the effective date of the offering up to and including the date on which the contingency must be met, i.e., during the Escrow Period. However, escrow cannot be broken and the offering may not proceed to closing until customer checks have been collected through the normal banking channels in an aggregate amount sufficient to meet the Minimum. The Escrow Agent makes the determination as to when sufficient funds have been deposited and collected to break escrow. If the Minimum is met with checks tendered on the last day of the Escrow Period and, subsequently, such checks fail to clear the banking system, thereby reducing the funds received by the Escrow Agent to an amount less than that necessary to meet the Minimum, the offering contingency has not been met. In this event, the Escrow Agent must promptly return all funds to subscribers.
In this connection, it should also be noted that purchases made after the Escrow Period has terminated, but prior to the date escrow is broken pending clearance of subscribers' funds, may not subsequently be counted to meet the Minimum should checks tendered prior to the termination of the Escrow Period fail to clear the banking system. Further, under Rule 15c2-4 and Rule 10b-9, a broker-dealer may not substitute its own good check for the check of a customer that has insufficient funds nor otherwise purchase to satisfy the offering contingency unless the broker-dealer is purchasing for investment prior to the termination of the Escrow Period and the offering document discloses the maximum amount of such potential purchase.*
Any check returned unpaid to the Escrow Agent shall be returned to the Selected Dealer that submitted the check. In such cases, the Escrow Agent will promptly notify the Company/Partnership of such return.
If the Company/Partnership rejects any subscription for which the Escrow Agent has already collected funds, the Escrow Agent shall promptly issue a refund check to the rejected subscriber. If the General Partner rejects any subscription for which the Escrow Agent has not yet collected funds but has submitted the subscriber's check for collection, the Escrow Agent shall promptly issue a check in the amount of the subscriber's check to the rejected subscriber after the Escrow Agent has cleared such funds. If the Escrow Agent has not yet submitted a rejected subscriber's check for collection, the Escrow Agent shall promptly remit the subscriber's check directly to the subscriber.
Bank accounts, including savings accounts and bank money-market accounts, are the types of investments permitted under Rule 15c2-4 pursuant to SEC staff interpretation. The SEC staff has also indicated it will not recommend any enforcement action under Rule 15c2-4 if the Escrow Agent invests offering proceeds in either short-term certificates of deposit issued by a bank, or short-term securities issued or guaranteed by the U.S. Government. It should be noted that it would be inappropriate for a bank escrow agent to invest in an otherwise permissible investment under Rule 15c2-4 if that investment's maturity date extends beyond the anticipated contingency occurrence date, unless the investments can readily be disposed of for cash by the time the contingency occurs without any dissipation of the offering proceeds invested.
Certain investments are specifically not permissible within the meaning of Rule 15c2-4:
- money-market funds;
- corporate equity or debt securities;
- repurchase agreements;
- banker acceptances;
- commercial paper; and
- municipal securities.
Until and unless the Minimum is reached, the Escrow Agent may not attach or otherwise place a lien on funds deposited in the Escrow Account.
SUGGESTED LANGUAGE FOR SELECTED DEALER AGREEMENT
Transmittal of Funds for Deposit Into the Escrow Account
When an Escrow Account is utilized to meet the requirements of Rule 15c2-4(b), it is suggested that the following language regarding transmittal of subscriber funds to the Escrow Agent for deposit into the Escrow Account be included in the Selected Dealer Agreement. If parallel language is not contained in the Underwriting Agreement, then the managing underwriter may sign the Selected Dealer Agreement and be bound by its terms or the Underwriting Agreement may incorporate by reference the Selected Dealer Agreement.
Until the contingency is met, Selected Dealers shall promptly, upon receipt of any and all checks, drafts, and money orders received from prospective purchasers of the shares/units, deliver same to the Escrow Agent for deposit in the Escrow Account by noon of the next business day following the receipt, together with a written account of each purchaser which sets forth, among other things, the name and address of the purchaser, the number of securities purchased and the amount paid therefor. Any checks received which are made payable to any party other than the Escrow Agent, shall be returned to the purchaser who submitted the check and not accepted.
When an Escrow Account is established to meet the requirements of Rule 15c2-4 (b), the rule requires that investors' funds be transmitted promptly. The SEC has interpreted "promptly" to mean by noon of the next business day following receipt until the Minimum contingency has been met. (See also comment to paragraph 1 of the Standard Form Escrow Agreement regarding the category of broker-dealers that may accept cash.)
Direct Participation Program Offerings
The Selected Dealers shall promptly, upon receipt of any and all checks, drafts, and money orders received from prospective purchasers of units, transmit same together with a copy of the executed Subscription Agreement or copy of the signature page of such agreement, stating among other things, the name of the purchaser, current address, and the amount of the investment to: [Insert one or more of paragraphs A-D following, as appropriate].
Paragraphs A through D following are alternative provisions, one or more of which may be included in the Underwriting and Selected Dealer Agreements depending on the structure of the distribution and the internal supervisory review procedures of participating broker-dealers. Under SEC staff interpretation of Rule 15c2-4, the procedure for transmittal of purchaser payments to the escrow agent for deposit in an offering of direct participation program securities may be accomplished by one of several methods depending on whether: (1) 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 purchasers; or (2) internal supervisory review is conducted at a different location from that which receives the subscription documents and checks from purchasers; or (3) a "processing broker-dealer," whose responsibilities in the offering include reviewing investor suitability, processing, and documentation of subscriptions and investor funds received, is involved in the distribution process.
* * * * *
Incorporation of Escrow Agreement by Reference
The Selected Dealer agrees that it is bound by the terms of the Escrow Agreement executed by the Underwriter and the Company/Partnership.
It is suggested that the Selected Dealer Agreement include a provision that will bind the Selected Dealers to the terms of the Escrow Agreement.
*Other conditions may be included which have been set forth in the offering document.
*If the amount is significant, consideration should be given to disclosing such potential purchases as a risk factor.