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  • 1994

    • For Your Information

      Member Assessments

      The NASD amended Section 1, Schedule A to the NASD By-Laws to increase the credit against a member's annual gross income assessment from 62 to 67 percent for calendar year 1993. The credit will be reduced to 59 percent for 1994.

      Because members have already paid their 1993 assessments with the 62 percent credit in effect, the increase to 67 percent will create a credit balance in their accounts for 1993 that the NASD will carry forward and apply to 1994 assessments. The first assessment invoices for 1994 will be based on 1992 gross income reported in 1993 with the 59 percent credit applied. After 1993 gross income reports are received in the spring of 1994, the NASD will, as has been the practice, adjust the mid-year assessment invoices to reflect 1993 actual gross income, less payments already made.

      American Stock Exchange Increases Registration, Re-Registration, and Renewal Fees

      Effective January 1, 1994, the American Stock Exchange (ASE) increased its agent registration fee to $45 and agent re-registration fee to $30. In addition, effective with the 1993-94 renewal program, the ASE's agent renewal fee increased to $25.

      If you have any questions regarding these changes, please call the NASD's Member Services Phone Center at (301) 590-6500.

      NASD Fingerprint Fee Increases

      The Federal Bureau of Investigation is increasing its fee for processing fingerprint cards submitted to it for noncriminal licensing and employment purposes. Effective January 3, 1994, the fingerprint fee for processing initial submissions and the third submission will increase by $1.00 per card to $24.50 per card. The second submission will remain $2.50, provided that the illegible card is attached. If the illegible card is not attached, the fee per card will be $24.50.

      Member Assessments

      The NASD amended Section 1, Schedule A to the NASD By-Laws to decrease the credit against a member's annual gross income assessment from 67 percent to 59 percent for calendar year 1994.

      The decrease is based on the estimated operating budget for 1994 and is subject to revision based on final actual gross income reports for 1993. After the NASD receives 1993 gross income reports this spring, it will adjust the mid-year assessment invoices to reflect 1993 actual gross income, less payments already made.

      Government Securities Act Expands NASD Authority

      In November, Congress passed the Government Securities Act Amendments of 1993. The bill, which permanently reauthorizes the original Government Securities Act passed in 1986, gives the NASD full sales-practice authority over its members that conduct a government securities business. In addition to enforcing capital and recordkeeping rules for its government securities dealers, the NASD now will write and enforce sales-practice rules. The new legislation also requires the Federal Reserve and the SEC to study the effectiveness of private systems in disseminating price and volume information on government securities and permits the Treasury to require large-position reporting.

      CMO/REMIC Brochure Can Help You Meet New NASD Requirements

      The NASD has recently mandated that securities dealers provide investors with materials to ensure that they are fully educated about Collateralized Mortgage Obligations (CMOs)/Real Estate Mortgage Investment Conduits (REMICs).

      The Public Securities Association (PSA), the international trade association of dealers in mortgage-backed securities, has published An Investor's Guide to REMICs, a 32-page booklet explaining the fundamentals of REMICs, their credit quality, interest and prepayment rates, tranches, types of REMICs, settlement and payment dates, minimum investments and liquidity, tax considerations, and other key points that every investor must know. It also features a worksheet, Questions You Should Ask Before Investing, and a full glossary of terms.

      Copies of this brochure can be ordered directly from the PSA's Publications Department. The minimum order is 50; they can also be imprinted with your company's logo with a minimum order of 1,000. For pricing information, call Cheryl Dantoni at (212) 440-9430 or write to the Public Securities Association, ATTN: Publications Department, 40 Broad Street, New York, NY 10004-2373.

      SEC Issues Alert Regarding So-Called "Prime" Bank And Similar Financial Instruments

      On November 2, 1993, the SEC issued a Commission Information for Investors bulletin to alert investors and regulated entities to the recent escalation in the number of possibly fraudulent schemes involving the issuance, trading, or use of so-called "prime" bank, "prime" European bank, or "prime" world financial instruments. The complete text of that bulletin is reprinted on the following pages.

      Information for Investors

      From the U.S. Securities and Exchange Commission

      So-Called "Prime" Bank and Similar Financial Instruments

      The Securities and Exchange Commission ("Commission") is alerting investors and regulated entities to the recent escalation in the number of possibly fraudulent schemes involving the issuance, trading or use of so-called "prime" bank, "prime" European bank or "prime" world bank financial instruments.1 These instruments typically take the form of notes, debentures, letters of credit, and guarantees. Also typical in the offer of these instruments is the promise or guarantee of unrealistic rates of return; e.g., a 150 percent annualized rate of "profits." Common targets of these schemes include both institutional and individual investors, who may also be induced to participate in possible "Ponzi" schemes involving the pooling of investors' funds to purchase "prime" bank financial instruments.

      On October 21, 1993, the federal financial institution supervisory agencies2 issued an Interagency Advisory to their regulated financial institutions. The Interagency Advisory also warned of the use of schemes involving "prime" bank financial instruments and noted that:

      • The agencies had been advised that "individuals have been improperly using the names of large, well-known domestic and foreign banks, the World Bank, and central banks in connection with their 'Prime Bank' schemes."

      • These institutions "had no knowledge about the unauthorized use of their names or the issuance or anything akin to 'Prime Bank'-type financial instruments."

      • The staffs of the federal financial institution supervisory agencies are unaware of the legitimate use of any financial instrument called a "Prime Bank" note, guarantee, letter of credit, debenture, or similar type of financial instrument

      • Financial institutions should be attentive to the attempted use of traditional types of financial instruments that are referred to in an unconventional manner, "such as a letter of credit referencing forms allegedly produced or approved by the International Chamber of Commerce."

      As to this latter point, the Interagency Advisory referred to examples of "bogus schemes involving the supposed issuance of an 'ICC 3034' or an 'ICC 3039' letter of credit by a domestic or foreign bank."

      The Interagency Advisory also noted that many of the illegal or dubious schemes that have come to the attention of regulatory agencies "appear to involve overly complex loan funding mechanisms." In the eyes of an unsophisticated investor, this complexity may make a questionable investment appear worthwhile. The Commission warns investors and those who may advise them, particularly broker-dealers and investment advisors, of this possible hallmark of fraud and reminds them of a basic rule for avoiding securities fraud, "If it looks too good to be true, it probably is!"


      1 These schemes do not involve the offer or sale of financial instruments issued by any financial institution having the word "prime" in its name; rather, that word (or a synonym, as in the phrase "top fifty world banks") is used to refer, generically, to financial institutions of purportedly high repute and financial soundness.

      2 These agencies are the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.

      * * * * *

      The Commission requests that those with information regarding the offer or sale of "prime" bank or similar financial instruments provide that information to one of the Commission offices listed below. When information is sent to one of the Commission's regional or district offices, it should be sent to the attention of the Assistant Regional Administrator (Enforcement).

      Northeast Regional Office
      7 World Trade Center
      Suite 1300
      New York, NY 10048
      (212) 748-8000
      FAX: (212)748-8049

      Boston District Office
      73 Tremont Street
      Suite 600
      Boston, MA 02108-3912
      (617) 424-5900
      FAX: (617)424-5940

      Philadelphia District Office
      The Curtis Center, Suite 1005 E. 601
      Walnut Street
      Philadelphia, PA 19106-3322
      (215)597-3100
      FAX: (215) 597-5885

      Southeast Regional Office
      1401 Brickell Avenue
      Suite 200
      Miami, FL
      33131 (305)536-5765
      FAX: (305)536-7465

      Atlanta District Office
      3475 Lenox Road, N.E.
      Suite 1000
      Atlanta, GA 30326-1232
      (404) 842-7600
      FAX: (404)842-7666

      Midwest Regional Office
      Northwestern Atrium Center
      500 West Madison Street
      Suite 1400
      Chicago, IL 60661-2511
      (312) 353-7390
      FAX: (312)353-7398

      Central Regional Office
      1801 California Street
      Suite 4800
      Denver, CO 80202-2648
      (303) 391-6800
      FAX: (303)391-6868

      Fort Worth District Office
      801 Cherry Street
      19th Floor
      Fort Worth, TX 76102
      (817)334-3821
      FAX: (817)334-2700

      Salt Lake District Office
      500 Key Bank Tower
      50 S. Main Street, Suite 500
      Box 79
      Salt Lake City, UT 84144-0402
      (801) 524-5796
      FAX: (801)524-3558

      Pacific Regional Office
      5670 Wilshire Boulevard
      11th Floor
      Los Angeles, CA 90036-3648
      (213) 965-3998
      FAX: (213)965-3812

      San Francisco District Office
      44 Montgomery Street
      Suite 1100
      San Francisco, CA 94104
      (415) 705-2500
      FAX: (415) 705-2501

      Seattle District Office
      3090 Jackson Federal Building
      915 Second Avenue
      Seattle, WA 98174
      (206) 220-7500
      FAX: (206) 220-7560

      Division of Enforcement
      Mail Stop 4-8A
      Washington, DC 20549
      (202) 504-2220
      FAX: (202)272-3636

      Exercise Caution When Opening New Offshore Accounts

      The NASD Market Surveillance Department has been advised that a number of member firms have opened new accounts with customers who represented themselves to be corporate/institutional type accounts domiciled offshore who were unknown to the firms. These accounts are dealing in large dollar transactions and are not fulfilling contractual obligations to pay for the transactions, often resulting in significant losses for the firms executing the transaction. Accounts of this nature have been identified at firms in New York and Texas. The NASD investigation of these matters continues, and in the meantime, the NASD recommends that members be particularly careful when approached to open such accounts for customers unknown to the firm.

      NASD Member Voting Result

      As a member service, the NASD publishes the result of member votes on issues presented to them for approval in the monthly Notices to Members. Most recently, members voted on the following issue:

      • Notice to Members 93-76—NASD Solicits Member Vote on Filing Requirements for Use of Mutual Fund Rankings and Elimination of Sunset Provisions in Prefiling Requirements for CMO Advertisements; Last Voting Date: December 31, 1993. Ballots For 1,759; Against 333; and Unsigned 15.

      Correction To Notice to Members 94-1

      Under the definition of the term "maximum order size" on page 3 of Notice to Members 94-1 dated January 5, 1994, the line of copy beginning at the bottom of the middle column and carrying over to the top of the last column incorrectly reads "Maximum order sizes for NASDAQ/NMS securities shall be 200, 500, or 1,000 shares depending upon trading characteristics of the securities." It should read "Maximum order sizes for NASDAQ/NMS securities shall be 200 or 500 shares depending upon trading characteristics of the securities," with the words "or 1,000" deleted.

      SEC Issues No-Action Letter Regarding Prime Broker Arrangements

      On January 25, 1994, the Securities and Exchange Commission (SEC) issued a no-action letter that permits broker/dealers to treat a prime broker account as if it were a broker/dealer credit account pursuant to Section 220.11 of Regulation T.

      The term "prime broker account" refers to an account maintained by a broker/dealer (usually a full-service firm) to facilitate the clearing and settling of securities transactions for substantial retail and institutional customers that are active market participants. A unique feature of these accounts allows the customer to place orders directly with one or more other registered broker/dealers (the executing broker).

      The letter, which was issued by the SEC Division of Market Regulation after consultation with the Division of Banking Supervision and Regulation of the Federal Reserve System, establishes certain conditions that broker/dealers must meet to treat these accounts in this manner. In particular, the letter clarifies the responsibilities and obligations of the prime broker, the executing broker, and the customer.

      The position is effective on an interim basis until December 31, 1995. During this time period, the SEC will review the operation of these accounts to determine whether to extend, modify, or terminate its no-action position.

      Members maintaining prime broker accounts for their customers are urged to review the no-action letter in its entirety. If you participate in these prime broker arrangements and have not already received a copy of the letter, please contact your local NASD district office.

      NASD Member Voting Results

      As a member service, the NASD publishes the result of member votes on issues presented to them for approval in the monthly Notices to Members. Most recently, members voted on the following issue:

      • Notice to Members 93-82— NASD Solicits Member Vote On Proposed Amendment Exempting Money Market Mutual Funds From Disclosure Requirements. Ballots For: 1,874; Against: 242; and Unsigned: 9.

      Correction to Notice to Members 94-8

      Please note in your copy of Notice to Members 94-8 that the missing fourth line from the top of the third column on page 41 should read "Rule 15c2-11." We regret any confusion this may have caused our readers.

      NASAA Publishes Revisions To Form U-4 And DRP For Public Comment

      The March 1994 edition of CCH NASAA Reports includes, for public comment, certain proposed revisions to Page 3 of Form U-4 and the Disclosure Reporting Pages (DRP). These changes represent an effort to categorize disclosure information and customize the reporting forms. Disclosures submitted in this format will be more precise, uniform, and consistent with the specifications being created for the redesigned Central Registration Depository (CRD).

      The revised Form U-4 will not be implemented before the new CRD; however, the North American Securities Administrators Association (NASAA) has proposed these changes at this time to allow for development of the system and conversion of existing disclosure information to the new format. Additionally, the Securities and Exchange Commission (SEC) requested amendments to Item 7 on Page 4 of the Form U-4 to accommodate the consent to service of process and investigative subpoenas or other documents in administrative and civil proceedings initiated by the SEC and the Commodity Futures Trading Commission (CFTC).

      The redesign of CRD will require additional changes to the Form U-4 and revisions to other forms.

      Publication of these changes for comment should occur later this year, with final implementation expected to coincide with the new CRD.

      Special Regulatory Alert

      March 10, 1994

      NASD Reiterates Members' Firm-Quote Obligations

      During the past several weeks the SelectNetSM system has experienced a marked increase in the number of preferenced orders priced at the inside, entered in the system and an increase in the number of backing away complaints. The reliability of market makers' disseminated quotes and the assurance to market participants that they can trade at these quotes is one of the fundamental operating principles of The Nasdaq Stock Market™ (Nasdaq) that ensures the fair, efficient, and orderly operation of Nasdaq and the protection of investors.

      Under the SEC's "firm-quote rule," Rule 11Acl-1, a market maker has the obligation to execute an order "presented" to it at its displayed quotation up to its displayed size. Additionally, Article III, Section 6 of the NASD's Rules of Fair Practice and Part V, Section 2(b) and Part VI, Section 2 of Schedule D to the NASD's By-Laws require market makers to honor their quotes up to their displayed size. A market maker is relieved from its firm-quote obligation if: (i) the market maker sends a quote change to the NASD before an order is presented or (ii) the market maker has effected or is in the process of effecting a transaction at the time an order sought to be executed is presented and immediately upon completion of the transaction communicates a revised quotation to the NASD. Thus, a market maker's firm-quote obligation with respect to a particular order is triggered when that market maker becomes aware of, or should reasonably be aware of, the pendency of that order.1

      The NASD takes most seriously its regulatory obligation to ensure that NASD members fully comply with the SEC's firm-quote rule. When presented with a backing away complaint, the NASD conducts a preliminary facts and circumstances analysis to determine when an order was presented to a market maker and whether the market maker was entitled to rely on an exemption from the firm-quote rule. Thereafter, the NASD vigorously and thoroughly investigates all valid backing away complaints and will not hesitate to take prompt and appropriate disciplinary action when warranted.

      Following are some guidelines that market makers should follow when simultaneously handling orders from multiple sources:

      • Once a market maker becomes aware of the receipt of an order, regardless of how the order is transmitted to the market maker, it is obligated under the firm-quote rule to process and execute that order at its disseminated quote up to its displayed size, absent an exemption from the firm-quote rule.

      • Preferenced orders received through SelectNet should be monitored with the same degree of diligence afforded other means of traditional order communication.

      • If a market maker failed to act on a preferenced SelectNet order before it "timed out" and did not execute any other order during the time that SelectNet order was pending, the NASD will infer, in the absence of convincing contrary evidence, that the market maker saw the SelectNet order and backed away from its quote. The NASD also would draw the same inference if the market maker changed its quote while the order was pending and did no trades during the pendency of the SelectNet order.

      In addition, to facilitate the aggressive review of all backing away complaints in a prompt manner, and, when backing away is established, to permit resolution that benefits the complainant, the NASD believes it is incumbent on members alleging backing away to raise their complaints in a timely manner. Moreover, the NASD believes that it is inappropriate for a firm to defer pursuing a backing away complaint, particularly in instances where the firm has an opportunity to determine if the market is moving in an advantageous direction for its order.

      • Members complaining of backing away should contact, or take reasonable steps to contact, the relevant market maker as soon as possible after the alleged backing away. While it is difficult to establish a hard and fast rule governing when backing away complaints should be lodged with the relevant market maker, the NASD notes that the Intermarket Trading System Plan entered into and followed by the NASD and every national securities exchange provides that trade-through complaints must be lodged within five (5) minutes of the alleged trade-through. Thus, a member's failure to take reasonable steps to contact the relevant market maker within five (5) minutes after the alleged backing away will be a very important factor that the NASD will consider when evaluating what action, if any, may be appropriate in response to a backing away complaint. The market maker also should ensure that it has the ability to timely receive and respond to potential backing away complaints.

      • If contact with the relevant market maker does not resolve the alleged backing away, the complaining member should notify the NASD's Market Surveillance Department within fifteen (15) minutes after the alleged backing away occurs, either by phone at (301) 590-6080 or by fax at (301) 590-6671. A member's failure to take reasonable steps to notify the NASD within fifteen (15) minutes of the alleged backing away will be a very important factor that the NASD will consider when evaluating what action, if any, may be appropriate in response to a backing away complaint. Thereafter, the complaint also must be filed on an official backing away complaint form within twenty-four (24) hours of the alleged backing away, copies of which can be obtained by contacting Market Surveillance at (301) 590-6080.

      • Recently, some order-entry firms have been cancelling their preferenced SelectNet orders within the minimum three-minute time period that the order is pending without having received a "decline" from the relevant market maker and, thereafter, alleging backing away. The NASD notes that the cancellation of preferenced SelectNet orders which have not been declined effectively precludes market makers from satisfying their firm-quote obligations. Thus, members should be advised that their cancellation of preferenced SelectNet orders before a market maker has declined the order or before the order "times out" will generally be deemed conduct evidencing a lack of an intent to trade, thus precluding the member from raising a valid backing away complaint.

      Questions regarding this notice may be directed to Bernard Thompson, Assistant Director, Market Surveillance, at (301) 590-6436, Sheila Dagucon, Market Surveillance, at (301) 590-6432, Robert Aber, Vice President & General Counsel, at (202) 728-8290, or Thomas Gira, Assistant General Counsel, at (202) 728-8957.

      NASD

      National Association of Securities Dealers, Inc. • 1735 K Street, NW Washington, DC 20006-1506 • (202) 728-8000


      1 The Policy accompanying Article III, Section 6 of the NASD's Rules of Fair Practice also imposes upon market makers an obligation to monitor orders being received.

      NASD Mail Insurance Program Provides Low-Cost Security

      The NASD Member Purchasing Service is constantly striving to provide protection in areas that are of paramount concern to our member firms. After discussing the shipping schedules and subsequent mail insurance needs of a number of our members, the NASD has developed a comprehensive mail insurance program that is specifically customized for the securities industry.

      In our discussions with members, they noted the features they'd like in a mail insurance program. They want coverage that extends to all sources of shipping, including their transfer agents and independent contractors, and that wouldn't require reporting, auditing, or back billing of shipments. They cited their frustration with cumbersome reporting and additional premiums associated with many insurance programs on the market. In response, with the assistance of Seabury & Smith, the program's administrator, and the Aetna Casualty and Surety Company, we have developed the NASD-sponsored Mail Insurance Program. This program covers transfer agents, independent contractors, and incoming shipments. In addition, it does not require reporting, auditing, or back billing of shipments.

      The NASD-sponsored Mail Insurance Program was designed on a "Non-Reporting Basis," which means your initial cost will remain intact throughout the policy term. You might find a less expensive mail insurance product in the marketplace, but it will probably require the maintenance of a shipping log for back-billing purposes and ultimately cost you more money. Not only is the NASD-sponsored Mail Insurance Program cost-effective, its non-reporting feature provides a simplified approach in which to provide coverage for your valuable shipments. Comparable policies would require up to three times as much in annual premiums.

      If you'd like more information on the NASD Mail Insurance Program, phone Kathy Jacobson, Seabury & Smith, (800) 922-9242 or direct, (202) 296-9640.

      NASD Initiates New Subordination Filing Procedures

      Many securities dealers tend to rely on their blanket fidelity bond to provide coverage for their shipments. Although the Form 14 or Securities Dealers Blanket Bond affords protection for securities, coverage is only provided while the shipment is on-premises or in the custody of a messenger, and ceases once the package is placed in the mail or in the custody of a Carrier for Hire. Moreover, most of the overnight carriers fail to provide any coverage for shipments. Other firms rely on coverage provided by the U.S. Postal Service, which provides insurance for shipments via registered mail. Unfortunately, the U.S. Postal Service provides a mere $25,000 of coverage for registered mail shipments, leaving most members significantly underinsured.

      As of April 1, 1994, the NASD transferred responsibility for processing and approving subordination agreements to the local district offices. Please note that the transfer date for the New York District Office is July 1. As of the effective transfer date, members should cease sending these filings to the NASD Washington, D.C., Office.

      Members must now file proposed agreements with the district office for the district in which the member maintains its principal place of business. All subordination agreements, with the original copy manually signed, must be filed, in duplicate, at least 30 days before the agreement's proposed effective date (10 days for temporary subordination agreements).

      Renewals of existing subordination agreements, as well as requests for prepayment, assignments, and conversions to capital, also must be filed with the appropriate district office.

      The NASD has standardized forms for subordinated loan agreements and secured demand note agreements. Use of the standardized forms, which are available from the district offices, will facilitate review by the NASD and reduce processing time. Members should note that there is no change to how these forms are completed, or to the required documentation; the only change involves sending the completed forms to the appropriate district office, rather than the Washington, D.C., Office.

      The NASD believes that this change will result in greater efficiency and will improve service for members. Questions concerning subordination agreements may be directed to members' local district offices.

      SEC Approves Several NASD Proposals

      On March 7, 1994, the Securities and Exchange Commission (SEC) approved an amendment to add new Subsection (b)(6) (G), Article III, Section 44 of the Rules of Fair Practice. This new rule requires that members file with the Corporate Financing Department a detailed explanation of, and any documents related to, any change in or modification of any item of underwriting compensation made after the NASD has reviewed and approved the proposed compensation arrangements for a public offering. This change ensures that NASD staff are notified of changes to previously approved underwriting arrangements.

      The SEC also approved amendments to Subsection (b)(10)(B), Article III, Section 44 of the Rules of Fair Practice and Subsection 6(b), Schedule A to the By-Laws to clarify that the calculation of the additional fee required as a result of additional securities being offered pursuant to an amendment to the initially filed documents shall be equal to .01 percent of the result of the number of new shares being offered multiplied by the offering price of the new shares.

      Finally, the SEC approved an amendment to Subsection 3(c), Schedule E to the By-Laws to remove the phrase "without limitation as to the amount of securities to be distributed by the member." The phase is a carryover from an early provision of Schedule E, eliminated in 1988, that restricted a member's participation in the syndicate or selling group to an amount not exceeding 10 percent of the dollar amount of the offering underwritten on a firm commitment basis and managed by a qualified independent underwriter. When the restriction was in effect, Schedule E required two qualified independent underwriters. However, if the member's participation was limited to 10 percent or less, Schedule E required only one qualified independent underwriter. The removal of the 10 percent restriction provision renders the quoted phase unwarranted and no longer operable.

      Nasdaq Now Reports Trades In Smaller Fractions

      Since Monday, April 4, The Nasdaq Stock Market™ has been reporting last-sale transactions in fractions smaller that 1/8. Before then, most Nasdaq last-sale transactions were rounded to the nearest 1 /8 fraction with certain exceptions. Now all last-sale transactions are rounded to the nearest 1/64 fraction.

      Credit Division Schedules Prime Brokerage Meeting

      The Credit Division of the Securities Industry Association (SIA) has scheduled a special meeting on Prime Brokerage, Wednesday, June 22, 1994, at Salomon Brothers Inc., Executive Center, 39th Floor, Seven World Trade Center, New York, New York. Registration is at 8:30 a.m. For more information, please contact Arthur Quartermaine, President, SIA Credit Division, (212) 902-7891.

      NAIC's "Own Your Share of America" Campaign Gets Underway

      To increase direct individual investment, the National Association of Investors Corporation (NAIC) is conducting its third annual "Own Your Share of America" campaign. This month-long promotional effort is intended to encourage people to become direct owners of the common stock of publicly traded companies. The last two campaigns have proven quite successful with corporate participants reporting increases of as much as 20 percent in their employee stock purchase and investment programs during that time period.

      The NASD supports NAIC's efforts because The Nasdaq Stock Market™ is the market of individual investors—they own 60 percent of Nasdaq® securities by market value, and their participation in this market is growing. According to recent survey data, between 1985 and 1990 the number of individual investors in Nasdaq securities jumped from 8.3 to 11.1 million, an increase of 33.7 percent.

      If you or your firm would like more information on the program, call NAIC at (810) 543-0612 ext. 323, or write NAIC, P.O. Box 220, Royal Oak, MI 48068.

      Treasury Proposal Would Affect Government Securities Broker/Dealers

      The U.S. Department of the Treasury (Treasury) recently published for comment amendments to the financial responsibility requirements established under the Government Securities Act of 1986 (GSA). The proposed amendments raise the minimum capital requirements for all government securities broker/dealers subject to the provisions of Section 402.2 of the regulations implemented under the GSA, and require written notification for certain withdrawals of capital. The changes parallel recent Securities and Exchange Commission (SEC) actions in these areas. Treasury also is proposing a conforming change to its recordkeeping requirements. Comments are due on or before August 22, 1994. This rule will affect 15C sole government securities broker/dealers only.

      The amendments create four minimum capital categories, to be phased-in over an 18-month period.

      • Government securities broker/dealers that carry customer or broker/dealer accounts would be subject to a minimum level of $250,000.

      • Government securities broker/dealers that carry customer accounts but operate under the exemption provided by Rule 15c3-3(k)(2)(i) would have a minimum requirement of $100,000.

      • Government securities broker/dealers that introduce accounts on a fully disclosed basis and receive but do not hold customer securities would be subject to a minimum requirement of $50,000.

      • Introducing firms that never handle customer funds or securities would be subject to a minimum requirement of $25,000.

      The proposed notification provisions require post-withdrawal notification of certain significant capital withdrawals as well as prior notification for larger withdrawals. Whether notification is required prior to the withdrawal depends upon the aggregate size of total withdrawals relative to the government securities broker/dealer's excess liquid capital over a 30-calendar-day period.

      • Aggregate withdrawals that exceed 20 percent of a government securities broker/dealer's excess liquid capital in a 30-calendar-day period require notification within two business days after the withdrawal.

      • Aggregate withdrawals in excess of 30 percent of excess liquid capital in any 30-calendar-day period require notification two business days prior to such withdrawal.

      The proposed rule excludes the reporting of net withdrawals that, in the aggregate, are less than $500,000 in any 30-calendar-day period or those that represent securities or commodities transactions between affiliates, except that forward settling transactions between affiliates are not eligible for this exclusion. The exclusion for securities and commodities transactions requires that the transactions be conducted in the ordinary course of business and settled no later than two business days after the date of the transaction.

      Notification must be sent to the SEC and to the broker/dealer's designated examining authority, not to Treasury.

      * * *

      A Special Notice to Selected Members subject to the provisions of Section 402.2 of the regulations implemented under the Government Securities Act of 1986 will be distributed separately. These members are urged to review the proposed amendments in their entirety.

      Questions regarding this Notice may be addressed to Brad Darfler, District Coordinator, (202) 728-8946.

      CRD Enhanced For PHLX Dual Registration

      Beginning August 1, 1994, a Central Registration Depository (CRD) enhancement will be rolled in for firms that are dually registered with the Philadelphia Stock Exchange (PHLX) and the NASD.

      This enhancement is a result of a PHLX request made pursuant to Exchange Rule 604. The Rule was amended in 1993 to require all Series 7 General Securities (GS) Representatives to register with PHLX via CRD. A CRD conversion in October 1993 identified all NASD-GS approved agents with PHLX firms and added a PHLX-GS status line. Thereafter, PHLX/NASD registered firms were instructed to mark the "PHLX" box in Item 10 of Form U-4 on all initial, transfer, or amended applications requesting a GS license.

      PHLX expressed a concern that omissions might occur respecting firm requirements to mark the PHLX box on these applications and would therefore fail to meet the Rule 604 requirement. The CRD enhancement will address this concern by systematically generating a PHLX-GS status line for any initial, transfer, or amended U-4 containing a GS registration request, even if the PHLX box is not marked.

      In addition, a second conversion will take place the weekend of July 30-31 that will follow the same logic as the October 1993 conversion described above. (Duplicate PHLX-GS status lines will not be generated for agents already possessing one, however.)

      If you have any questions, please contact Amy Kitzen, PHLX Market Regulation, at (215) 496-5378.

      SEC Expands Wrap Fee Disclosure

      The Securities and Exchange Commission (SEC) recently adopted amendments to the Investment Advisers Act of 1940 that require advisers sponsoring wrap fee programs to deliver to current and prospective clients a separate brochure describing the cost of the wrap fee programs and the services provided.

      The specific information that must be included in the brochure is set forth in a new schedule, Schedule H, to Form ADV. The brochure must be delivered to prospective wrap fee clients and annually offered to an adviser's existing wrap fee clients.

      Also, advisers must deliver the brochure to all clients on a one-time basis when the brochure is filed with the SEC. The brochure must be updated promptly for material changes; other changes must be added within 90 days after the end of the sponsor's fiscal year.

      In addition, sponsors must file the brochure with the SEC as part of Form ADV. The amendments also mandate when the brochure must be updated. Sponsors must comply with the new requirements by October 1, 1994.

      For complete details regarding these changes, members may refer to Release No. IA-1411, which was published in the April 26, 1994, Federal Register.

      NAIC's "Own Your Share of America" Campaign Gets Underway

      To increase direct individual investment, the National Association of Investors Corporation (NAIC) is conducting its third annual "Own Your Share of America" campaign. This month-long promotional effort is intended to encourage people to become direct owners of the common stock of publicly traded companies. The last two campaigns have proven quite successful, with corporate participants reporting increases of as much as 20 percent in their employee stock purchase and investment programs during that time period.

      The NASD supports NAIC's efforts because The Nasdaq Stock Market™ is the market of individual investors—they own 60 percent of Nasdaq® securities by market value, and their participation in this market is growing. According to recent survey data, between 1985 and 1990 the number of individual investors in Nasdaq securities jumped from 8.3 to 11.1 million, an increase of 32.4 percent.

      If you or your firm would like more information on the program, call NAIC at (810) 543-0612 ext. 323, or write NAIC, P.O. Box 220, Royal Oak, MI 48068.

      NASD Extends Mutual Fund Reporting Deadline To 5:40 P.M.

      The National Association of Securities Dealers, Inc. (NASD®), which collects and reports mutual fund net asset values (NAVs) to the public, extended the reporting deadline for them by 10 minutes to 5:40 p.m., Eastern Time, effective Monday, July 11, 1994.

      The new deadline was set in consultation with representatives of the news media.

      A representative from the Investment Company Institute (ICI) said that the trade association will encourage its mutual-fund members in a memo to make their best efforts to meet the new deadline and to alert the NASD in advance when the fund or reporting service may miss the deadline.

      The NASD and the mutual fund industry are exploring ways to improve the technology used in collecting and reporting NAVs to vendors and the news media.

      The NASD also issued procedures for funds to alert the NASD and the news media if delays occur in their reporting. These procedures will be distributed by the NASD and ICI to mutual funds.

      Procedures For Alerting NASD And Media About Fund Delays

      1. When a mutual fund group, or its reporting service, expects a delay in its ability to calculate its same-day NAVs for its family of funds, the fund or service should alert the NASD as soon as possible if it wishes to have its NAVs in the dissemination. As the day progresses toward the deadline, the fund or service should continue to keep the NASD apprised as to the length of the delay in reporting same-day NAVs to the NASD.
      2. If it appears that the fund or service will not meet the 5:40 p.m., ET, deadline, the NASD will contact The Wall Street Journal, the Associated Press, and Tribune Media Services to seek their guidance about whether the time at which the NASD disseminates the feed can be extended given their deadlines.
      3. If there is general agreement by the media to extend the feed deadline, the NASD will do so and notify the funds seeking the extension. If the media does not agree to an extension, the fund or reporting service may report their NAVs directly to news organizations.

      Farewell Reception And Retirement Dinner To Be Held For DTC Chairman

      NASD and 25 other securities groups are sponsoring a reception and retirement dinner for departing DTC Chairman and CEO William T. Dentzer, Jr. The dinner will be held at the New York Hilton's Grand Ballroom September 20, 1994. Proceeds from the event will be contributed to the Securities Industry Foundation for Economic Education to establish the William T. Dentzer, Jr., Education Fund. For ticket information, call (212) 618-0580.

      SEC Extends Comment Period On Proposed Capital Charges For Listed Options And Related Positions

      The SEC is extending the comment period for Release No. 34-33761 (March 21, 1994, Federal Register) on proposed amendments to the net capital rule concerning capital charges for listed options and related positions. In its release, the SEC also solicited comments on the applicability of the proposed theoretical pricing haircut methodology to assess the market risk for OTC options. The new deadline for comments is now September 16, 1994.

      Persons interested in submitting written comments should file three copies with Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Stop 6-9, Washington, D.C. 20549. All comments should refer to File No. S7-7-94.

      Virginia, New Hampshire Provide IPO Exemption To Nasdaq National Market Securities

      Securities listed on the Nasdaq National Market® are now regulated the same as securities listed on the New York and American stock exchanges in all 50 states. As of July 25, 1994, Virginia Securities Act Rule 504 is amended to grant an initial public offering (IPO) exemption from registration to Nasdaq National Market securities. Virginia was the last state that treated the Nasdaq market differently for "blue-sky" registration purposes. Since 1988 Nasdaq National Market securities have been granted an exemption by Virginia to trade six months after they have been issued without registration, although exchange-listed securities were exempt at issuance.

      On August 8, 1994, a New Hampshire Securities Act amendment becomes effective to exempt IPOs listed on the Nasdaq National Market, as well as those listed on the New York and American stock exchanges. Issuers must pay a fee to claim the exemption. Before this amendment, IPOs listed on these three stock markets were required to register with the New Hampshire Bureau of Securities Regulation.

      NASD Member Voting Results

      As a member service, the NASD publishes the result of member votes on issues presented to them for approval in the monthly Notices to Members. Most recently, members voted on this issue:

      • Notice to Members 94-22NASD Solicits Member Vote On Proposed Amendments To The Pre-Membership Interview Procedures. Ballots For: 1,879; Against: 161; and Unsigned: 6.

      Questions regarding this item should be directed to Joan Conley, President's Office, at (202) 728-8381.

      LA County Bar Association Schedules Regulation Seminar

      The Business & Corporations Law Section of the Los Angeles County Bar Association has announced its 27th Annual Securities Regulation Seminar.

      When: October 3, 1994 Where: Biltmore Hotel

      506 South Grand Avenue

      Los Angeles Cost: $175 section members

      $200 non-section members

      Top Washington and regional SEC officials, together with leading private practitioners, will present a comprehensive review of current events and developments in the securities field, including an overview of judicial, regulatory, and enforcement developments, and recent trends in the public and private offering of securities. Featured speakers will include Simon Lome, SEC General Counsel and the Hon. Stanley Sporkin, U.S. District Judge for the District of Columbia.

      For more information or to register, call Gail Emery at (213) 896-6523.

      Corporate Financing Moves From D.C. To MD

      The NASD Corporate Financing Department is pleased to announce its offices are now located at:

      9513 Key West Avenue 3rd Floor Rockville, MD 20850

      Main: (301) 208-2700

      Director: (301) 208-2786

      FAX: (202) 728-8454 (until 9/30)

      Market Hours For Upcoming Holidays

      The Nasdaq Stock MarketSM will close at 1 p m., ET, on Friday, November 25. SelectNetSM trading will continue until 2:15 p.m., ET.

      The Nasdaq Stock Market will be closed for business on Thursday, November 24, 1994, in observance of Thanksgiving Day.

      The Nasdaq Stock Market will be closed on Monday, December 26, in observance of Christmas, and on Monday, January 2, 1995, in observance of New Year's Day.

      The Nasdaq Stock Market will be open regular hours, 9:30 a.m. to 4 p.m. ET, on Friday, December 30.

      Excess Spread Calculation Includes Exchange Quotes

      On October 28, 1994, the Securities and Exchange Commission (SEC) approved an NASD proposal to include quotations from national securities exchanges in the calculation of excess spread parameters for CQS securities. The rule change went into effect on November 21, 1994.

      Registered market makers in CQS securities are prohibited from entering quotations in CQS securities that exceed the NASD's parameters for maximum allowable spreads. Before this rule change, the maximum allowable spread for any given CQS security was 125 percent of the average of the three narrowest market maker spreads in that security, with the limitation that the maximum allowable spread could never be less than 1/4 of a point. This calculation methodology, however, only factored in quotations by CQS market makers and did not take into account quotations disseminated by exchanges. Accordingly, in order to have the excess spread parameters for CQS securities be more reflective of and related to quotations disseminated by all market centers trading CQS securities, the NASD proposed, and the SEC approved, the inclusion of exchange quotations in the calculations of excess spread parameters for CQS securities. Thus, with this rule change, the maximum allowable spread for any CQS security will be 125 percent of the average of the three narrowest market maker spreads in that security, which average spread calculations shall include quotations from national securities exchanges (if the number of CQS market makers in that security plus the number of national securities exchanges trading that security is less than three, the maximum allowable spread will be 125 percent of the average spread). In addition, as before the rule change, the maximum allowable spread shall never be less than 1/4 of a point.

      Short-Sale Revision Postponed Until January 9, 1995

      In Notice to Members 94-80, the NASD announced that the SEC approved an NASD rule change that amends the Prompt Receipt and Delivery of Securities Interpretation (Interpretation) issued by the NASD Board of Governors under Article HI, Section 1 of the NASD Rules of Fair Practice. Specifically, the Interpretation, as amended, requires members to annotate their affirmative determinations as to stock availability that are required to be made when effecting short sales for their own proprietary account or the account of a customer. This rule change was scheduled to go into effect on November 30, 1994; however, the NASD has postponed the effective date of the rule change until January 9, 1995.

      The NASD is also clarifying that the Interpretation applies to any security traded by an NASD member, including exchange-listed securities, non-Nasdaq securities, and foreign securities. With respect to foreign securities, however, short sales in such securities effected on a foreign securities exchange or market through a member of such exchange or market are not subject to the Interpretation.

    • 94-102 New Exercise Advice Procedures For Expiring Equity Options

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance
      Operations
      Options

      Executive Summary

      New uniform provisions regarding the exercise cut-off rules for expiring equity options will become effective commencing with the February 1995 expiration at each of the five registered national options exchanges and the National Association of Securities Dealers, Inc, (the SROs).1 This circular describing these new provisions and requirements was prepared by the SROs acting jointly as members of the Intermarket Surveillance Group (ISG).

      The exercise cut-off rules continue to require that exercise decisions relating to expiring equity options that are contrary to the Options Clearing Corporation's (OCC) Exercise-by-Exception (Ex-by-Ex)2 procedure, be made and recorded by clearing firms prior to 5:30 p.m. Eastern Time, 4:30 p.m. Central Time, or 2:30 p.m. Pacific Time on the last business day prior to expiration (i.e., the exercise cut-off time). The new rules, however, required that evidence of such contrary exercise decisions must also be submitted in the form of a Contrary Exercise Advice to an eligible options exchange3 or directly to OCC prior to the cut-off time.

      Contrary Exercise Advices represent decisions of an option holder to either (1) exercise an out-of-the-money expiring equity options position or (2) not exercise an in-the-money expiring equity options position, as defined by the Ex-by-Ex procedures of OCC Rule 805. In addition, cancellations or changes to previously submitted Contrary Exercise Advices also must be submitted to an eligible exchange or to OCC prior to the cut-off time.

      Member organizations that maintain standing instructions from customers or market makers to routinely exercise options contracts at closing values below the OCC Exercise-by-Exception parameters, will not be required to submit a Contrary Exercise Advice in those instances where the closing value meets or exceeds the standing instruction. Member organizations must retain such dated standing instructions on file and submit copies of the instructions to each options SRO of which they are a member (market-maker standing instructions need only be forwarded to the exchange where the market maker is a member). Should a customer or member elect to take action on a specific occasion that differs from a standing instruction, a Contrary Exercise Advice must be submitted in the prescribed form and the member organization must prepare for its files a time-stamped written memorandum prior to the exercise cut-off time detailing the change.

      The rules require member organizations that maintain proprietary or customer account positions in expiring equity options to be responsible for ensuring that Contrary Exercise Advices are communicated to an eligible exchange or directly to OCC (by OCC clearing members) regarding such positions. In addition, member organizations may make arrangements to indicate their final exercise decisions to an OCC clearing member that has accepted the responsibility to submit Contrary Exercise Advices on their behalf. The OCC clearing member shall take reasonable steps to ensure that such decisions are properly submitted to an eligible exchange or directly to OCC.

      Contrary Exercise Advices must be submitted at the place designated by each exchange. In the alternative, Contrary Exercise Advices may be submitted by OCC clearing members directly to OCC via the electronic Clearing Management and Control System (C/MACS). A sample of a Contrary Exercise Advice Form (see Attachment 1) used for manual submission to an exchange is attached, as well as a sample of OCC's automated C/MACS Contrary Exercise Advice page (see Attachment 2), to be used for electronic submissions.

      It should be noted that the responsibility of providing an explanation regarding late submissions or the failure to submit a Contrary Exercise Advice (under the extraordinary circumstance exception of the Rules), is the responsibility of the member or member organization holding the options position, unless that member or member organization has appropriately submitted the instruction to a clearing member that has agreed to make the submission on that member's or member organization's behalf. Explanations relating to extraordinary circumstances must be submitted by members or member organizations to each SRO of which they are a member on the business day following expiration.

      Member organizations may wish to establish a time by which customers must inform them of contrary exercise intentions. Such times should be sufficiently prior to the SROs' exercise cut-off time to allow the clearing member adequate time for the processing of Contrary Exercise Advices.

      It is important to note that, while submission of a Contrary Exercise Advice evidences that a contrary exercise decision was made prior to the exercise cut-off time, it does not serve as an effective notice to OCC to exercise or not exercise the option in question. The Expiration Saturday procedure for the submission of exercise notices to OCC is not affected by these new procedures.

      The primary purpose of these new provisions is to promote fairness among options market participants by ensuring compliance with the SROs' exercise cut-off rules. In this regard, members and member organizations are hereby advised that a decision to either exercise an option that is out-of-the-money, or not exercise an option that is in-the-money, on the basis of news obtained after the exercise cut-off time will be deemed to be conduct inconsistent with just and equitable principles of trade in violation of exchange and NASD rules, and may also be fraudulent activity in violation of the federal securities laws.

      * * *

      Questions regarding the new provisions may be directed to the Market Surveillance representatives at each of the following SROs or OCC:

      AMEX: George Peckman
      (212) 306-1550

      CBOE: Jeffrey Schroer
      (312)786-7716

      NASD: Joseph Alotto
      (301) 590-6845

      NYSE: Hope Duffy
      (212) 656-6197

      OCC: Stan Schretter
      (312)322-4534

      PHLX: Rick McDonald
      (215) 496-5407

      PSE: Thao Ngo
      (415) 393-7957.


      1 American Stock Exchange – Rule 980 Chicago Board Options Exchange – Rule 11.1 National Association of Securities Dealers, Inc. – Uniform Practice Code, Section 63 New York Stock Exchange – Rule 780 Philadelphia Stock Exchange – Rule 1042 Pacific Stock Exchange – Rule 6.24

      2 Under OCC's Exercise-by-Exception procedure, expiring equity options that are 3/4 of a point or more in-the-money for customer accounts and 1/4 of a point or more for firm or market-maker accounts are automatically exercised. Expiring options that are below these parameters, will be exercised only if the OCC clearing member holding the position submits an Exercise Notice to OCC.

      3 An eligible exchange is an exchange of which a member or member organization is a member and which lists a particular option.


      Attachment 1

      PDF TO BE INCLUDED

      Attachment 2

      MM/DD/YY

      THE OPTIONS CLEARING CORPORATION

      CMADE137

      HH:MM:SS

      FIRM 9999 XXXXXXXXXXXXXXXXXXX

       

      CONTRARY EXERCISE INTENTIONS FOR OPTIONS EXPIRING XXXXX, 19XX

      THIS IS NOT AN EXERCISE INSTRUCTION

      CFM

      SUB/ACCT

      QUANTITY

      P

      SYMBOL

      STRIKE

      C

      DOL

      FR

                   
                   
                   

      INSTRUCTIONS:

      1. ENTER THE QUANTITY NOT TO BE EXERCISED IF THE SERIES IS IN THE MONEY BY THE THRESHOLD AND WILL BE EXERCISED BY OCC.

      2. ENTER THE QUANTITY TO BE EXERCISED IF THE SERIES IS NOT IN THE MONEY BY THE THRESHOLD AND WILL NOT BE EXERCISED BY OCC.

      SEQUENCE

      RESPONSE A

      A=ADD

      I=INQUIRE

      PF1=HELP

      PF10=QUIT

      CLEAR=EXIT

    • 94-101 Fixed Income Pricing System Additions, Changes, And Deletions As Of November 28, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Institutional
      Legal & Compliance
      Municipal
      Operations
      Systems
      Trading

      As of November 28, 1994, the following bonds were added to the Fixed Income Pricing System (FIPSSM). These bonds are not subject to mandatory quotation:

      Symbol

      Name

      Coupon

      Maturity

      SHST.GA

      Sheffield Steel Corp.

      12.000

      11/1/01

      CMDC.GA

      Charter Med. Corp.

      11.250

      4/15/04

      FOHO.GG

      Fort Howard Corp.

      8.250

      2/1/02

      YGBR.GA

      Young Broadcasting Inc.

      11.750

      11/15/04

      HRJZ.GA

      Harrahs Jazz Co.

      14.250

      11/15/00

      ORSP.GA

      Orchard Supply Hardware Corp.

      9.375

      2/15/02

      FLCS.GA

      Florsheim Shoe

      12.750

      9/1/02

      MLTT.GA

      Malette Inc.

      12.250

      7/15/04

      As of November 28, 1994, the following change to the list of FIPS symbols occurred:

      New/Old Symbol

      Name

      Coupon

      Maturity

      SYND.GA/SYNT.GA

      Synthetic Ind.

      12.750

      12/1/02

      All bonds listed above are subject to trade-reporting requirements. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-100 Nasdaq National Market Additions, Changes, And Deletions As Of November 28, 1994

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      As of November 28, 1994, the following 37 issues joined the Nasdaq National Market®, bringing the total number of issues to 3,739:

      Symbol

      Company

      Entry Date

      SOES Execution Level

      CVTI

      Covenant Transport, Inc. (Cl A)

      10/28/94

      500

      LION

      Fidelity Southern Corp.

      10/31/94

      200

      BUMM

      B.U.M. International, Inc.

      11/1/94

      200

      HSKL

      Haskel International, Inc. (Cl A)

      11/1/94

      200

      SNIFF

      American Sensors, Inc.

      11/2/94

      200

      AMOO

      AMERCO

      11/3/94

      200

      MICN

      Micrion Corp.

      11/4/94

      200

      NECB

      New England Community Bancorp, Inc.

      11/4/94

      200

      TCAM

      Transport Corporation of America, Inc.

      11/4/94

      500

      AKSEF

      Arakis Energy Corp.

      11/7/94

      200

      CONT

      Continental Waste Industries, Inc.

      11/7/94

      200

      NWSB

      Northwest Savings Bank

      11/7/94

      500

      PCLE

      Pinnacle Systems, Inc.

      11/8/94

      200

      TMAT

      Tele-Matic Corp.

      11/8/94

      1000

      THOM

      Thompson PBE, Inc.

      11/8/94

      500

      YBTVA

      Young Broadcasting, Inc. (Cl A)

      11/8/94

      200

      DPKG

      Dolco Packaging Corp.

      11/9/94

      200

      ELRRF

      Elron Electronic Industries Ltd. (Rts 11/29/94)

      11/10/94

      200

      CNMWR

      Cincinnati Microwave, Inc. (Rts 12/8/94)

      11/10/94

      200

      SINGW

      The Singing Machine Company, Inc. (Wts 11/10/99)

      11/10/94

      500

      SING

      The Singing Machine Company, Inc.

      11/10/94

      500

      NAGCV

      National Gaming Corp. (WI)

      11/14/94

      200

      FLSCV

      The Florsheim Shoe Company (WI)

      11/14/94

      200

      YSH

      Youth Services International, Inc.

      11/15/94

      500

      BIKE

      Cannondale Corp.

      11/16/94

      500

      JPFS

      JP Foodservice, Inc.

      11/16/94

      200

      ORRA

      Orbit Semiconductor, Inc.

      11/16/94

      200

      UTII

      Unitech Industries, Inc.

      11/16/94

      200

      FGCI

      Family Golf Centers, Inc.

      11/17/94

      500

      QUAL

      Quality Semiconductor, Inc.

      11/17/94

      500

      SHVA

      Shiva Corp.

      11/18/94

      200

      ALAB

      Alabama National BanCorporation

      11/22/94

      200

      ITII

      ITI Technologies, Inc.

      11/22/94

      500

      TWSTY

      TeleWest Communications pic (ADR)

      11/22/94

      200

      ADYNF

      Andyne Computing, Ltd.

      11/23/94

      200

      PHYN

      Physician Reliance Network, Inc.

      11/23/94

      500

      LGND

      Ligand Pharmaceuticals, Inc. (Cl B)

      11/25/94

      200

      Nasdaq National Market Symbol And/Or Name Changes

      The following changes to the list of Nasdaq National Market securities occurred since October 28, 1994:

      New/Old Symbol

      New/Old Security

      Date of Change

      BPIEL/BPIEW

      BPI Packaging Technologies, Inc. (Wts A New 3/31/95)/BPI Packaging Technologies, Inc. (Cl A)

      10/31/94

      PNCE/PFBS

      PONCEBANK/Ponce Federal Bank FSB

      11/1/94

      HMIS/HMIS

      Health Management, Inc/Homecare Management, Inc.

      11/4/94

      OUTL/OUTL

      Outlook Group Corp./Outlook Graphics Corp.

      11/14/94

      CYNRW/CYNRW

      Canyon Resources Corp. (Wts 6/30/95)/Canyon Resources Corp. (Wts 12/31/94)

      11/15/94

      ALPS/PRAN

      Allegiant Physician Services, Inc/Premier Anesthesia, Inc.

      11/15/94

      REHB/MDEV

      Rehabilicare, Inc/Medical Devices, Inc.

      11/17/94

      BKCT/SSBB

      Bancorp Connecticut, Inc/Southington Savings Bank (Conn.)

      11/17/94

      FLSC/FLSCV

      Florsheim Shoe Co./Florsheim Shoe Co. (WI)

      11/21/94

      NAGC/NAGCV

      National Gaming Corp./National Gaming Corp. (WI)

      11/28/94

      Nasdaq National Market Deletions

      Symbol

      Security

      Date

      AMSE

      American Mobile Systems, Inc.

      10/28/94

      GRPI

      Greenwich Pharmaceuticals, Inc.

      10/28/94

      PRETB

      Price REIT (Cl B)

      10/31/94

      VMORZ

      Banyan Mortgage Investors L.P. HI (Dep Uts)

      11/1/94

      FWES

      First Western Financial Corp.

      11/1/94

      USCG

      U.S. Capital Group, Inc.

      11/1/94

      BRCK

      Brock Candy Company

      11/2/94

      CFED

      Charter FSB Bancorp, Inc.

      11/2/94

      IGHC

      Intergroup Healthcare Corp.

      11/3/94

      KMDC

      Kirschner Medical Corp.

      11/7/94

      BASER

      Base Ten Systems, Inc. (Ser B Rts 11/10/94)

      11/10/94

      RHNB

      RHNB Corp.

      11/10/94

      SPLE

      Sports/Leisure, Inc.

      11/10/94

      MENJ

      Menley & James, Inc.

      11/11/94

      IPOP

      Input/Output, Inc.

      11/14/94

      KURZE

      Kurzweil Applied Intelligence

      11/14/94

      INFO

      Information America, Inc.

      11/15/94

      SMMT

      Summit Bancorp, Inc. (Wash)

      11/15/94

      GARI

      General Atlantic Resources, Inc.

      11/16/94

      NCSI

      National Convenience Stores, Inc.

      11/16/94

      GWAY

      Gateway Communications, Inc.

      11/17/94

      PFIL

      Purolator Products Company

      11/17/94

      KPTL

      Keptel, Inc.

      11/18/94

      MRVCW

      MRV Communications, Inc. (Wts 12/7/97)

      11/18/94

      AEAGF

      Agnico-Eagle Mines, Ltd.

      11/22/94

      BWRLF

      Breakwater Resources, Ltd.

      11/23/94

      SLIQ

      Scott's Liquid Gold, Inc.

      11/23/94

      KOLL

      Koll Management Services, Inc.

      11/25/94

      LGNDA

      Ligand Pharmaceuticals, Inc. (Cl A)

      11/25/94

      PHIP

      Providential Corp.

      11/25/94

      Questions regarding this Notice should be directed to Mark A. Esposito, Supervisor, Market Listing Qualifications, at (202) 728-8002. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-99 Trade Date-Settlement Date Schedule For 1995

      SUGGESTED ROUTING

      Internal Audit
      Legal & Compliance
      Municipal
      Operations
      Syndicate
      Systems
      Trading

      Martin Luther King, Jr., Day: Trade Date-Settlement Date Schedule

      The schedule of trade dates-settlement dates below reflects the observance by the financial community of Martin Luther King, Jr., Day, Monday, January 16, 1995. On January 16, 1995, The Nasdaq Stock Market™ and the securities exchanges will be open for trading. However, it will not be a settlement date because many of the nation's banking institutions will be closed.

      Trade Date

      Settlement Date

      Reg. T Date*

      Jan. 5

      Jan. 12

      Jan. 16

      6

      13

      17

      9

      17

      19

      10

      18

      20

      11

      19

      23

      12

      20

      24

      13

      23

      25

      16

      23

      25

      17

      24

      26

      Note: January 16, 1995, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board.

      Transactions made on January 16 will be combined with transactions made on the previous business day, January 13, for settlement on January 23. Securities will not be quoted ex-dividend, and settlements, marks to the market, reclamations, and buy-ins and sell-outs, as provided in the Uniform Practice Code, will not be made and/or exercised on January 16.

      *Pursuant to Sections 220.8(b)(1) and (4) of Regulation T of the Federal Reserve Board, a broker/dealer must promptly cancel or otherwise liquidate a customer purchase transaction in a cash account if full payment is not received within two (2) business days after the settlement date of the purchase transaction or, pursuant to Section 220.8(d)(1), make application to extend the time period specified. The date by which members must take such action is shown in the column entitled "Reg. T Date."

      Presidents' Day: Trade Date-Settlement Date Schedule

      The Nasdaq Stock MarketSM and the securities exchanges will be closed on Monday, February 20, 1995, in observance of Presidents' Day, "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date

      Settlement Date

      Reg. T Date*

      Feb. 10

      Feb. 17

      Feb. 22

      13

      21

      23

      14

      22

      24

      15

      23

      27

      16

      24

      28

      17

      27

      Mar. 1

      20

      Markets Closed

      -

      21

      28

      2

      Good Friday: Trade Date-Settlement Date Schedule

      The Nasdaq Stock MarketSM and the securities exchanges will be closed on Good Friday, April 14, 1995. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date

      Settlement Date

      Reg. T Date*

      Apr. 6

      Apr. 13

      Apr. 18

      7

      17

      19

      10

      18

      20

      11

      19

      21

      12

      20

      24

      13

      21

      25

      14

      Markets Closed

      -

      17

      24

      26

      Memorial Day: Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market™ and the securities exchanges will be closed on Monday, May 29, 1995, in observance of Memorial Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date

      Settlement Date

      Reg. T Date*

      May 19

      May 26

      May 31

      22

      30

      June 1

      23

      31

      2

      24

      June 1

      5

      25

      2

      6

      26

      5

      7

      29

      Markets Closed

      -

      30

      6

      8

      T+3 Implementation: Trade Date-Settlement Date Schedule

      The following schedule represents the implementation of the conversion from a five (5) business day settlement cycle to three (3) business days. The Nasdaq Stock MarketSM and the securities exchanges will settle "regular way" transactions on the business days noted below. Wednesday, June 7, 1995 will be the first trade date for the three (3) business day settlement period.

      Trade Date

      Settlement Date

      Reg. T Date*

      May 31

      June 7

      June 9

      June 1

      8

      12

      2

      9

      13

      5

      9

      13

      6

      12

      14

      7

      12

      14

      8

      13

      15

      Note: Transactions made on June 5 will settle in four (4) business days and will be combined with transactions made on the previous business day, June 2, for settlement on June 9. Transactions made on June 6 will settle in four (4) business days and will be combined with transactions made on the next business day, June 7, for settlement on June 12.

      Independence Day: Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market™ and the securities exchanges will be closed on Tuesday, July 4, 1995, in observance of Independence Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date

      Settlement Date

      Reg. T Date*

      June 28

      July 3

      July 6

      29

      5

      7

      30

      6

      10

      July 3

      7

      11

      4

      Markets Closed

      -

      5

      10

      12

      Labor Day: Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market™ and the securities exchanges will be closed on Monday, September 4, 1995, in observance of Labor Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date

      Settlement Date

      Reg. T Date*

      Aug. 29

      Sept. 1

      Sept. 6

      30

      5

      7

      31

      6

      8

      Sept. 1

      7

      11

      4

      Markets Closed

      -

      5

      8

      12

      Columbus Day: Trade Date-Settlement Date Schedule

      The schedule of trade dates-settlement dates below reflects the observance by the financial community of Columbus Day, Monday, October 9, 1995. On this day, The Nasdaq Stock MarketSM and the securities exchanges will be open for trading. However, it will not be a settlement date because many of the nation's banking institutions will be closed.

      Trade Date

      Settlement Date

      Reg. T Date*

      Oct. 2

      Oct. 5

      Oct. 9

      3

      6

      10

      4

      10

      12

      5

      11

      13

      6

      12

      16

      9

      12

      16

      10

      13

      17

      Note: October 9, 1995, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board. Transactions made on Monday, October 9, will be combined with transactions made on the previous business day, October 6, for settlement on October 12. Securities will not be quoted ex-dividend, and settlements, marks to the market, reclamations, and buy-ins and sell-outs, as provided in the Uniform Practice Code, will not be made and/or exercised on October 9.

      Thanksgiving Day: Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market™ and the securities exchanges will be closed on Thursday, November 23, in observance of Thanksgiving Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date

      Settlement Date

      Reg. T Date*

      Nov. 17

      Nov. 22

      Nov. 27

      20

      24

      28

      21

      27

      29

      22

      28

      30

      23

      Markets Closed

      -

      24

      29

      Dec. 1

      Christmas Day and New Year's Day: Trade Date-Settlement Date Schedule

      The Nasdaq Stock MarketSM and the securities exchanges will be closed on Monday, December 25, 1995, in observance of Christmas Day, and Monday, January 1, 1996, in observance of New Year's Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date

      Settlement Date

      Reg. T Date*

      Dec. 19

      Dec. 22

      Dec. 27

      20

      26

      28

      21

      27

      29

      22

      28

      Jan. 2, 1996

      25

      Markets Closed

      -

      26

      29

      3

      27

      Jan. 2, 1996

      4

      28

      3

      5

      29

      4

      8

      Jan. 1, 1996

      Markets Closed

      -

      2

      5

      9

      Brokers, dealers, and municipal securities dealers should use the foregoing settlement dates for purposes of clearing and settling transactions pursuant to the NASD Uniform Practice Code and Municipal Securities Rulemaking Board Rule G-12 on Uniform Practice.

      Questions regarding the application of those settlement dates to a particular situation may be directed to the NASD Uniform Practice Department at (203) 375-9609.

    • 94-98 SEC Approves NASD Listing Requirements Proposal To Prohibit Immediate Delistings Of Units

      SUGGESTED ROUTING

      Corporate Finance
      Legal & Compliance
      Operations
      Trading

      Executive Summary

      On September 20, 1994, the Securities and Exchange Commission approved a proposed rule change by the NASD that amends the listing requirements in Parts II and III of Schedule D to the NASD By-Laws to impose specific delisting requirements for units listed on the Nasdaq National Market® and The Nasdaq SmallCap Market™. The new requirements, which are effective immediately, specifically require:

      • All units included for quotation on Nasdaq® must continue to be included for quotation for a minimum of 30 days from the first day of inclusion, barring suspension or withdrawal for regulatory purposes;

      • Issuers or underwriters seeking to withdraw units from inclusion must provide Nasdaq with notice of intent 15 days before withdrawal; and

      • Issuers of units are required to include in the prospectus or other offering document a statement disclosing any intention to withdraw the units immediately after the minimum inclusion period.

      The NASD and The Nasdaq Stock Market, Inc., believe that these changes will diminish confusion, promote orderly trading markets, and enhance the integrity of Nasdaq listings. The text of the amendments, as approved by the SEC, follows the discussion below.

      Background And Description Of The Rule Change

      The NASD determined the integrity of The Nasdaq Stock MarketSM could be harmed by instances where units were withdrawn without previous notice almost immediately after initially being included for quotation on Nasdaq. The sudden withdrawal, after trading begins, could adversely affect investors and market makers who had taken positions in these securities. In addition, the NASD was concerned that certain issuers and underwriters of units could be engaged in potentially manipulative activity related to immediate delisting of units. The NASD proposed several amendments to the listing criteria for units included for quotation in the Nasdaq National Market and The Nasdaq SmallCap Market. These changes were approved by the SEC.1

      Minimum 30-Day Listing Requirement

      One of the critical problems with the immediate delisting of units was the uncertainty that units would continue to be available for trading for a reasonable period of time after initial listing. To counteract this problem, the new unit listing requirements include a minimum 30-day period for inclusion. Once the issuer and underwriter have obtained a listing on Nasdaq, the units must continue to be listed for 30 days thereafter. This change allows investors and others some certainty that the units will continue in the marketplace for a period of time. Of course, if there are regulatory problems with the units, the NASD retains the authority to remove the listings from trading before the 30-day minimum period expires.

      15-Day Advance Notice Of Withdrawal

      In a related vein, the lack of advance notice to market participants regarding withdrawal of units from listing harmed investors and others. Another change to the units requirements mandates that the issuer or underwriter of the units provide Nasdaq with 15-days notice that it intends to withdraw the units from listing. This notice period, coupled with the 30-day minimum period, should allow investors and market makers sufficient advance opportunity to make reasoned decisions concerning market activity in the units.

      Prospectus Notice Requirement

      Finally, the new rules include a provision that specifies the issuers obligation to provide adequate notice of any intention to withdraw units from listing shortly after final listing. Any such intention should be discussed as material information in the issuer's prospectus or other offering document to provide investors with adequate disclosure of a likely event that would materially affect the value of the securities.

      Questions regarding this Notice should be directed to Eugene A. Lopez, Senior Attorney, Office of General Counsel, at (202) 728-6998.


      1 See Securities Exchange Act Release No. 34-34515 (August 10, 1994); 59 FR 42626 (August 18, 1994).


      Text Of Amendments To Schedule D To The NASD By-Laws

      (Note: New language is underlined.)

      Schedule D

      Part II

      Sec. 1(c)(10)(a) No Change.

      (b) In the case of units, the minimum period for inclusion of the units shall be 30 days from the first day of inclusion, except the period may be shortened if the units are suspended or withdrawn for regulatory purposes. Issuers and underwriters seeking to withdraw units from inclusion must provide the Association with notice of such intent at least 15 days prior to withdrawal.

      Sec. 1(c)(11)–(20) No Change.

      Sec. 1(c)

      (21) The issuer of units shall include in its prospectus or other offering document used in connection with any offering of securities that is required to be filed with the Commission under the federal securities laws and the rules and regulations thereunder a statement regarding any intention to delist the units immediately after the minimum inclusion period.

      Sec. 1(c)(22) – Sec. 4 No Change.

      Sec. 5

      (1) Units
      (1) Minimum Inclusion Period and Notice of Withdrawal

      In the case of units, the minimum period for inclusion of the units shall be 30 days from the first day of inclusion, except the period may be shortened if the units are suspended or withdrawn for regulatory purposes. Issuers and underwriters seeking to withdraw units from inclusion must provide the Association with notice of such intent at least 15 days prior to withdrawal.
      (2) Disclosure Requirements for Units

      Each Nasdaq/NM issuer of units shall include in its prospectus or other offering document used in connection with any offering of securities that is required to be filed with the Commission under the federal securities laws and the rules and regulations promulgated thereunder a statement regarding any intention to delist the units immediately after the minimum inclusion period.

    • 94-97 Treasury Proposes Risk Assessment Rules For Government Securities Broker/Dealers

      Comment Period Expires January 17, 1995

      SUGGESTED ROUTING

      Senior Management
      Government Securities
      Internal Audit
      Legal & Compliance

      Executive Summary

      The Department of the Treasury (Treasury) is publishing for comment proposed amendments under the Government Securities Act of 1986 (GSA). The amendments would establish risk assessment rules for government securities broker/dealers registered under Section 15C (Section 15C broker/dealers) of the Securities Exchange Act of 1934 that parallel similar Securities and Exchange Commission (SEC) rules already in place for broker/dealers that conduct a general or municipal securities business. Comments are due on or before January 17, 1995.

      Background And Description Of Proposed Amendments

      The Market Reform Act of 1990 (the Reform Act) was passed by Congress in response to several developments in the securities markets, including the bankruptcy of Drexel Burnham Lambert Group, Inc. (Drexel) in February 1990. Among its provisions, the Reform Act authorized the SEC to promulgate risk assessment rules for broker/dealers holding company structures and authorized Treasury to promulgate risk assessment rules for registered government securities broker/dealers.

      Risk assessment rules are intended to provide greater warning of situations, such as the Drexel failure, which could have a significant impact on the functioning of the markets and investors in general. The SEC adopted its risk assessment rules in July 1992. Treasury, whose rulemaking authority under the GSA expired on October 1, 1991, and was not renewed until December 17, 1993, was unable to issue proposed risk assessment rules until now.

      Treasury's proposed risk assessment rules incorporate SEC Rules 17h-1T and 17h-2T, with minor modifications. In general, the recordkeeping amendments require Section 15C broker/dealers to maintain and preserve records concerning the financial and securities activities of affiliates whose business activities are reasonably likely to have a material impact on the financial or operational condition of the Section 15C broker/dealers. The reporting amendments would require Section 15C broker/dealers to file with the SEC quarterly summary reports of this information.

      The information required to be maintained and reported by the firms pertains only to the firms' "material associated persons" (MAPs). A number of factors that should be considered when determining which affiliates, or associated persons, might have a "material" impact on the broker/dealer's financial or operational conditions are incorporated as guidelines in SEC Rule 17h-1T. The initial designation of MAPs will be made by the Section 15C broker/dealers.

      Information To Be Maintained And Reported

      The proposed amendments would require the following general categories of information to be maintained and reported:

      • an organizational chart of the holding company structure, showing the registered government securities broker/dealer and all its associated persons, including a designation of which associated persons are MAPs;

      • written risk management policies and procedures;

      • information on material legal proceedings to which the registered government securities broker/dealer or a MAP is a party or to which any of its property is subject, as would be required to be disclosed by all firms under generally accepted accounting principles;

      • quarterly consolidated and consolidating balance sheets and income statements;

      • quarterly consolidated cash flow statements for the registered government securities broker/dealer and the highest level holding company that is a MAP;

      • aggregate, gross long and short securities and commodities positions held by each MAP at quarter-end (and month-end if greater than quarter-end);

      • a separate listing of each single unhedged securities or commodities position, other than U.S. Treasury securities, held by each MAP that exceeds the "materiality threshold" at any month-end;

      • data on certain financial instruments with off-balance sheet risk and concentration of credit risk, such as gross long and short positions in when-issued securities, written stock options, futures, forwards, interest rate swaps, other swaps, foreign exchange, commodities, loan commitments, commercial letters of credit, assets sold with recourse, and a summary of delta or similar analysis if available; and

      • data on bridge loans and other material unsecured extensions of credit by each MAP, funding sources for the registered government securities broker/dealer and each MAP, and real estate activities conducted by each MAP.

      Exemptions

      The proposed amendments would exempt a Section 15C broker/dealer if it:

      • does not carry customer accounts and maintains capital of less than $20 million;

      • maintains capital of less than $250,000 (regardless of whether it carries customer accounts or not); and

      • has an affiliated registered broker/ dealer that is subject to, and in compliance with, the SEC's risk assessment rules, and provided that all of the MAPs of the Section 15C broker/dealer are also MAPs of the registered broker/dealer.

      A Section 15C broker/dealer that has no affiliates or holding company would not be subject to Treasury's risk assessment rules.

      Special Provisions

      The proposed amendments would allow affiliated Section 15C broker/dealers to request in writing that Treasury permit one of the firms (a "reporting registered government securities broker/dealer") to maintain and report risk assessment information on behalf of the other firms.

      Treasury also is proposing to adopt the SEC's special provisions for affiliates that are already subject to supervision by certain U.S. or foreign financial regulatory authorities. With respect to such affiliates, Section 15C broker/dealers would be deemed in compliance with the financial and securities recordkeeping requirements by maintaining copies of reports mat such affiliates already submit to other regulators; however, they would be required to maintain organizational charts, risk management policies, and records of legal proceedings, and submit that information to the SEC.

      * * *

      Treasury's request for comments appeared in the November 15, 1994, Federal Register. Members wishing to comment on the proposed amendments have until January 17, 1995, to do so. Comment letters should be sent to:

      Government Securities
      Regulations Staff
      Bureau of the Public Debt
      Department of the Treasury
      999 E Street, NW
      Room 515
      Washington, DC 20239-0001.

      Members are requested to send copies of their comment letters to:

      Ms. Joan Conley
      Corporate Secretary
      National Association of Securities Dealers, Inc.
      1735 K Street, NW
      Washington, DC 20006-1500.

      Questions concerning this Notice may be directed to Erin Gilligan, NASD Compliance Department, at (202) 728-8946.

    • 94-96 NASD Requests Comment On Disclosure Of Partnership Valuations On Customer Account Statements

      Comment Period Expires January 31, 1995

      SUGGESTED ROUTING

      Senior Management
      Internal Audit
      Legal & Compliance
      Operations
      Systems

      Executive Summary

      The NASD requests comments on proposed amendments to Article in, Section 45 of the Rules of Fair Practice that would require certain disclosures and reporting of Direct Participation Program (DPP) securities on customer account statements. Units of limited partnership interest are the most common DPP security held in customer accounts. The proposed amendments generally require that DPP securities held by the member or listed on a customer account statement be segregated from other securities. DPP securities may then be listed on the account statement without a price and include a statement that accurate pricing information is not available where no active secondary market exists. If, however, a DPP security is listed on the account statement with a price, the amendments would prohibit the value from being aggregated with the value of other securities held for the customer, or included in any calculation of net worth of the customer's securities. The member would also be required to provide a statement disclosing the method by which the value was obtained or derived, and advise the customer that DPP securities are generally illiquid and thus the value disclosed may not be realized if the customer needs to sell the security in the near future.

      Background

      The NASD Direct Participation Programs Committee (DPP Committee or Committee) has studied the issues surrounding how DPP security values are reported to investors on customer account statements. The issues addressed by the Committee were also reviewed and endorsed by the NASD Operations Committee. Both Committees recommended to the NASD Board of Governors that amendments to Article III, Section 45 of the Rules of Fair Practice be proposed for member comment.

      The DPP Committee recognizes that some members report purchase price as the value of partnership interests on customer account statements, which is usually not equivalent to the current market value. Further, members that list DPP securities at purchase price tend to include that amount in the aggregate total current value of all securities held in the customer's account. The Committee is particularly concerned about this practice because DPP securities are generally illiquid and the purchase price probably has no relationship to current value.

      The Committee also reviewed issues that arise when members report partnership securities on customer account statements without a price. This is a growing practice that reflects the difficulty of arriving at a definitive current value for DPP securities because this type of security does not generally have an active secondary market.

      The Committee is, however, also aware of both regulatory and practical business considerations that might make it desirable for a member to disclose a value for DPP securities on a customer account statement. For example, when members act as fiduciaries for individual retirement accounts or ERISA plans, the regulations on the Departments of Labor and Treasury require that at least annually, a value be obtained or derived, and reported. Thus, members acting as fiduciaries often report a value for these types of accounts on the customer account statement. The Committee also noted that often the only reliable source of obtaining information on the value of DPP securities is the general partner.

      The Committee is also aware that recently some members, general partners, and independent third-party services have begun to utilize sophisticated valuation methodologies to derive a value for DPP securities. These methodologies include the appraisal of the underlying assets, an analysis of income expected to be earned by the partnership, discounted to a current value, or an analysis of recent sales. The Committee believes that because the values obtained or derived through these methodologies could be beneficial if disclosed to investors, the proposed amendments provide for them to appear on the customer account statement.

      Explanation Of Provisions

      The proposed amendments set forth a general requirement that DPP securities listed on a customer account statement (even if not held by the member) must be segregated into a separate location from other securities on the customer account statement. This can be accomplished by grouping all DPP securities and placing them, for example, below a demarcation line on the statement. This requirement also covers any description of DPP securities listed by the member on an account statement even if the actual security is not held in possession or control of the member. This provision recognizes that often DPP securities were originally sold in uncertificated form and therefore, the member and customer are aware of the investment, even though physical securities do not exist. Thereafter, DPP securities may be listed as priced or unpriced as more specifically described below, so long as there is compliance with the disclosure provisions of the proposed amendments.

      If a customer's ownership of DPP securities is listed without a price and there is no active secondary market in the securities, the proposal would require a member to include a narrative statement that explains the difficulty of pricing DPP securities because no active secondary market exists. If a value is disclosed for DPP securities, it must not be aggregated with other non-DPP securities to arrive at a total value of the securities held in the customer account. Further, the methodologies utilized for obtaining or deriving the value of DPP securities must be adequately disclosed and a disclaimer must be included that indicates the value may not be realizable if the customer seeks to liquidate its DPP securities in the near future.

      Request For Comments

      The NASD encourages all members and other interested parties to comment on the proposed amendments. Comments should be addressed to:

      Joan C. Conley
      Office of the Secretary
      National Association of Securities
      Dealers, Inc.
      1735 K Street, NW
      Washington, DC 20006-1506

      Comments must be received no later than January 31, 1995.

      Comments received by this date will be reviewed by the Direct Participation Programs and Operations Committees and the NASD Board of Governors. Before becoming effective, the proposed amendments must be filed with and approved by the Securities and Exchange Commission.

      Questions concerning this Notice may be directed to Charles L. Bennett, Director, Corporate Financing Department at (301) 208-2736.

      Text Of Proposed Rule

      (Note: New text is underlined.

      Deleted text is bracketed.)

      Customer Account Statements

      Sec. 45.

      (a) Each general securities member shall, with a frequency of not less than once every calendar quarter, send a statement of account containing a description of any securities positions, money balances, or account activity to each customer whose account had a security position, money balance, or account activity during the period since the last such statement was sent to the customer. Where the securities positions or account activity reported to the customer include direct participation program securities (even if not held by the member), the statement of account shall:
      (1) segregate the direct participation program securities into a separate location on the customer account statement:
      (2) if the direct participation program securities are listed without a price and there is no active secondary market in the securities, include a statement that accurate pricing information is not available because the value of the direct partnership program security is not determinable until the liquidation of the partner ship and no active secondary market exists: and
      (3) if the direct participation program securities are listed with a price,
      (i) not aggregate the value of direct participation program securities with the value of any other securities:
      (ii) not include the value of direct participation program securities in any customer account net worth calculation:
      (iii) include a statement of the methodology used for obtaining or deriving the valuation of the direct participation program securities: and
      (iv) include a statement that direct participation program securities are generally illiquid securities and the price listed may not be realizable if the customer seeks to liquidate the
      (b) For purposes of this section, the term "account activity" shall include, but not be limited to, purchases, sales, interest credits or debits, charges or credits, dividend payments, transfer activity, securities receipts or deliveries, and/or journal entries relating to securities or funds in the possession or control of the member.
      (c) For purposes of this section, the term "general securities member" shall refer to any member which conducts a general securities business and is required to calculate its net capital pursuant to the provisions of SEC Rule 15c3-1(a), except for paragraph (a)(2) and (a)(3).

      Notwithstanding the foregoing definition, a member which does not carry customer accounts and does not hold customer funds and securities is exempt from the provisions of this section.
      (d) The Association, acting through its Operations Committee, may, pursuant to a written request for good cause shown, exempt any member from the provisions of this section.

      [Sec. 45 added effective January 31, 1993.]

    • 94-95 NASD Requests Comment On Proposed Customer Complaint Rules

      Comment Period Expires January 31, 1995

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance
      Registration

      Executive Summary

      The National Association of Securities Dealers, Inc. (NASD) requests comments on a proposed amendment to Article III of the Rules of Fair Practice (Rules) to require members to report to the NASD the occurrence of specified events and quarterly summary statistics concerning customer complaints. The proposed rule would provide important new regulatory information that will assist the NASD in the timely identification of problem members, branch offices, and registered representatives in order to more aggressively detect and investigate sale practice violations. If adopted, the proposed rule would significantly parallel comparable provisions of existing Rule 351 of the New York Stock Exchange (NYSE). The text of the proposed rule follows this Notice.

      Background

      In view of increasing concerns about sales practice abuses of some registered representatives associated with broker/dealers, the NASD's regulation program for 1994 required each District Office to identify and conduct intense sales practice examinations of main offices, branch offices, and individuals associated with such offices who may pose certain regulatory concerns due to, among other things, past misconduct related to abusive sales and trading practices.

      In this regard, the NASD has developed an interim automated system that draws on the Central Registration Depository (CRD) and NASD internal regulatory systems to profile and analyze the current registered representative population. When incorporated with NASD regulatory systems that contain, for example, information about all examinations, District Business Conduct Committee (DBCC) disciplinary actions, customer complaints, and terminations for cause, the NASD has the capacity to more precisely and expeditiously profile registered representatives that pose regulatory risks to public investors.

      Over the past several years, the NASD has taken a number of actions to increase sanctions for sales practice violations, to emphasize improving the hiring and termination practices of member firms, and to commit additional resources to sales practice cases. Member supervisory systems, practices, and procedures also remain the subject of increased scrutiny. Members employing individuals with a history of compliance or disciplinary problems have also been made aware of their heightened standard of supervisory responsibility that demands that special supervisory practices be designed to address the particular problems of those individuals.

      In furtherance of its varied initiatives to address sales practice abuses and supervisory concerns, the NASD is proposing an amendment to Article III of the Rules that will significantly strengthen the NASD's regulatory and surveillance efforts by requiring member firms to report to the NASD the occurrence of certain specified events and summary statistics concerning customer complaints. If adopted, the proposed NASD rule would significantly parallel comparable provisions of NYSE Rule 351.

      Critical material information identified in the proposed rule, such as reports on statutory disqualifications, internal disciplinary actions, and quarterly statistical data regarding customer complaints received by a member is not required by Form U-4 or other required filings made with the NASD. As such, this information is not available to the NASD staff on a routine, systematic, or timely basis. In this regard, the NASD believes that the affirmative obligation of members to provide the NASD with notice of certain events concerning member firms or their associated persons will significantly enhance the NASD's ability to quickly identify problem representatives and appropriately respond in a timely manner.

      The Securities and Exchange Commission (SEC) supported the NASD adoption of a customer complaint reporting rule similar to NYSE Rule 351 in its Large Firm Project Report issued in conjunction with a cooperative effort involving the NASD, SEC, and NYSE that examined the hiring and retention practices of nine of the largest broker/dealers in the United States. Similarly, the General Accounting Office (GAO) in its report titled Securities Markets: Actions Needed to Better Protect Investors Against Unscrupulous Brokers, recommended that member firms' customer complaint information be computer captured and utilized as an additional tool by regulators for identifying potentially problem firms.

      Summary Of The Proposed Amendments

      As proposed, Subsection (a) of the rule requires member firms to file a report with the NASD when any of 10 different specified events occurs. These 10 events vary significantly, ranging from situations where a court, government agency, or self-regulatory organization (SRO) has determined there has been a violation of the securities laws, to circumstances where a firm has received a written customer complaint alleging theft or misappropriation of funds or securities, or forgery. Subsection (b) of the proposed rule requires each person associated with an NASD member to properly report to the member the existence of any of the 10 conditions set forth in Subsection (a) of the proposed rule.

      Subsection (c) of the rule further requires members to report to the NASD statistical and summary information regarding written customer complaints received by the member firm or relating to the firm or any of its associated persons. Importantly, Subsection (e) of the proposed rule eliminates the possibility of unnecessary regulatory duplication by providing an exemption from filing with the NASD for members already subject to similar reporting requirements of another SRO. NYSE Rule 351 is the only such rule in place at this time.

      Recision Of Schedule C, Part V

      Currently, Part V of Schedule C to the NASD By-Laws requires members to promptly notify the NASD in writing of any disciplinary action that the member takes against any of its associated persons involving suspension, termination, the withholding of commissions or imposition of fines in excess of $2,500, or any other significant limitation on activities. As this existing disclosure requirement is incorporated into the proposed rule in Subsection (a)(10), the NASD proposes to rescind this part of Schedule C with the adoption of the new rule.

      Request For Comment

      The NASD asks members and other interested persons to comment on the proposed amendment to the Rules of Fair Practice. Comments should be directed to:

      Ms. Joan Conley
      Corporate Secretary
      National Association of Securities Dealers, Inc.
      1735 K Street, NW
      Washington, DC 20006-1500.

      Comments must be received no later than January 31, 1995. Comments received by this date will be considered by the Board. Before becoming effective, the rule must be adopted by the Board and the membership and then filed with the SEC for its approval.

      Text Of Proposed Rule

      (Note: New language is underlined.)

      Reporting Requirements

      Section

      (a) Each member should promptly report to the Association whenever such member or person associated with the member:
      (1) has violated any provision of any securities law or regulation, or rule or standards of conduct of any governmental agency, self-regulatory organization, or business or professional organization, or engaged in conduct which is inconsistent with just and equitable principles of trade;
      (2) is the subject of any written customer complaint involving allegations of theft or misappropriation of funds or securities or of forgery:
      (3) is named as a defendant or respondent in any proceeding brought by a regulatory or serf-regulatory body alleging the violation of any provision of the Securities Exchange Act of 1934, or any other federal or state securities, insurance, or commodities statute, or of any rule or regulation thereunder, or of any provision of the By-Laws, rules or similar governing instruments of any securities, insurance or commodities regulatory or self-regulatory organization:
      (4) is denied registration or is expelled, enjoined, directed to cease and desist, suspended or otherwise disciplined by any securities, insurance or commodities industry regulatory or serf-regulatory organization or is denied membership or continued membership in any such self-regulatory organization: or is barred from becoming associated with any member of any such serf-regulatory organization:
      (5) is arrested, arraigned, indicted, or convicted of. or pleads guilty to. or pleads no contest to. any criminal offense (other than minor traffic violations):
      (6) is a director, controlling stockholder, partner, officer or sole proprietor of, or an associated person with, a broker-dealer, investment company, investment advisor, underwriter or insurance company which was suspended, expelled or had its registration denied or revoked by any agency, jurisdiction or organization or is associated in such a capacity with a bank, trust company or other financial institution which was convicted of or pleaded no contest to. any felony or misdemeanor:
      (7) is defendant or respondent in any securities or commodities-related civil litigation or arbitration which has been disposed of by judgement, award or settlement for an amount exceeding $15.000. However, when the member is defendant or respondent, then the reporting to the Association shall be required only when such judgement, award or settlement is for an amount exceeding $25.000:
      (8) is the subject of any claim for damages by a customer, broker, or dealer which is settled for an amount exceeding $15.000. However, when the claim for damages is against a member, then the reporting to the Association shall be required only when such claim is settled for and amount exceeding $25.000:
      (9) is. or learns that he is associated in any business or financial activity with any person who is. subject to a "statutory disqualification" as that term is defined in the Securities Exchange Act of 1934. and shall include with required reports the name of the person subject to the statutory disqualification and detail concerning the disqualification:
      (10) is the subject of any disciplinary action taken by the member against any person associated with the member involving suspension, termination, the withholding of commissions or imposition of fines in excess of $2.500. or otherwise disciplined in any manner which would have significant limitation on the individual's activities on a temporary or permanent basis.
      (b) Each person associated with a member shall promptly report to the member the existence of any of the conditions set forth in paragraph (a) of misrule.
      (c) Each member shall report to the Association statistical and summary information regarding customer complaints in such detail as the Association shall specify by the 15th day of the month following the calendar quarter in which customer complaints are received by the member. For the purposes of this paragraph, "customer" includes any person other than a broker or dealer with whom the member has engaged, or has sought to engage, in securities activities, and "complaint" includes any written grievance by a customer involving the member or person associated with a member.
      (d) Nothing contained in paragraph (a), (b), and (c) of this Section shall eliminate, reduce, or otherwise abrogate the responsibilities of a member or person associated with a member to promptly file with full disclosure, required amendments to Form BD, Forms U-4 and U-5, or other required filings, and to respond to the Association with respect to any customer complaint, examination, or
      (c) Any member subject to substantially similar reporting requirements of another self-regulatory organization of which it is a member is exempt from the provisions of this Section.

    • 94-94 NASD Requests Comment On Proposed Rule Governing Members Operating On Bank Premises;

      Comment Period Expires February 15, 1995

      SUGGESTED ROUTING

      Senior Management
      Advertising
      Legal & Compliance
      Mutual Fund

      Executive Summary

      The National Association of Securities Dealers, Inc. (NASD) requests comment on proposed amendments to the NASD Rules of Fair Practice to adopt rules governing broker/dealers operating on the premises of financial institutions. The proposed rules adopt investor protection principles that are substantially similar to those embodied in a recent no-action letter issued by the staff of the Securities and Exchange Commission (SEC) to the Chubb Securities Corporation (the Chubb Letter). In particular, the Chubb Letter addresses broker/dealer networking agreements with financial institutions. The proposed rules respond to continuing concerns about the lack of clear guidance for NASD members in the nature of specific rules or regulations that address the activities of bank-affiliated and networking broker/dealers operating on the premises of financial institutions. The text of the proposed rules follows this Notice.

      Background

      On November 24, 1993, the SEC staff issued the Chubb Letter that describes the SEC's policy regarding certain broker/dealers operating on the premises of financial institutions. Following the release of the Chubb Letter, on February 15, 1994, the four banking agencies—the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision— issued an Interagency Statement on Retail Sales of Non-deposit Investment Products (the Interagency Statement). The Interagency Statement adopts many of the investor protection concepts of the Chubb Letter and directs banks to follow these principles when making direct sales of securities to customers and overseeing the activities of NASD members selling securities on the premises of financial institutions.

      To assist members doing business on the premises of financial institutions in their efforts to comply with the NASD Rules of Fair Practice, the federal securities laws, and applicable banking regulations, Notice to Members 94-47 advised these members of the policies described in the Chubb Letter and the Interagency Statement. Bank-affiliated members and members participating in bank networking arrangements previously had been advised by the NASD to take precautions to protect investors by addressing issues of investor confusion.

      In particular, Notice to Members 94-16 reminded members of mutual fund sales practice obligations, citing the explosive growth of fund sales by bank-affiliated and networking broker/dealers. Similarly, Notice to Members 93-87 provided members guidance for reinvestment of maturing certificates of deposits in mutual funds, focusing on NASD members affiliated with financial institutions or participating in networking arrangements. Among other things, Notice to Members 93-87 described the specific disclosure requirements for money market, fixed income, and equity funds, and pointed out specific concerns that may arise in connection with sales of mutual funds on bank premises.

      Regulatory Need For The Proposed Rules

      Although the Chubb Letter provides regulatory guidance for some members operating on the premises of financial institutions, the NASD believes further action is required to establish uniform and consistent standards to govern this activity.

      Most significantly, the Chubb Letter focuses on broker/dealer networking arrangements and, in this regard, presents some uncertainties as to the regulatory obligations of bank-affiliated broker/dealers. Accordingly, action is needed to ensure the existence of a level playing field for bank-affiliated members and members operating on the premises of banks pursuant to networking agreements. Further, because the Chubb Letter is a "no-action" position, it may be viewed as a guideline or an interpretive position rather than a required rule or regulation designed to protect investors.

      Description Of The Proposed Rules

      The proposed rules apply exclusively to the activities of NASD members that are conducting broker/dealer services on the premises of a financial institution where retail deposits are taken. Although applicable to all customers of such members, the main focus of the proposed rules is to minimize confusion by retail customers. Broker/dealer services are defined as services that include, but are not limited to, conducting an investment banking business, recommending any security, giving investment advice, describing investment vehicles, discussing the merits of any security or type of security with a customer, exercising judgment regarding securities and investment alternatives, accepting customer orders, transmitting orders, or handling customer funds or securities.

      The proposed new rules also require that a member operating on the premises of a financial institution enter into a written agreement with the financial institution that describes the responsibilities of the parties to the agreement and the conditions to the agreement. Conditions for conducting broker/dealer services on the premises of a financial institution include the member's physical location, customer disclosure, compensation, supervisory responsibilities, solicitation of customers, and communications with the public.

      This written "Networking and Brokerage Affiliate Agreement" required by the proposed rules must stipulate that the broker/dealer will have exclusive responsibility for securities activities conducted through the broker/dealer at its location at the financial institution. Significantly, the agreement must contain provisions whereby the member agrees to notify the financial institution if any associated person of the member who is also an employee of the financial institution (dual employee) is terminated for cause by the member.

      In turn, pursuant to the terms and conditions of the written agreement, the financial institution must agree to allow supervisory personnel of the member, and representatives of the SEC and the NASD, to have access to the financial institution's premises where the member conducts broker/dealer activities in order to conduct examinations and carry out any other regulatory responsibilities with regard to the member. Further, the financial institution must agree to monitor the unregistered employees of the financial institution to ensure that they perform only clerical- and ministerial-related functions with regard to investment-related services.

      The written agreement also must stipulate that the financial institution agrees that unregistered employees of the financial institution will not receive any compensation, cash or non-cash, that is based on the effectiveness or the success of referrals of financial institution customers to the member. Importantly, the written agreement must contain provisions whereby the financial institution agrees that any dual employee whom the member suspends from association with the member, or whom the SEC, the NASD, or any other regulatory or serf-regulatory organization bars or suspends from association with the member or any other broker/dealer, will be terminated or suspended, respectively, from any securities activities conducted directly by the financial institution.

      To minimize customer confusion, the proposed rules require that the member's broker/dealer services be conducted in a physical location distinct from the area where retail deposits of the financial institution are taken. Member's disclosure obligations require that, when an account is opened, the member obtain a written acknowledgement from each customer that products purchased or sold by the member:

      • are not insured by the Federal Deposit Insurance Corporation;

      • are not deposits or obligations of the financial institution;

      • are subject to investment risks, including possible loss of principal invested; and

      • are not protected by the Securities Investor Protection Corporation (SIPC) as to loss of principal.

      The compensation conditions of the proposed rules prohibit the member from making any payments, including referral fees, to individuals employed with the financial institution who are not registered with the member. Broker/dealer services offered by the member are required to be provided only by persons associated with the member. To comply with the supervisory requirements of Article III, Section 27 of the NASD Rules of Fair Practice, associated persons must be properly supervised by the member in light of the member's particular activities conducted at the financial institution. To that end, the rules require that the member designate a registered principal to supervise its associated persons at its location at the financial institution, and the member is further required to register its location at the financial institution as a branch office.

      With regard to the member's communications with the public and the solicitation of customers, the rules stipulate that materials used to promote the member's broker/dealer services will be deemed to be materials of the member, and, as such, must be in compliance with Article III, Section 35 of the NASD Rules of Fair Practice. Additionally, the rules address the manner in which the financial institution may be referenced in advertising and promotional materials so as to ensure that it is clear that the broker/dealer services are provided by the member and not the financial institution. Finally, the rules prohibit the member from using confidential financial information maintained by the financial institution to solicit customers for its broker/ dealer services.

      Request For Comment

      The NASD asks members and other interested persons to comment on the proposed amendments to the NASD Rules of Fair Practice. Comments should be directed to:

      Ms. Joan Conley
      Corporate Secretary
      National Association of Securities Dealers, Inc.
      1735 K Street, NW
      Washington, DC 20006-1500.

      Comments must be received no later than February 15, 1995. Comments received by this date will be considered by the Board. Before becoming effective, the rule amendments must be adopted by the Board and the membership and then filed with the SEC for its approval.

      Text Of Proposed Rule

      (Note: New language is underlined.)

      Broker-Dealer Conduct on Premises of Financial Institution

      (a) Applicability

      This section shall apply exclusively to the activities of NASD members that are conducting broker-dealer services on the premises of a financial institution where retail deposits are taken. This section does not alter or abrogate members' obligations to comply with other applicable NASD rules, regulations, and requirements, nor those of bank regulatory authorities which may govern members operating on the premises of financial institutions.
      (b) Definitions
      (1) "Financial institution" shall mean federal and state chartered banks, savings and loan associations, savings banks, credit unions, and the service corporations of such institutions.
      (2) "Networking arrangement" shall mean a contractual arrangement between a member and a financial institution pursuant to which agreement the member conducts broker-dealer services for customers of the financial institution and the general public on the premises of such financial institution, without the financial institution, any required service corporation, or their respective non-registered employees registering as broker-dealers under the Securities Exchange Act of 1934 ("Exchange Act").
      (3) "Brokerage affiliate of a financial institution" shall mean a member which is controlled by. or under common control with a non-member financial institution as defined in Schedule E of the NASD By-Laws.
      (4) "Dual employees" shall mean associated persons of the member who are also employees of the financial institution.
      (5) "Broker-dealer services" offered through an NASD member include, but are not limited to. conducting an investment banking business, recommending any security, giving investment advice, describing investment vehicles, discussing the merits of any security or type of security with a customer, exercising judgment regarding securities and investment alternatives, accepting customer orders, transmitting orders, or handling customer funds or securities.
      (c) Conducting broker-dealer services on the premises of a financial institution shall be conditioned upon the initial and continuing compliance with the following requirements:

      Physical Location

      (1) The member's broker-dealer services shall be conducted in a physical location distinct from the area where the financial institution's retail deposits are taken and identified in a manner that clearly segregates and distinguishes the broker-dealer services from the activities of the financial institution. In all settings, it is incumbent upon the member to distinguish the broker-dealer services from the activities of the financial institution.

      Signage

      (2) The member's name shall be clearly displayed in the area in which the member conducts its broker-dealer services. In no event shall signs regarding the broker-dealer services appear in the financial institution's deposit-taking area.

      Branch Office Registration

      (3) The member must register as a branch office any of its offices which operates on the premises of a financial institution. As interpreted by the NASD Board of Governors. Article III. Section 27 of the NASD Rules of Fair Practice defines branch office to include any office location that:
      (A) operates from public areas of buildings, such as bank branches, even when such locations are temporarily staffed:
      (B) advertises an address in any public media;
      (C) publicly displays signage; or
      (D) performs any function of an office of supervisory jurisdiction as defined by Article III, Section 27.

      Networking and Brokerage Affiliate Agreements

      (4) Networking and brokerage affiliate arrangements between a member and a financial institution must be governed by a written agreement that sets forth the responsibilities of the parties, the conditions of the arrangement, and the compensation to be received by the financial institution. The agreement must contain provisions whereby the financial institution agrees:
      (A) to allow supervisory personnel of the member, representatives of the Securities and Exchange Commission ("SEC"), and the NASD to have access to the financial institution's premises where the member conducts broker-dealer services in order to inspect the books and records and other relevant information maintained by the member with respect to broker-dealer services:
      (B) to monitor the activities of the employees of the financial institution who are not registered with the broker-dealer, and ensure their compliance with the limits on their permissible activities with respect to securities transactions and non-deposit broker-dealer services:
      (C) to permit the member to conduct periodic reviews to assure that the financial institution and its unregistered employees comply with the limits on their activities with respect to securities transactions and non-deposit broker-dealer services:
      (D) that any dual employee whom the member suspends from association with the member, or the SEC, the NASD, or any other regulatory or self-regulatory organization bars or suspends from association with the member or any other broker or dealer will be terminated or suspended, respectively, from all securities activities conducted directly by the financial institution: and
      (E) that unregistered employees of the financial institution will not receive any compensation, cash or non-cash, that is based on the effectiveness or the success of referrals of customers of the financial institution to the member.
      (5) The written agreement must contain provisions whereby the member agrees to notify the financial institution if any dual employee who is associated with the member is terminated for cause by the member.

      Personnel Registration/Associated Persons

      (6) Broker-dealer services offered by the member may be provided only by persons associated with the member, including dual employees who are registered and qualified as necessary with the NASD, and any appropriate state, or other self-regulatory authorities, provided however, that unregistered employees may provide clerical and ministerial assistance.

      Compensation of Registered/Unregistered Persons

      (7)
      (A) The amount of any transaction-related compensation paid to the member's registered representatives-including dual employees, acting under a networking arrangement or as associated persons of a brokerage affiliate of a financial institution, shall be determined solely by the member. Transaction-related compensation may be paid to dual employees by the employer financial institution with a clear designation that such payments are made on behalf of the member.
      (B) Employees of the financial institution who are not registered with the NASD member may not engage in any broker-dealer services on behalf of the member, nor receive any compensation from the member, cash or non-cash, in connection with but not limited to the referral of customers of the financial institution to the member, or locating or introducing customers of the financial institution to the member.

      Supervision and Responsibility

      (8)
      (A) The member shall establish, maintain, and enforce written procedures to supervise all broker-dealer services conducted by the member and its associated persons at its location at the financial institution. A designated principal of the member shall supervise registered personnel at the member's location at the financial institution. Pursuant to its responsibilities as a designated principal as set forth in Article III, Section 27 of the NASD Rules of Fair Practice, the designated principal shall review the member's supervisory system and written procedures and, where appropriate, recommend action by the member designed to achieve compliance with the applicable securities laws, regulations, and rules of the NASD.
      (B) The member shall notify and make available to all of its associated persons the written procedures that govern the broker-dealer services conducted at the financial institution to its associated persons. The supervisory procedures governing the broker-dealer services conducted at the financial institution shall be amended by the member as appropriate within a reasonable time after changes occur in applicable securities laws and regulations, including the rules of the NASD, and the member shall be responsible for communicating amendments to all associated persons engaged in broker-dealer services at its location at the financial institution.
      (C) The member shall make available to the financial institution, for distribution to its employees, written procedures that specify the limits of the permissible activities of unregistered persons.

      Customer Disclosure and Written Acknowledgment

      (9) At the time an account is opened, the member must obtain from each customer a separate written acknowledgment that the securities products purchased or sold by the member through offices located on the premises of the financial institution:
      (A) are not insured by the Federal Deposit Insurance Corporation ("FDIC"):
      (B) are not deposits or other obligations of the financial institution and are not guaranteed by the financial institution:
      (C) are subject to investment risks, including possible loss of the principal invested: and
      (D) are not insured by the Securities Investors Protection Corporation ("SIPC") as to the loss of principal amounts invested.

      Solicitation

      (10) The member shall not use confidential financial information maintained by the financial institution to solicit customers for its broker-dealer services.

      Communications with the Public

      (11)
      (A) All member communications with the public must be in compliance with Article III. Section 35 of the NASD Rules of Fair Practice and the guidelines set forth thereunder.
      (B) All communications regarding securities transactions and long and short positions, including confirmations and account statements, must be sent directly to the customer by the member, or by the issuer, transfer agent, or principal underwriter of the security. All communications sent by the member to a customer must clearly indicate that the broker-dealer services are provided by the member and not by the financial institution. The member shall be responsible for ensuring that any documentation regarding securities transactions sent directly to a member's customer by an issuer, transfer agent, or principal underwriter is in compliance with the federal securities laws and NASD rules.
      (C) Any advertisement or sales literature, as defined in Article III. Section 35. of the NASD Rules of Fair Practice, used to describe or promote the availability of broker-dealer services of the member on the premises of a financial institution must be approved by the member prior to distribution, in compliance with Article III. Section 35(b)(1) of the NASD Rules of Fair Practice and, where required, filed with the NASD Advertising Regulation Department.
      (D) All advertisements, sales literature and other similar materials issued by the member which relate exclusively to its broker-dealer services will be deemed to be the materials of the member and must indicate prominently that the broker-dealer services are being provided by the member and not the financial institution: that the financial institution is not a registered broker or dealer: and whether the member is or is not affiliated with the financial institution. The financial institution may be referenced in a non-prominent manner in advertising or promotional materials solely for the purpose of identifying the location where broker-dealer services are available.
      (E) Notwithstanding the provisions of Subparagraph (11)(D), advertisements, sales literature, and other similar materials jointly issued by the member and a financial institution that discuss services or products offered by both entities must clearly separate the products and services offered by the financial institution from those offered by the NASD member. The name of the member must be displayed prominently in the section of the materials that describes the broker-dealer services offered by the member, which section will be deemed materials of the member, and, as such, the section must comply with the provisions of Subparagraph (11) (C).
      (12) The member must be in compliance with rules of the SIPC, which require, among other things, that a member identify its SIPC membership in its principal place of business, branch offices, and in advertising material. If the member's sales activities include any written or oral representations concerning protection provided by SIPC. clear explanations of the protection must be provided to customers, including material distinctions between SIPC and FDIC insurance.

    • 94-93 NASD Requests Comment On Proposed Rule Governing Registered Persons Lending To Or Borrowing From Customers

      Comment Period Expires January 31, 1995

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance
      Operations

      Executive Summary

      At its November 1994 meeting, the NASD Board of Governors (Board) approved the issuance of a Notice to Members soliciting member comment on a proposed amendment to Article III of the Rules of Fair Practice. The proposed rule would require registered persons to provide prior notification to, and obtain prior approval from, their employing member firm before personally borrowing funds or securities from a customer, or before personally lending funds or securities to a customer. As proposed by the rule, the notification and the prior approval must be in writing.

      Background And Description Of The Proposed Amendment

      In May 1994, the Board's Advisory Council (composed of District Business Conduct and Market Surveillance Committee Chairpersons) issued its report of recommendations to the Board. Included in the report was a recommendation that the NASD consider adopting a rule that would require registered persons to notify their employing member when personally borrowing funds or securities from customers. The Council's proposal was discussed by the National Business Conduct Committee (NBCC) at its November 1994 meeting.

      The NBCC supported the Advisory Council's proposal and recommended to the Board that the coverage of the proposed rule be expanded to include lending of funds or securities, in addition to the borrowing of funds or securities, by registered persons with their customers. The NBCC also recommended that the member, upon prior written notification by the registered person, must record in writing the approval or disapproval of the proposed transaction with the customer.

      The NBCC's determinations were based, in part, on several recent NASD disciplinary actions that demonstrated examples of abuse where registered representatives had borrowed funds or securities from customers. Specifically, the SEC affirmed two NASD disciplinary actions where the principal violation focused on registered representatives borrowing funds from, but not repaying, customers.1

      In approving this rule proposal for comment, the Board recognized that a number of member firms prohibit this type of conduct by their registered persons. Thus, the rule amendment is being proposed to establish a regulatory framework for member firms, which currently permit this practice by its registered persons, to follow.

      A member's prior knowledge that a registered representative intends to borrow funds or securities from or loan funds or securities to its customers, and the member's subsequent approval, may serve as an effective deterrent to potential misconduct. It will also improve the member's ability to control and supervise the activities of its registered personnel. Additionally, the notice requirement will place an affirmative obligation on the representative that could be separately charged in a disciplinary action if not followed.

      Along with the deterrent effect, the present proposal, if ultimately adopted, would clearly serve as an information gathering source for members about additional activities engaged in by their registered persons that may be considered to be beyond the scope of their normal activities. With the information in hand, members would be able to evaluate, before granting approval, whether these activities pose any unnecessary risk to the customer and/or the member.

      Request For Comments

      The NASD asks members to provide comments on the proposed amendment to the Rules of Fair Practice. Comments should be directed to:

      Ms. Joan Conley
      Corporate Secretary
      National Association of Securities Dealers, Inc.
      1735 K Street, NW
      Washington, DC 20006-1500.

      Comments must be received no later than January 31, 1995. Comments received by this date will be considered by the Board. Before becoming effective, the rule must be adopted by the Board and the membership and then filed with the SEC for its approval.


      1 In the Matter of Terry Wayne White. Exchange Act Release No. 34-27895, April 11, 1990: and In the Matter of William Louis Morgan. Exchange Act Release No. 34-32744, August 12, 1993, respectively.


      Text Of The Proposed Amendment To Article III Of The Rules Of Fair Practice

      (Note: New language is underlined.)

      Borrowing Or Loaning Funds Or Securities With Customers

      Section __.

      No person associated with a member in any registered capacity shall borrow funds or securities from or lend funds or securities to any customer of the member unless prior to such borrowing or loaning the registered person has provided written notice to the member and obtained written approval from the member. Notice shall be in the form required by the member. Activities subject to the requirements of Article in. Section 40 of the Rules of Fair Practice shall be exempted from the requirement of this Section.

    • 94-92 Fixed Income Pricing System Additions, Changes, And Deletions As Of October 31, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Institutional
      Legal & Compliance
      Municipal
      Operations
      Systems
      Trading

      As of October 31, 1994, the following bonds were added to the Fixed Income Pricing System (FIPSSM). These bonds are not subject to mandatory quotation:

      Symbol

      Name

      Coupon

      Maturity

      HRVD.GA

      Harvard Inds., Inc.

      12.000

      7/15/04

      HLST.GA

      Hills Stores Co.

      10.250

      9/30/03

      PRTF.GA

      PRT FDG Corp.

      11.625

      4/15/04

      DTC.GC

      Domtar Inc.

      11.750

      3/15/99

      SPFN.GA

      Southern Pacific Transp. Co.

      10.500

      7/1/99

      STO.GI

      Stone Container Corp.

      11.500

      10/1/04

      STO.GJ

      Stone Container Corp.

      10.750

      10/1/02

      AMLH.GA

      American Life Holding

      11.250

      11/15/04

      AMR.GR

      AMR Corp.

      8.470

      2/20/02

      MAWS.GA

      Mid-Amer Waste Sys. Inc.

      12.000

      11/1/01

      FOMR.GB

      Formica

      15.750

      10/1/01

      As of October 31, 1994, there were no changes to the list of FIPS symbols.

      All bonds listed above are subject to trade-reporting requirements. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-91 Nasdaq National Market Additions, Changes, And Deletions As Of October 27, 1994

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      As of October 27, 1994, the following 45 issues joined the Nasdaq National Market, bringing the total number of issues to 3,732:

      Symbol

      Company

      Entry Date

      SOES Execution Level

      MTLG

      Metrologic Instruments, Inc.

      9/29/94

      500

      ALRM

      Protection One, Inc.

      9/29/94

      1000

      GCHI

      Giant Cement Holding, Inc.

      9/30/94

      200

      SUGN

      SUGEN, Inc.

      10/4/94

      200

      MAVK

      Maverick Tube Corp.

      10/5/94

      200

      STRD

      Strategic Distribution, Inc.

      10/6/94

      200

      XPRSA

      U.S. Xpress Enterprises, Inc. (Cl AO

      10/6/94

      200

      AKSTP

      AK Steel Holding Corp. (7%ConvPfd)

      10/7/94

      500

      CTFC

      Central Tractor Farm & Country, Inc.

      10/7/94

      200

      FFHH

      FSF Financial Corp.

      10/7/94

      200

      MFFC

      Milton Federal Financial Corp.

      10/7/94

      500

      NHWK

      Harris Computer Systems Corp.

      10/10/94

      500

      LIFB

      Life Bancorp, Inc.

      10/11/94

      500

      NORWY

      NORWEB pic (ADR)

      10/11/94

      500

      FFFC

      FFVA Financial Corp.

      10/12/94

      200

      FFEC

      First Federal Bancshares of Eau

      10/12/94

      200

      MSPO

      Claire, Inc. Meridian Sports Inc.

      10/12/94

      1000

      STRO

      Strouds, Inc.

      10/12/94

      200

      WBKC

      WestBank Corp.

      10/12/94

      200

      CETV

      Central European Enterprises Ltd. (CIA)

      10/13/94

      500

      CLNTF

      Clearnet Communications Inc. (Cl A Non-Voting)

      10/13/94

      500

      IBSF

      IBS Financial Corp.

      10/13/94

      200

      PRIA

      PRI Automation, Inc.

      10/13/94

      200

      PGDA

      Piercing Pagoda, Inc.

      10/13/94

      200

      MLIN

      Micro Linear Corp.

      10/14/94

      200

      EFBI

      Enterprise Federal Bancorp, Inc.

      10/17/94

      200

      ECII

      Equity Corporation Intl.

      10/19/94

      500

      SEVL

      7th Level, Inc.

      10/20/94

      500

      EDEL

      Edelbrock Corp.

      10/20/94

      1000

      FBTC

      F B & T Financial Corp.

      10/21/94

      200

      FPAM

      FPA Medical Management, Inc.

      10/21/94

      500

      OREX

      Isolyser Company, Inc.

      10/21/94

      200

      OCENY

      Oce-van der Grinten N.V.(ADR)

      10/21/94

      200

      ORTL

      Ortel Corp.

      10/21/94

      200

      PICM

      PICOM Insurance Co.

      10/21/94

      200

      WAVO

      WavePhore, Inc.

      10/21/94

      200

      CMSV

      Community Savings, F.A.

      10/24/94

      200

      CARV

      Carver Federal Savings Bank

      10/25/94

      200

      KNGT

      Knight Transportation, Inc.

      10/25/94

      200

      OWOS

      Owosso Corp.

      10/25/94

      200

      WCSTF

      Wescast Industries Inc.(Cl A)

      10/25/94

      500

      AZPN

      Aspen Technology, Inc.

      10/26/94

      200


      EPIC

      EPIC Design Technology, Inc.

      10/26/94

      200

      TSEMF

      Tower Semiconductor Ltd.

      10/26/94

      200

      HARC

      HarCor Energy Co.

      10/27/94

      200

      Nasdaq National Market Symbol And/Or Name Changes

      The following changes to the list of Nasdaq National Market securities occurred since August 30, 1994:

      New/Old Symbol

      New/Old Security

      Date of Change

      HCBK/CBNK

      Hudson Chartered Bancorp, Inc/Community Bancorp, Inc.

      10/3/94

      HCBKP/CBNKP

      Hudson Chartered Bancorp, Inc.(Pfd B)/Community Bancorp, Inc.(Pfd B)

      10/3/94

      TLIOW/TLIWV

      Telios Pharmaceuticals, Inc. (Wt 9/22/96)/ Telios Pharmaceuticals, Inc. (Wt 9/22/96 WI)

      10/3/94

      CLNP/CLNPV

      Callon Petroleum Cc/Callon Petroleum Co.(WI)

      10/7/94

      KHLR/KHLR

      Kahler Realty Corp./Kahler Corp.

      10/13/94

      BPIEW/BPIEW

      BPI Packaging Technologies, Inc. (Wt A 3/31/95)/ BPI Packaging Technologies, Inc. (Wt A 10/28/94)

      10/20/94

      BASEW/BASEW

      Base Ten Systems, Inc. (Wts A 4/30/95)/ Base Ten Systems, Inc. (Wts A 11/9/94)

      10/20/94

      CELIW/CELIW

      Cel-Sci Corp. (Wts 2/6/96)/Cel-Sci Corp.(Wts 2/6/95)

      10/25/94

      HOFL/HOFL

      Home Financial Corp./Home Savings Bank FSB

      10/25/94

      Nasdaq National Market Deletions

      Symbol

      Security

      Date

      MAMS

      Mid Atlantic Medical Services, Inc.

      9/29/94

      ALCDP

      Alcide Corp. (Ser 1 Pfd)

      9/30/94

      CPSA

      Central Pennsylvania Financial Corp.

      9/30/94

      IRGT

      IRG Technologies, Inc.

      9/30/94

      LPAC

      Laser-Pacific Media Corp.

      9/30/94

      RESB

      Reliable Financial Corp.

      9/30/94

      WNSB

      West Newton Savings Bank (MA)

      9/30/94

      CHTB

      Cohasset Savings Bank

      10/3/94

      HTPIW

      Home Theater Products Intl., Inc. (Wts 9/30/94)

      10/3/94

      LAFCB

      Loan America Financial Corp. (Cl B)

      10/3/94

      MPRO

      MicroProbe Corp.

      10/3/94

      MPROW

      MicroProbe Corp. (Wts exp 9/28/98)

      10/3/94

      NPHIF

      Nalcap Holdings, Inc.

      10/3/94

      NGNA

      Neutrogena Corp.

      10/3/94

      SASZ

      Sage Technologies, Inc.

      10/3/94

      SUBBA

      Suburban Bancorp, Inc.

      10/3/94

      TSIN

      TSI Corp.

      10/3/94

      TSINW

      TSI Corp. (Wts)

      10/3/94

      CNLF

      CNL Financial Corp.

      10/6/94

      HMHC

      Hallmark Healthcare Corp. (CIA)

      10/6/94

      MLOG

      Microlog Corp.

      10/10/94

      MEGFQ

      Megafoods Stores, Inc.

      10/13/94

      ORCO

      Optical Radiation Corp.

      10/13/94

      KRGCF

      Kinross Gold Corp.

      10/14/94

      MMPI

      Marquest Medical Products, Inc.

      10/14/94

      MEGXC

      Megacards, Inc.

      10/14/94

      NAFD

      Nature Food Centres, Inc.

      10/14/94

      XPLX

      Xyplex, Inc.

      10/14/94

      FSVBP

      Franklin Bank, NA(Pfd A)

      10/17/94

      CHSI

      Community Health Systems, Inc.

      10/19/94

      DIAU

      Diasonics Ultrasound, Inc.

      10/20/94

      DOSKR

      Doskocil Companies Inc. (Rts 10/19/94)

      10/20/94

      OSFIF

      OSF, Inc.

      10/20/94

      SGH

      SGI International

      10/20/94

      HOENW

      Hoenig Group Inc. (Wts A10/31/94)

      10/25/94

      SERF

      Service Fracturing Company Inc.

      10/25/94

      PTMLY

      Palmer Tube Mills Ltd. (ADR)

      10/26/94

      ENZNW

      Enzon, Inc. (Wts 94)

      10/27/94

      Questions regarding this Notice should be directed to Mark A. Esposito, Supervisor, Market Listing Qualifications, at (202) 728-8002. Questions pertaining to trade reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-90 Christmas Day And New Year's Day: Trade Date-Settlement Date Schedule

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      The Nasdaq Stock Market™ and the securities exchanges will be closed on Monday, December 26, 1994, in observance of Christmas Day, and Monday, January 2, 1995, in observance of New Year's Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date

      Settlement Date

      Reg. T Date*

      Dec. 16

      Dec. 23

      Dec. 28

      19

      27

      29

      20

      28

      30

      21

      29

      Jan. 3, 1995

      22

      30

      4

      23

      Jan. 3, 1995

      5

      26

      Markets Closed

      -

      27

      4

      6

      28

      5

      9

      29

      6

      10

      30

      9

      11

      Jan. 2, 1995

      Markets Closed

      -

      3

      10

      12

      *Pursuant to Sections 220.8(b)(1) and (4) of Regulation T of the Federal Reserve Board, a broker/dealer must promptly cancel or otherwise liquidate a customer purchase transaction in a cash account if full payment is not received within seven (7) business days of the date of purchase or, pursuant to Section 220.8(d)(1), make application to extend the time period specified. The date by which members must take such action is shown in the column entitled "Reg. T Date."

      Brokers, dealers, and municipal securities dealers should use these settlement dates to clear and settle transactions pursuant to the NASD Uniform Practice Code and Municipal Securities Rulemaking Board Rule G-12 on Uniform Practice.

      Questions regarding the application of these settlement dates to a particular situation may be directed to the NASD Uniform Practice Department at (203) 375-9609.

    • 94-89 Fed Amends Regulation T

      SUGGESTED ROUTING

      Senior Management
      Government Securities
      Institutional
      Operations

      Effective November 25, 1994, the Board of Governors of the Federal Reserve System (Fed) is adopting several amendments to Regulation T (Credit by Brokers and Dealers) regarding the payment periods for securities purchases and transactions in government securities.

      Payment Periods

      One amendment deletes references to a specific number of days in which customers must meet initial margin calls or make full cash payment for securities purchases; instead the amendment establishes that the "payment period" will be two business days beyond "the standard securities settlement cycle in the United States" as defined in SEC Rule 15c6-1.

      Presently, standard settlement is five days after trade date and Reg. T requirements must be met in seven business days. There is no change until June 1, 1995, when SEC Rule 15c6-1 becomes effective. Then, the standard settlement period will shorten to three business days (T+3) and payments required by Reg. T must be made in five business days.

      De Minimis Amount

      Broker/dealers are required to liquidate customer purchases for which they have not received payment within the required time period. Currently, amounts of $500 or less are exempt from this requirement. The amendments to Reg. T increase this de minimis amount to $1,000.

      Extension Requests

      Under certain circumstances, broker/ dealers can obtain an extension of time for a customer who has not made full cash payment or met an initial margin call within the payment period. Reg. T currently permits a broker/dealer to request these extensions from any serf-regulatory organization. As amended, Reg. T requires that these extensions be granted only by a broker/dealer's designated examining authority.

      Foreign Securities, Unissued Securities, When-Issued Securities, and Refunded Securities

      Among the changes to Reg. T are technical amendments to the language concerning cash accounts. These changes ensure that the time periods in which extensions must be obtained and when the "90-day freeze" may be lifted are consistent for certain transactions in which settlement exceeds the standard settlement period.

      Government Securities

      The changes to Reg. T include two amendments that affect transactions in government securities. The amendments:

      • Exempt from Reg. T those broker/ dealers registered with the SEC solely as government securities broker/ dealers (Section 15C broker/dealers), and

      • Create a new account for customers of general securities broker/dealers in which transactions in government securities may be effected exempt from the other provisions of Reg. T.

      For a detailed description of these amendments, members may review NASD Notice to Members 94-53, which discusses the proposed changes, and the October 25, 1994, Federal Register, which contains the Fed's release adopting these changes. Questions regarding this Notice may be directed to Derick Black, NASD Compliance Department, at (202) 728-8225.

    • 94-88 Fixed Income Pricing System Additions, Changes, And Deletions As Of September 30, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Institutional
      Legal & Compliance
      Municipal
      Operations
      Systems
      Trading

      As of September 30, 1994, the following bonds were added to the Fixed Income Pricing System (FIPSSM). These bonds are not subject to mandatory quotation:

      Name

      Symbol

      Coupon

      Maturity

      PLTT.GA

      Plitt Theatres Inc.

      10.875

      6/15/04

      DMTR.GA

      Domtar Inc.

      11.250

      9/15/17

      SBO.GA

      Showboat Inc.

      13.000

      8/1/09

      RPWI.GB

      Repap Wis. Inc.

      9.250

      2/1/02

      KSRE.GA

      Kearny Str. Real Estate

      9.560

      7/15/03

      TIPK.GA

      Tiphook Fin. Corp.

      7.125

      5/1/98

      TIPK.GB

      Tiphook Fin. Corp.

      10.750

      11/1/02

      CBLV.GB

      Cablevision Inds Corp.

      9.250

      4/1/08

      TLXC.GA

      Telex Communications

      12.000

      7/15/04

      LRHI.GA

      Laroche Inds Inc

      13.000

      8/15/04

      NTK.GC

      Nortek Inc.

      9.875

      3/1/04

      TIPK.GC

      Tiphook Fin. Corp.

      8.000

      3/15/00

      CVC.GD

      Cablevision Sys Corp.

      14.000

      11/15/03

      BLY.GC

      Ballys PI PI FDG Inc.

      9.250

      3/15/04

      CONA. GD

      Container Corp. Amer.

      14.000

      12/1/01

      BLG.GB

      Bally Grand Inc.

      10.375

      12/15/03

      As of September 30, 1994, the following changes to the list of FDPS symbols occurred:

      New/Old Symbol

      Name

      Coupon

      Maturity

      DTC.GB/DMTR.GA

      Domtar Inc.

      11.250

      9/15/17

      All bonds listed above are subject to trade-reporting requirements. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301)590-6436.

    • 94-87 Nasdaq National Market Additions, Changes, And Deletions As Of September 29, 1994

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      As of September 29, 1994, the following 49 issues joined the Nasdaq National Market, bringing the total number of issues to 3,725:

      Symbol

      Company

      Entry Date

      SOES Execution Level

      BDTC

      Bio-Dental Technologies

      8/30/94

      200

      FCNB

      Corporation FCNB Corp.

      8/30/94

      200

      CCIL

      Cellular Communications International, Inc.

      8/31/94

      500

      FFFD

      First Federal Savings Bank of

      8/31/94

      200

      IDMC

      Fort Dodge IDM Environmental Corp.

      8/31/94

      200

      IDMCW

      IDM Environmental Corp. (Cl A Wtsexp 4/21/99)

      8/31/94

      200

      WAVX

      Wave Systems Corp.

      8/31/94

      500

      CGMV

      Cedar Group, Inc.

      9/1/94

      200

      SBSE

      SBS Engineering, Inc.

      9/6/94

      200

      CBNJ

      Carnegie Bancorp

      9/8/94

      200

      CBNJW

      Carnegie Bancorp (Wts exp 8/9/97)

      9/8/94

      200

      INCL

      InControl, Inc.

      9/9/94

      500

      DARL

      Darling International Inc.

      9/12/94

      200

      PNTGF

      Petromet Resources Limited

      9/12/94

      200

      AQUX

      Aquagenix, Inc.

      9/13/94

      500

      AQUXW

      Aquagenix, Inc. (Wts exp 9/12/99)

      9/13/94

      500

      EGFC

      Eagle Financial Corp.

      9/13/94

      200

      MIHOW

      Miles Homes, Inc. (Wts exp 4/1/97)

      9/13/94

      200

      COHU

      Cohu, Inc.

      9/14/94

      200

      CBTC

      CBT Corporation

      9/15/94

      200

      DRMD

      Duramed Pharmaceuticals, Inc.

      9/16/94

      200

      MMRI

      Macheezmo Mouse

      9/16/94

      200

      ARIA

      Restaurants, Inc. ARIAD Pharmaceuticals, Inc.

      9/19/94

      500

      ARIAW

      ARIAD Pharmaceuticals, Inc. (Wts 5/20/99)

      9/19/94

      500

      CLNPV

      Callon Petroleum Company (WI)

      9/19/94

      200

      DRTK

      GTS Duratek Inc.

      9/19/94

      200

      NDCOO

      Noble Drilling Corporation ($1.5ConvPfd)

      9/19/94

      200

      CMCAF

      Comcast UK Cable Partners Limited

      9/20/94

      200

      ERCC

      Energy Research Corporation

      9/21/94

      200

      IGCA

      Innovative Gaming Corporation of America

      9/21/94

      200

      PBBUF

      Pacific Basin Bulk Shipping Limited (Uts exp 9/30/99)

      9/21/94

      1000

      OSKY

      Mahaska Investment Company

      9/22/94

      200

      PSCM

      Professional Sports Care Management, Inc.

      9/22/94

      500

      TLIWV

      Telios Pharmaceuticals, Inc. (Wts 9/29/96)(WI)

      9/22/94

      200

      BOBJY

      Business Objects S.A. (ADS)

      9/23/94

      200

      CEXP

      Corporate Express, Inc.

      9/23/94

      200

      FMAC

      First Merchants Acceptance Corporation

      9/23/94

      500

      NKPR

      Innkeepers USA Trust

      9/23/94

      200

      WELC

      Welcome Home, Inc.

      9/23/94

      200

      ASHE

      Aasche Transportation Services, Inc.

      9/26/94

      200

      AFLX

      ADFlex Solutions, Inc.

      9/27/94

      200

      ACSA

      Affiliated Computer Services, Inc. (Cl A)

      9/27/94

      200

      ARANY

      Aran Energy pic (ADR)

      9/27/94

      200

      BSST

      Baby Superstore, Inc.

      9/27/94

      500

      BFCX

      Benson Financial Corporation

      9/27/94

      200

      DOSKR

      Doskocil Companies Incorporated (Rts exp 10/19/94)

      9/27/94

      200

      ERNS

      Ernst Home Center, Inc.

      9/27/94

      200

      IPCI

      IPC Information Systems, Inc.

      9/27/94

      200

      EBMA

      E & B Marine, Inc.

      9/28/94

      200

      Nasdaq National Market Symbol And/Or Name Changes

      The following changes to the list of Nasdaq National Market securities occurred since August 29, 1994:

      New/Old Symbol

      New/Old Security

      Date of Change

      PSRC/PNJI

      PrimeSource Corporation/Phillips & Jacobs, Inc.

      9/2/94

      GENE/CRIC

      Genome Therapeutics CorpVCollaborative Research, Inc.

      9/6/94

      OXIS/DDIX

      OXIS International, Inc/DDI Pharmaceuticals, Inc.

      9/8/94

      RPAPF/RPAPF

      REPAP Enterprises Corp. (Com Stk)/REPAP Enterprises Corp. (Sub Vtg Shs)

      9/9/94

      SEMCF/ISEAF

      Semi-Tech Corp. (Vtg Cl A)/ International Semi-Tech Microelectronics, Inc. (Vtg Cl A)

      9/22/94

      TWMC/TWMC

      Trans World Entertainment Corp./Trans World Music Corp.

      9/22/94

      Nasdaq National Market Deletions

      Symbol

      Security

      Date

      GAFA

      Gates/FA Distributing, Inc.

      8/30/94

      ALDC

      Aldus Corporation

      9/1/94

      PION

      Pioneer Financial Corporation

      9/1/94

      SMAC

      SuperMac Technology, Inc.

      9/1/94

      DFCO

      Destron Fearing Corporation

      9/2/94

      HHOT

      H & H Oil Tool Co., Inc.

      9/2/94

      MAXMW

      Maxim Group Inc. (The) (Wts exp 9/30/98)

      9/2/94

      MMDI

      Momentum Corporation

      9/2/94

      CDIC

      Cardinal Health, Inc.

      9/7/94

      AMRS

      American Residential Holding Corporation

      9/9/94

      SPHX

      SPHINX Pharmaceuticals Corporation

      9/12/94

      CRES

      Crestmont Financial Corp.

      9/14/94

      NNCXF

      Newbridge Networks Corporation

      9/14/94

      SERV

      Serving Software, Inc.

      9/14/94

      GNBC

      Glendale Bancorporation

      9/15/94

      KNFL

      Kenfillnc.

      9/15/94

      MCTIE

      Micro Component Technology, Inc.

      9/15/94

      REST

      Restor Industries, Inc.

      9/15/94

      SCRP

      Scripps Howard Broadcasting Company

      9/15/94

      SPRC

      Sports & Recreation, Inc.

      9/15/94

      SHRO

      Sports Heroes, Inc.

      9/15/94

      SHROW

      Sports Heroes, Inc. (Wts exp 11/20/95)

      9/15/94

      FSVBW

      Franklin Bank, National Association (Wts exp 9/15/94)

      9/16/94

      INFD

      Infodata Systems, Inc.

      9/16/94

      ARIAZ

      ARIAD Pharmaceuticals, Inc. (Uts)

      9/19/94

      CCLPZ

      Callon Consolidated Partners, L.P. (Uts)

      9/19/94

      MCAWA

      McCaw Cellular Communications, Inc. (Cl A)

      9/20/94

      MEDQ

      Medquist, Inc.

      9/20/94

      ASKI

      Ask Group, Inc. (The)

      9/21/94

      BDRM

      Body Drama, Inc.

      9/23/94

      NTAWF

      Nam Tai Electronics, Inc. (Wts exp 9/29/96)

      9/23/94

      Questions regarding this Notice should be directed to Mark A. Esposito, Supervisor, Market Listing Qualifications, at (202) 728-8002. Questions pertaining to trade reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-86 NASD 1995 Holiday Schedule

      SUGGESTED ROUTING

      Internal Audit
      Legal & Compliance
      Operations
      Systems
      Trading

      The NASD will observe the following holiday schedule for 1995:

      January 2

      New Year's Day (observance)

      February 20

      President's Day

      April 14

      Good Friday

      May 29

      Memorial Day

      July 4

      Independence Day

      September 4

      Labor Day

      November 23

      Thanksgiving Day

      December 25

      Christmas Day

      Questions regarding this holiday schedule may be directed to NASD Human Resources, at (301) 590-6821.

    • 94-85 Veterans' Day And Thanksgiving Day: Trade Date-Settlement Date Schedule

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      The schedule of trade dates-settlement dates below reflects the observance by the financial community of Veterans' Day, Friday, November 11, 1994, and Thanksgiving Day, Thursday, November 24, 1994. On Friday, November 11, The Nasdaq Stock Market™ and the securities exchanges will be open for trading. However, it will not be a settlement date because many of the nation's banking institutions will be closed in observance of Veterans' Day. All securities markets will be closed on Thursday, November 24, in observance of Thanksgiving Day.

      Trade Date

      Settlement Date

      Reg. T Date*

      Nov. 2

      Nov. 9

      Nov. 11

      3

      10

      14

      4

      14

      15

      7

      15

      16

      8

      16

      17

      9

      17

      18

      10

      18

      21

      11

      18

      22

      14

      21

      23

      15

      22

      25

      16

      23

      28

      17

      25

      29

      18

      28

      30

      21

      29

      Dec. 1

      22

      30

      2

      23

      Dec. 1

      5

      24

      Markets Closed

      -

      25

      2

      6

      * Pursuant to Sections 220.8(b)(1) and (4) of Regulation T of the Federal Reserve Board, a broker/dealer must promptly cancel or otherwise liquidate a customer purchase transaction in a cash account if full payment is not received within seven (7) business days of the date of purchase or, pursuant to Section 220.8(d)(1), make application to extend the time period specified. The date by which members must take such action is shown in the column entitled "Reg. T Date."

      Note: November 11, 1994, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board. Transactions made on November 11 will be combined with transactions made on the previous business day, November 10, for settlement on November 18. Securities will not be quoted ex-dividend, and settlements, marks to the market, reclamations, and buy-ins and sell-outs, as provided in the Uniform Practice Code, will not be made and/or exercised on November 11.

      Brokers, dealers, and municipal securities dealers should use these settlement dates to clear and settle transactions pursuant to the NASD Uniform Practice Code and Municipal Securities Rulemaking Board Rule G-12 on Uniform Practice.

      Questions regarding the application of these settlement dates to a particular situation may be directed to the NASD Uniform Practice Department at (203) 375-9609.

    • 94-84 Broker/Dealer And Agent Renewals For 1994-95

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance
      Operations
      Registration

      Executive Summary

      The 1994-95 NASD broker/dealer and agent registration renewal cycle begins in early November. This program simplifies the registration renewal process through the payment of one invoiced amount that will include fees for NASD personnel assessments, NASD branch-office fees, New York Stock Exchange (NYSE), American Stock Exchange (ASE), Chicago Board Options Exchange (CBOE), Pacific Stock Exchange (PSE), and Philadelphia Stock Exchange (PHLX) maintenance fees. The invoice also includes state agent renewal fees and state broker/dealer renewal fees. Members should read this Notice and the instruction materials to be sent with the November invoice package to ensure continued eligibility to do business in the states, effective January 1, 1995.

      Initial Renewal Invoices

      On or around November 11, 1994, initial renewal invoices will be mailed to all member firms. The invoices will include fees for NASD personnel assessments, NASD branch-office fees, NYSE, ASE, CBOE, PSE, and PHLX maintenance fees, state agent renewal fees, and state broker/dealer renewal fees. The NASD must receive full payment of the November invoice no later than December 16, 1994.

      NASD personnel assessments for 1995, which will be $10 per person, will be based on the number of registered personnel with an approved NASD license as of December 31, 1994. NASD branch-office assessments, which have increased from $50 to $75 per branch pending a filing with the Securities and Exchange Commission, will be based on the number of active branches as of December 31, 1994.

      Agent renewal fees for NYSE, ASE, CBOE, PSE, PHLX, and state affiliations are listed in a matrix enclosed with each invoice. The matrix includes a list of broker/dealer renewal fees for states that participate in the broker/dealer renewal program. NYSE, ASE, CBOE, PSE, and PHLX maintenance fees—collected by the NASD for firms that are registered with those exchanges as well as the NASD—are based on the number of NYSE-, ASE-, CBOE-, PSE-, and PHLX-registered personnel employed by the member.

      If a state does not participate in this year's broker/dealer renewal program, members registered in that state must contact the state directly to ensure compliance with renewal requirements. In addition, some participating states may require steps beyond the payment of renewal fees to complete the broker/dealer renewal process. Members should contact states directly for further information on state renewal requirements.

      Payment of the initial invoice should be in the form of a check made payable to the National Association of Securities Dealers, Inc., or by bank wire transfer. The check should be drawn on the member firm's account, with the firm's Central Registration Depository (CRD) number included on the check. Submit the check along with the top portion of the invoice and mail in the return envelope provided with the invoice. To ensure prompt processing, the renewal invoice payment should not be included with other forms or fee submissions. Members should be advised that failure to return payment to the NASD by the deadline, which is December 16, 1994, could mean a loss of the eligibility to do business in the states, effective January 1, 1995.

      Filing Form U-5

      Members may avoid paying unnecessary renewal fees by filing Form U-5s for agents terminating in one or more jurisdiction affiliations. Due to the positive feedback received by NASD member firms that used postdated Form U-5s for renewals, the NASD will again accept post-dated agent termination notices on Form U-5s. From November 1 to December 16, 1994, the NASD will accept and process Form U-5s (partial and full terminations) with post-dated dates of termination. Under this procedure, if the Form U-5 indicates a December 31, 1994, termination date, an agent may continue doing business in a jurisdiction until the end of the calendar year without being assessed renewal fees for that jurisdiction. Please ensure that Form U-5s are filed by the renewal deadline date of December 16, 1994. Also, post-dated Form U-5s cannot be processed if the date of termination indicated is after December 31, 1994.

      Members should exercise care when submitting post-dated Form U-5s. The NASD will process these forms as they are received but cannot withdraw a post-dated termination once processed. To withdraw a post-dated termination, a member would have to file a new Form U-4 after the termination date indicated on the Form U-5.

      The NASD encourages members having access to the Firm Access Query System (FAQS) to use electronic filings to submit all Form U-5s and Page 1s of Form U-4s. FAQS offers several advantages to firms in this regard, including the ability to immediately process terminations, ensure in-house control over agent registrations, and reduce normal and express mailing costs as well as long distance telephone charges. FAQS also allows members to quickly and efficiently handle the large filing volumes that typically occur at this time every year. Because of that, the NASD will provide an additional service to FAQS users by expanding the on-line user hours for November and December 1994. The system will be operational from 7 a.m. to 11 p.m., Eastern Time (ET), Monday through Friday and will also be available on Saturdays from 9 a.m. to 5 p.m., ET, during these months.

      Filing Forms BDW

      The CRD Phase II program, now in its 6th year, allows firms requesting terminations (full or state only) to file their Forms BDW with the CRD to avoid the assessment of renewal fees in those jurisdictions that are designated on the Form BDW, provided that the jurisdiction is a CRD Phase II participant. Currently, there are seven jurisdictions that are not participating in Phase II:

      • Alabama

      • Michigan

      • Puerto Rico

      • American Stock Exchange

      • Chicago Board Options Exchange

      • New York Stock Exchange

      • Pacific Stock Exchange.

      Firms requesting termination in any of the above-listed jurisdictions must submit a Form BDW directly to the jurisdiction as well as to the CRD.

      The deadline for receipt of Forms BDW by the CRD for firms desiring to terminate an affiliation before year-end 1994 is December 16, 1994. This same date applies to the filing of Forms BDW with the jurisdictions that are not participating in Phase II. Post-dated Forms BDW filed with the CRD will be accepted and processed in the same manner as postdated Form U-5s.

      Removing Open Registrations

      For the 8th year, the initial invoice package will include in a roster of firm agents whose NASD registration is terminated or purged due to the existence of a deficient condition for more than 180 days, but who have an approved registration with a state. This roster should help reconcile personnel registrations before year end. Firms may terminate obsolete state registrations by submitting Form U-5s or reinstate the NASD licenses by filing Page Is of Form U-4s. No roster will be included if a firm does not have agents in this category.

      Final Adjusted Invoices

      On or about January 17, 1995, the NASD will mail final adjusted invoices to its members. These invoices will reflect the final status of firm and agent registrations as of December 31, 1994. Any adjustments in fees owed as a result of registration terminations or approvals subsequent to the initial invoice mailing will be made in this final reconciled invoice. If a member has more agents and/or branch offices registered at year end than it did on the November invoice date, additional fees will be assessed. If a member has fewer agents and/or branch offices registered at year end than it did in November, a credit/refund will be issued.

      Included with this adjusted invoice will be the member renewal rosters, which will list all renewed personnel with the NASD, NYSE, ASE, CBOE, PSE, PHLX, and each state. Persons whose registrations are approved in any of these jurisdictions during November and December will automatically be included in this roster, while registrations that are pending approval or are deficient at year end will not be included in the renewal process. Firms will also receive an NASD branch-office roster that lists all branches for which they have been assessed.

      Firms then will have two months to reconcile any discrepancies on the rosters. All jurisdictions should be contacted directly in writing. Specific information and instructions concerning the final adjusted invoice package will appear in the January 1995 issue of Notices to Members, as well as on the inside cover of the renewal roster. Firms may also refer to their Renewal Edition of Membership on Your Side for details concerning the renewal process.

      This year's final invoice package will also include a breakdown of fees assessed by billing code for firms that use billing codes in the registration process. This breakdown will aid firms in their internal research and allocation of fees.

      Questions concerning this Notice may be directed to your firm's assigned Quality and Service Team or the NASD's Member Services Phone Center at (301) 590-6500.

    • 94-83 NASD Provides Additional Guidance Concerning The Operation Of The NASD Short-Sale Rule

      SUGGESTED ROUTING

      Institutional
      Legal & Compliance
      Operations
      Systems
      Trading

      On August 25, 1994, the NASD issued Special Notice to Members 94-68 (Special Notice) dealing with the NASD's recently approved short-sale rule (Rule). In that Special Notice, the NASD set forth a description of the Rule, provided answers to questions concerning the operation of the Rule, and included the final text of the short-sale rule. In addition, the NASD separately issued ACT Notice 94-1 describing new rules applicable to the reporting of short sales through The Nasdaq Stock Market, Inc., Automated Confirmation Transaction (ACTSM) service. Since the Special Notice was issued and the Rule became effective on September 6, the NASD has received additional questions concerning the operation of the Rule. Accordingly, this Notice provides answers to these and other questions in an attempt to enhance member-firm compliance with the Rule. As with the Special Notice dealing with the Rule, the NASD hopes this Notice is helpful to the membership in understanding the new obligations that apply to them as a result of the Rule. The NASD also recognizes that additional assistance may be needed to respond to specific areas of concern to the membership. Inquiries should be directed to the staff members listed after the "Questions And Answers" section below.

      Questions And Answers

      Question #1: To determine whether a short sale is a "legal" short sale (that is, a non-exempt short sale effected at a price 1/16th above the bid on a down bid), should members refer to the "gross" price at which the short sale is reported to and disseminated by the NASD exclusive of any markdown or should the reference price be the "net" price inclusive of any markdown?
      Answer: The reported price generally is the "benchmark" price to determine whether a non-exempt short sale is a legal short sale when there is a down bid, not the "net" price incorporating any markdown. For example, if the market is 10–10 1/4 and the 10 bid is a down bid, a transaction reported at 10 1/16 would be a legal short sale, even if there were a markdown of 1/16 on the sale. However, if a firm were to modify its practices in dealing with a customer or group of customers after implementation of the Rule such that it commenced charging markdowns or commenced charging larger mark-downs so that it could effect and report short sales for its customers at higher "gross" prices while trading at virtually the same "net" price, then the NASD would deem such conduct to be a violation of the short-sale rule and Interpretation C thereto.

      For example, the NASD understands that members often trade on a "net" basis with large, institutional clients. If a member were to deviate from this practice by charging such customers a markdown when they are effecting short sales, the NASD would presume that the member is assessing the markdown to facilitate the customer's short-sale transaction. Moreover, if a member were to assess a markdown on a short sale by a customer who had previously traded with the firm exclusively on a "net" basis and, thereafter, immediately sell the stock at the bid, the NASD's presumption that the short sale was effected in violation of the Rule would be even stronger.
      Question #2: Is it a violation of the Rule to effect a short sale at a price below the bid when the bid is an "up" bid?
      Answer: No. The Rule only constrains the execution of short sales when there is a down bid. However, depending on the circumstances, the NASD may deem such activity to be a manipulative act or practice inconsistent with just and equitable principles of trade and a violation of the SEC's anti-fraud rule. The NASD also notes that members should be aware that the execution of a short sale for a customer at a price below the best inside bid may raise concerns that the member did not adequately discharge its best execution obligation with respect to that order. Nevertheless, the NASD acknowledges that it is conceivable that large, institutional-size sell orders may receive best execution even if they are effected at prices below the inside bid.
      Question #3: When executing a customer's limit order to sell short, does compliance with the NASD's Limit Order Protection Interpretation supersede compliance with the Rule?
      Answer: If a customer's limit order to sell short is activated by a member's sale transaction, the customer's short-sale order still must be effected in compliance with the Rule. For example, assuming the market for XYZ is 10–10 1/4 and the 10 bid is a down bid, if a market maker were to execute a customer's market order to buy XYZ at 10 1/4 while holding a customer's limit order to sell XYZ short at 10, the market maker would not be able to immediately execute the limit order. While the market maker's execution of the market order would activate execution of the limit order under the NASD Limit Order Protection Interpretation, the Rule would preclude the market maker from executing the limit order at 10 because the 10 bid in XYZ is a down bid. If the inside bid for XYZ were to decline to 9 7/8, however, then the limit order could be executed in the event of a subsequent sale by the market maker at the offer because the short sale would be effected at a price at least a 1/16th above the inside bid.

      Members should not confuse the answer to this question with the answer to Question #10 in the Special Notice. Question #10 in the Special Notice addressed the situation where a market maker would be selling short on a down bid to fill a customer's limit order to buy at the bid. In that case, the NASD concluded that the market maker's obligation to comply with the Limit Order Protection Interpretation superseded the member's obligation to comply with the Rule.
      Question #4: If a qualified market maker receives an order to sell 20,000 shares of XYZ short when the market for XYZ is 10–10 1/4 on a down bid, would it be a violation of the Rule if the market maker were to sell 20,000 shares of XYZ at the 10 bid and subsequent lower bids in reliance on its exemption from the Rule and then turn around and buy the 20,000 shares from its customer at 1/16th of a point above the new, lower "down" bid?
      Answer: Yes. The NASD would view the market maker's short sales as an impermissible use of the market-maker exemption and an attempt to avoid application of the Rule to its customer's short sale.
      Question #5: If a qualified market maker effects short sales in anticipation of selling pressure in a stock or in anticipation of a general decline in the market, are the short sales exempt from the Rule?
      Answer: If a qualified market maker reasonably believes that the price of a stock is going to decline because of specific news about the stock, a general decline in market prices, or otherwise, then the qualified market maker can effect short sales at down bids in an attempt to "liquify" itself to facilitate customer selling interest in the stock. However, as noted in Question #6 above, if a marketmaker were to effect short sales at down bids after having received a customer's short-sale order, the NASD would view such short sales as an impermissible use of the market-maker exemption. In the event a qualified market maker receives a customer order to sell short during a declining market or while the market maker has a reasonable belief that the price of the stock is declining, it will involve a facts-and-circumstances analysis to determine whether the market makers' short sales are attributable to the facilitation of the customer's short-sale order or the result of bona fide market-making activity.
      Question #6: Are sale transactions that are "short against the box"1 subject to the Rule?
      Answer: Yes. Section 48(1)(1) of the NASD Rules of Fair Practice provides that the term short sale means "any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller." Accordingly, if a customer intends to satisfy its settlement obligation for a sale transaction with borrowed stock, then that sale transaction is subject to the Rule, regardless of whether the customer has a long position in the stock.
      Question #7: If a member facilitates a customer transaction in a standardized equity or stock index option, is it eligible for an exemption from the rule to effect hedging short-sale transactions?
      Answer: With respect to the facilitation of customer transactions in standardized equity options, a member is eligible for an exemption from the Rule for short sales made in connection with hedging activities associated with the facilitation of such transactions, provided the short sales hedge, and in fact serve to hedge, an existing offsetting standardized options position or an offsetting options position that was created in a transaction(s) contemporaneous with the short sale and provided the member is a qualified market maker in the stock underlying the option.2

      With respect to the facilitation of customer transactions in standardized index options, a member is eligible for an exemption from the Rule for short sales made in connection with hedging activities associated with the facilitation of such transactions, provided the short sales hedge, and in fact serve to hedge, the corresponding stock index options position and the underlying stock index option is a qualified stock index under Section 48(h)(2)(d) of the NASD Rules of Fair Practice.3 Members do not have to be a qualified market maker in each of the Nasdaq National Market® stocks underlying a qualified stock index to be eligible for the exemption from the Rule for hedging short-sale transactions.

      In sum, Nasdaq market makers are afforded treatment comparable to that afforded "qualified options market makers" under the rule when hedging standardized options positions with short sales. In addition, as noted above, this interpretation only applies to Nasdaq market makers hedging customer facilitation transactions in standardized options.
      Question #8: If a member is a registered market maker in a convertible bond or holds itself out as a market maker in a convertible bond, is it eligible for an exemption from the rule if it effects short sales in the underlying security to hedge transactions in the convertible bonds?
      Answer: If a member establishes a convertible bond position during the course of bona fide market-making activity and the member is a qualified market maker in the stock underlying the bond, the member can effect short sales in the underlying security to hedge such bond positions. Members are directed to Questions 33 – 39 of the Special Notice for guidance on when short sales in the corresponding stock are deemed to be hedges of bona fide market making transactions in the related convertible bond and when they are considered arbitrage transactions unrelated to normal market-making activity.
      Question #9: Are there any circumstances under which a qualified market maker would ever have to mark an ACT report "short sale" or "sell short exempt?"
      Answer: Yes. Even though a qualified market maker does not have to append a short-sale indicator to its ACT Report when it is selling short, when a qualified market maker is buying from a customer who is selling short, the market maker must indicate in its ACT Report that the sale was a short sale. In addition, if a customer of a qualified market maker is effecting a short sale that is exempt from the Rule, the market maker must indicate on its ACT Report that the sale was "sell short exempt." For example, if the customer is an options market maker effecting a hedging short-sale transaction in reliance on the options market-maker exemption to the Rule, the market maker would have to mark its ACT Report "sell short exempt." Similarly, if a customer of a qualified market maker effected a short sale in reliance on the "special arbitrage exemption" afforded investors in Section 48(c)(6) of the Rule (or any other exemption afforded investors), then the marker maker would have to mark its ACT Report "sell short exempt."

      Members are directed to ACT Notice 94-1 for further guidance on how to mark their ACT Reports to reflect short sales.
      Question #10: Do non-qualified market makers have to append a "sell short" designator to their ACT Reports when effecting short sales?
      Answer: Yes. A "sell short" designator is required for all proprietary short sales by members who are not qualified market makers. In addition, as noted in Question #9 above, if a customer of a market maker is selling short or selling short in reliance on an exemption from the Rule, the market maker must indicate on its ACT Report that the sale was a short sale or an exempt short sale.
      Question #11: If a member has an arrangement with a customer whereby it will buy stock from a customer at a higher price to accommodate a short sale by the customer at a price a 1/16th above the bid on a down bid (short-sale accommodation differential) in return for the ability to recoup the short-sale accommodation differential when selling that stock to the customer in the future, would such an arrangement violate the Rule?
      Answer: Short sales effected pursuant to an arrangement involving any price modifications, rebates, discounts, or other remuneration that is designed to circumvent application of the Rule would be in violation of the Rule.
      Question #12: If a non-qualified market maker has a short position of 10,000 shares in XYZ and it purchases 1,000 shares of XYZ, is it "long" the 1,000 shares of XYZ it just purchased?
      Answer: No. Members must net out long positions and short positions in the same stock to determine if they are net long or short. In this case, the purchase of the 1,000 shares of XYZ merely lowered the market maker's net short position in XYZ to 9,000 shares from 10,000 shares. Any subsequent resale of the 1,000 shares would be considered a short sale and subject to the Rule.
      Question #13: If a non-qualified market maker effects a short sale because of a SOESSM transaction, does the market maker have to report that sale as a short sale?
      Answer: No. Because SOES automatically executed the short sale for the market maker and reported the transaction, the market maker has no reporting obligation with respect to the short sale.
      Question #14: After a merger or acquisition involving an exchange of stock has been publicly announced and not yet consummated or terminated, the Rule provides that a market maker may register and begin entering quotations in either or both of the two affected securities and immediately become a qualified market maker in either or both of the issues. The Rule also provides that if the market maker withdraws on an unexcused basis from any stock in which it has so registered within 20 days of so registering, the market maker will not be eligible for immediate designation as a qualified market maker for any merger or acquisition announced within three months subsequent to such unexcused withdrawal. If a merger or acquisition is consummated or terminated within 20 days of a market maker's registration in either or both of the effected securities, may the market maker withdraw from either or both of the securities before the balance of the 20 days has elapsed without being subject to the "three month" waiting provision?
      Answer: Yes. If the merger or acquisition is consummated or terminated before the 20-day period elapses, the market maker may withdraw from either or both of the stocks upon such termination or consummation of the merger or acquisition and not be subject to the three-month waiting period.
      Question #15: If a non-market maker effects a short-sale transaction with a market maker, can the member use the "browse/accept" feature of ACT to compare the trade for clearance and settlement purposes?
      Answer: Yes. The member can use the "browse/accept" feature, provided the member updates the ACT Report to append a "short sale" or "short sale exempt" indicator with the symbols "S" or "X", respectively. This answer is a clarification of the answer to Question #31 in the Special Notice. In the answer to Question #31, the NASD stated that members would be "unable to use the ACT 'browse/accept' feature to compare trades in ACT for clearance and settlement purposes." This statement was incorrect, as members can use the "browse/accept" feature so long as they mark their ACT Reports appropriately during the acceptance process. If the member were to use the "browse/accept" feature without marking the ACT Report to appropriately reflect the short sale, however, it would be a violation of the ACT Rules.

      Questions regarding this Notice should be directed to NASD Market Surveillance, at (301) 590-6080; Glen Shipway, Senior Vice President, Nasdaq Market Operations, at (203) 385-6250; or Thomas R. Gira, Assistant General Counsel, at (202) 728-8957.


      1 A sale transaction that is "short against the box" is one where an investor owns the stock sold but intends to deliver borrowed stock to satisfy its settlement obligation.

      2 Consistent with Section 48(h)(2)(a)(i) of the NASD Rules of Fair Practice, the phrase contemporaneously established includes transactions occurring simultaneously with the short sale as well as transactions occurring within the same brief period of time.

      3 Section 48(h)(2)(d) provides that "a 'qualified stock index' shall mean any stock index that includes one or more Nasdaq National Market securities, provided that more than 10% of the weight of the index is accounted for by Nasdaq National Market securities and provided further that the qualification of an index as a qualified stock index shall be reviewed as of the end of each calendar quarter, and the index shall cease to qualify if the value of the index represented by one or more Nasdaq National Market securities is less than 8% at the end of any subsequent calendar quarter."

    • 94-82 NASD Solicits Comment On Proposed Amendment To The Corporate Financing Rule Relating To Rights Of First Refusal;

      Comment Period Expires November 30, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Legal & Compliance
      Syndicate

      Executive Summary

      The NASD is requesting comment on an amendment to its Corporate Financing Rule (the Rule) relating to rights of first refusal granted to underwriters and related persons in connection with the distribution of public offerings. The amendment would continue to permit the use of rights of first refusal, but would prohibit an underwriter from receiving a right of first refusal to underwrite or participate in future offerings of the issuer that has a duration of longer than three years, has more than one opportunity to waive or terminate the right in consideration of any payment or fee, and is paid other than in cash. The amendment would also require that a right of first refusal have a compensation value of the lesser of one percent of the offering proceeds or the dollar amount contractually agreed to for waiver or termination of the right. Finally, the amendment would prohibit any payment or fee to waive or terminate a right of first refusal that has a value in excess of the greater of one percent of the original offering (or an amount in excess of one percent if additional compensation is available under the compensation guideline of the original offering) or 5 percent of the underwriting discount or commission paid in connection with the future offering. The text of the amendment follows this Notice.

      Background

      The NASD developed its policy on the valuation of rights of first refusal in the early 1970s. Rights of first refusal are typically negotiated in connection with an issuer's initial public offering and grant the underwriter a right to underwrite or participate in any future public offerings, private placements, or other financings by the issuer for a certain period of years. The NASD values rights of first refusal as a non-cash item of compensation at one percent of the offering proceeds and currently limits the duration of the right to 5 years.1 To the extent that an underwriting agreement includes a provision specifying a dollar amount for the waiver or termination of a right of first refusal, it has been the policy of the NASD Corporate Financing Department (the Department) to value the right of first refusal on the basis of the specified dollar amount in place of the one percent valuation.

      The NASD believes that members should be permitted to negotiate to waive or terminate a right of first refusal in the event that the issuer wishes to use a different underwriter to subsequently raise additional capital through a public or private offering of its securities, provided that amounts negotiated are limited to an amount that has some relation to the size of the subsequent offering in which the member is not participating. Because use of rights of first refusal is primarily confined to certain underwriters of companies that are generally small and without significant operative history, the NASD has found that issuers negotiating with an underwriter for the first time in connection with an initial public offering often may not fully comprehend that they have agreed to extend their relationship with the underwriter for as many as five years, nor be in a position to influence the terms of the right. In addition, the NASD has observed that certain underwriters routinely negotiate to receive rights of first refusal at the time of an initial public offering and later negotiate to waive or terminate their rights, apparently without any original intent to actually underwrite any subsequent offering of securities by the issuer.

      The NASD is concerned that underwriters not be permitted to avoid underwriting compensation limits by negotiating to waive or terminate a right of first refusal with no limitation whatsoever on the amount of compensation they might negotiate to receive. The NASD is also concerned that an issuer may find it difficult to negotiate appropriate underwriting compensation with a new underwriter, where the issuer has determined to sever its relationship with its former underwriter and the former underwriter requires a substantial payment to waive or terminate its right of first refusal. Finally, the NASD believes that the policy on rights of first refusal should also protect investors, who ultimately incur the cost when an issuer compensates an underwriter for waiving or terminating a right of first refusal.

      NASD Proposal

      The NASD is proposing to amend Section (c)(3)(A)(ix) and Section (c)(6)(B)(v) of the Rule to modify its current provisions regulating the receipt of a right of first refusal. The amendment is intended to preserve rights of first refusal as a valuable item of compensation to an underwriter, while protecting issuers from excessive payments to waive or terminate a right of first refusal granted to a former underwriter.

      The amendment would prohibit an underwriter from receiving a right of first refusal that has a duration of longer than three years from the effective date of the offering. The NASD has concluded that a 5-year right is "overreaching" and determined a 3-year period more appropriate. The amendment would also prohibit a right of first refusal that grants the underwriter more than one opportunity to waive or terminate the right in consideration of any payment or fee. The NASD believes that only one payment should be received by a member for waiving a right of first refusal and that such a payment indicates that the originally negotiated relationship between the issuer and the member has been severed.

      With respect to valuation of a right of first refusal in connection with the offering where the right is granted, the amendment would require that a right of first refusal have a compensation value of the lesser of one percent of the offering proceeds or the dollar amount contractually agreed to for waiver or termination of the right.

      With respect to the amount of the fee permitted to be paid to a former underwriter in connection with the waiver or termination of a right of first refusal, the NASD has determined to continue to permit such payments, subject to limitations, and to not include the fee paid in connection with its review of the subsequent offering of securities. The amendment would permit the former underwriter to receive a payment or fee to waive or terminate a right of first refusal, so long as the payment or fee does not exceed the greater of one percent of the original offering (or an amount in excess of one percent if additional compensation is available under the compensation guideline of the original offering),2 or 5 percent of the underwriting discount or commission paid in connection with the future offering (including any overallotment option that is exercised). The payment or fee would be permitted regardless of whether it is negotiated at the time of or subsequent to the original public offering. The NASD believes that it is appropriate that the former underwriter be permitted to negotiate a fee that is at least equal to the original valuation of the right of first refusal. With respect to the 5 percent alternative limitation, the NASD recognizes that a right of first refusal is intended to benefit the former underwriter that assumed the risk of distributing the issuer's initial public offering by allowing that underwriter to participate in the issuer's subsequent offering of securities, which is usually considerably larger. The NASD believes, therefore, that it is appropriate to permit the former underwriter to receive a fee based on the new underwriter's commission in the event that the issuer wishes to sever its relationship with the former underwriter.3

      Finally, the amendment would require that any payment or fee for terminating or waiving a right of first refusal can only be in cash, not in securities or rights to acquire securities.

      The NASD recognizes that a right of first refusal may be entered into between an issuer and an underwriter in connection with a private placement that occurs before a public offering, with the result that the underwriting agreement in connection with the public offering will not include this arrangement. The NASD recognizes that in most cases, the right of first refusal only relates to the right of the underwriter to distribute the subsequent public offering. In certain cases, however, the right may have a longer duration. Although private placements are not subject to the Rule, the underwriting arrangements entered into in connection with the distribution of the private placement are subject to review by the Department at the time it reviews a subsequent public offering that is subject to the Rule. Under the Rule, any compensation or securities received by the underwriter and related persons may be considered in connection with a public offering if received within the 12 months immediately preceding the filing of the public offering. The Department, therefore, intends to review any right of first refusal granted in connection with a private offering that occurs within the previous 12 months to determine if it should be considered compensation received in connection with the public offering. If the right is found to be in connection with the public offering, the terms of the right will be required to be in compliance with the Rule's limitations on rights of first refusal.

      Request For Comments

      The NASD encourages all members and other interested parties to comment on the proposed amendment to the Rule on rights of first refusal. Comments should be forwarded to: Joan C. Conley, Office of the Secretary, NASD, 1735 K Street, N.W., Washington, D.C. 20006-1506. Comments should be received by November 30, 1994.

      Questions concerning this Notice may be directed to Richard J. Fortwengler or Paul M. Mathews, Corporate Financing Department, (301) 208-2700. Comments received on or before November 30, 1994, will be considered before final action by the Corporate Financing Committee and the NASD Board on the proposed amendment. If approved by the Committee and the Board, the amendment will be filed with the Securities and Exchange Commission (SEC). It is anticipated that the SEC will also publish the proposed amendment before acting on it. SEC approval of the amendment is required before it can become effective.


      1 See, Corporate Financing Rule at Article III, Section 44 of the Rules of Fair Practice (Corporate Financing Rule), Section (c)(3)(A)(ix) and Section (c)(6)(B)(v). NASD Manual, paragraph 2200D at pages 2206 and 2209.

      2 It is anticipated that the former underwriter will contact the Department when it is negotiating a waiver or termination of a right of first refusal to obtain information on whether additional compensation is available under the compensation guideline of the original offering.

      3 For example, where the offering proceeds of the original offering were $10 million and the new offering was to be $150 million, with a discount of 6 percent or $9 million, the member could negotiate a fee for waiver or termination of the right of first refusal of up to $450,000 (5 percent of $6 million, or $450,000, which is greater than 1 percent of $10 million, or $100,000).


      Text Of Proposed Amendment To The Corporate Financing Rule, Article III, Section 44 Of The Rules Of Fair Practice

      [Note: New text is underlined; deleted text is bracketed.]

      (3) Items of Compensation
      (A) For purposes of determining the amount of underwriting compensation received or to be received by the underwriter and related persons pursuant to paragraph (c)(2) above, the following items and all other items of value received or to be received by the underwriter and related persons in connection with or related to the distribution of the offering, as determined pursuant to paragraph (c)(4) below shall be included:
      (i) through (viii) No change.
      (ix) any right of first refusal provided to the underwriter and related persons to underwrite or participate in future public offerings, private placements or other financings [by the issuer], which will have a compensation value of the lesser of one percent of the offering proceeds or that dollar amount contractually agreed to by the issuer and underwriter to waive or terminate the right of first refusal;
      (x) through (xiii) No change. (3)(B), (4) and (5) No change.
      (6) Unreasonable Terms and Arrangements
      (A) No change.
      (B) Without limiting the foregoing, the following terms and arrangements, when proposed in connection with the distribution of a public offering of securities, shall be unfair and unreasonable:
      (i) through (iv) No change.
      (v) any right of first refusal provided to the underwriter and related persons [regarding] to underwrite and participate in future public offerings, private placements or other financings which:
      (1) has a duration of more than [five (5)] three (3) years from the effective date of the offering; or
      (2) has more than one opportunity to waive or terminate the right of first refusal in consideration of any payment or fee:
      (vi) any payment or fee to waive or terminate a right of first refusal regarding future public offerings, private placements or other financings provided to the underwriter and related persons which:
      (1) has a value in excess of the greater of one (1) percent of the offering proceeds in the public offering where the right of first refusal was granted (or an amount in excess of one percent if additional compensation is available under the compensation guideline of the original offering) or five (5) per cent of the underwriting discount or commission paid in connection with the future financing (including any overallotment option that may be exercised), regardless of whether the payment or fee is negotiated at the time of or subsequent to the original public offering: or
      (2) is not paid in cash.
      [(vi)] (vii) Text unchanged.
      [(vii)] (viii) Text unchanged.
      [(viii)] (ix) Text unchanged.
      [(ix)] (x) Text unchanged.
      [(x)] (xi) Text unchanged.
      [(xi)] (xii) Text unchanged,
      [(xii)] (xiii) Text unchanged.

    • 94-81 SEC Approves NASD Proposal To Require CQS Market-Maker Participation In ITS/CAES And CAES

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      Executive Summary

      On June 29, 1994, the Securities and Exchange Commission (SEC) approved several proposed rule changes by the NASD concerning trading in exchange-listed securities by NASD Consolidated Quotation System (CQS) market makers.1 Specifically, the following rules will be effective on October 31, 1994:

      • All CQS market makers in Rule 19c-3 securities2 must register as ITS/CAES market makers;3

      • All CQS market makers in non-Rule 19c-3 securities must register as Computer Assisted Execution System (CAES) market makers;4

      • All CQS market makers must input a minimum size of 500 shares in their quotations;5

      • All CQS market makers must abide by the excess spread parameters for CQS securities in Part V of Schedule D to the NASD By-Laws; and

      • All CQS market makers will be permitted to enter principal orders into CAES.

      The NASD and The Nasdaq Stock Market, Inc., believe these changes will enhance the quality and liquidity of the markets provided by CQS market makers in exchange-listed securities, improve opportunities for customers to receive automated executions of their orders in the third market, and make ITS a more effective market link mechanism in exchange-listed securities. The text of the amendments follows the discussion below.

      Background And Description

      In an effort to enhance the quality of the markets provided by CQS market makers in exchange-listed securities, promote competition among exchange markets and markets provided by CQS market makers, and facilitate better order interaction among ITS Participant Markets, the NASD proposed various amendments to Schedules D and G and the Rules of Practice and Procedure for ITS/CAES. Following is a more detailed explanation of the specific rule changes approved by the SEC.6

      1. Mandatory Inclusion Of CQS Market Makers In Rule 19c-3 Securities In ITS/CAES

      One of the most significant amendments approved by the SEC is the requirement that all CQS market makers in Rule 19c-3 securities must register as ITS/CAES market makers, thereby subjecting all CQS market makers in these securities to the obligations and protections afforded participants in the ITS Plan. This rule change is designed to eliminate confusion by exchange participants and others concerning the accessibility of quotations disseminated by CQS market makers. Currently, the quotes of all CQS market makers in exchange-listed securities are consolidated into a composite third-market quote and disseminated to vendors and to the floors of competing exchanges on CQS. The quotes of CQS market makers that are not ITS-linked are included in the consolidated quote, but are not accessible through the facilities of ITS or ITS/CAES to other ITS Participants or ITS/CAES market makers. ITS has its own display of quotations, available only to ITS Participants, and this dual system of quotation information is sometimes confusing. Specifically, when other market centers send ITS commitments to the NASD in response to non-ITS/CAES market-maker quotes seen through CQS, the commitments expire unexecuted and the other market centers may believe that an ITS/CAES market maker has backed away from its quotes. With this rule change, there will be no confusion as to the accessibility of CQS market makers' quotes in Rule 19c-3 securities through ITS.

      In addition, by requiring all CQS market makers in Rule 19c-3 securities to participate in ITS, the rule change facilitates better interaction between CQS market makers and the exchanges. Currently, other ITS Participant Markets cannot execute transactions through ITS with CQS market makers that are not ITS/CAES market makers, even though these market makers may be quoting superior prices. Conversely, non-ITS-linked CQS market makers cannot access, through ITS, superior quotes displayed by the exchanges. With this rule change, orders received by all CQS market makers in Rule 19c-3 securities will be able to interact, through ITS, with orders placed on the exchanges, thus promoting the best execution of investors' orders.

      Non-ITS-linked CQS market makers also are presently not bound by the ITS Plan or operating procedures. The ITS Plan contains provisions regarding treatment of trade-through occurrences, block trades, pre-opening procedures, and resolution of obvious errors and intermarket disputes. The new rule will eliminate the current disparate regulatory treatment between those CQS market makers bound by the ITS Plan and those not bound by the Plan. In addition, pursuant to Section (b)(2) of the NASD's ITS/CAES Rules, members are reminded that they must execute an ITS/CAES Market Maker Application Agreement at least two days before the date they intend to be registered as an ITS/CAES market maker in a CQS security.

      Members are reminded, however, that if they effect and report a transaction in a CQS security that is included within the ITS/CAES linkage after 9:30 a.m. Eastern Time, but before any ITS/CAES market maker in that security has commenced quoting or trading the issue, then all ITS/CAES market makers in that security may be precluded from participating in the ITS pre-opening procedure for that security on that trading day.
      2. Mandatory Participation In CAES For Non-Rule 19c-3 Securities/Permitting Principal Transactions Through CAES

      The SEC approved the requirement that all CQS market makers in non-Rule 19c-3 securities must register as CAES market makers. Mandatory participation in CAES will enhance the liquidity provided through CAES and permit CAES to be a more efficient mechanism for trading exchange-listed securities in the third market. In addition, with mandatory CAES participation, the NASD believes it is appropriate for CAES market makers to be able to access each other through CAES, reducing reliance on telephone contact. Accordingly, the SEC also approved an NASD proposal to modify CAES to permit market-maker-to-market-maker executions within the system.
      3. Minimum Quotation Sizes For CQS Market Makers

      All CQS market makers, regardless of whether they are ITS/CAES market makers or CAES market makers, are now required to input a minimum size of 500 shares in their quotations. The minimum quotation size for an individual CQS security may be lowered from 500 shares to 200 shares from time to time by the NASD depending on unique circumstances, however.7 The minimum quotation size for each CQS issue will be displayed to the left of the issue's name in the bid/ask quotation display on the Nasdaq Workstation®.
      4. Excess Spread Parameters To CQS Market Makers

      All CQS market makers will be required to adhere to the excess spread parameters established in Part VI, Section 2 of Schedule D to the NASD By-Laws. Specifically, the maximum permissible spread for a dealer's quote in a CQS security will be equal to 125 percent of the average of the narrowest three dealer spreads in that issue, provided that the maximum allowable spread will never be less than 1/4 a point. In determining the maximum allowable spread, quotations of exchange participants will be included in the calculation.

      Questions regarding this rule change should be directed to Glen Shipway, Senior Vice President, Nasdaq Market Operations, at (203) 385-6250, or Thomas R. Gira, Assistant General Counsel, at (202) 728-8957. Questions concerning the ITS/CAES Market Maker Application Agreement should be directed to Market Data Services at (301) 948-6162.


      1 The third market is the market for exchange-listed securities away from exchange markets.

      2 SEC Rule 19c-3 prohibits the application of off-board trading restrictions to securities that: (1) were not traded on an exchange before April 26, 1979; or (2) were traded on an exchange on April 26, 1979, but ceased to be traded on an exchange for any period of time thereafter. The Intermarket Trading System (ITS) Plan limits the securities eligible for trading through the ITS/CAES linkage to Rule 19c-3 securities.

      3ITS/C AES is the NASD's link to ITS that enables ITS/CAES market makers in Rule 19c-3 securities to direct agency and principal orders to and receive orders from the floors of participating ITS exchanges. Only CQS market makers registered as ITS/CAES market makers with the NASD are eligible to participate in the ITS/C AES link.

      4 CAES is an automated system regulated by the NASD and operated by The Nasdaq Stock Market, Inc., that allows NASD members to direct agency orders (and principal orders with this rule change) in exchange-listed securities to CAES for automated execution in the third market. CAES market makers are CQS market makers that have registered as CAES market makers.

      5 The NASD's new rule with respect to minimum quotation sizes in CQS securities provides that" CQS market makers shall be required to input a minimum quotation size of 200 or 500 shares in each reported security (as established and published from time to time by the Association) depending on trading characteristics of the security ...." In this connection, the NASD has determined to require a minimum quotation size of 500 shares for all CQS market-maker quotations.

      6 See Securities Exchange Act Release No. 34280 (June 29, 1994), 59 FR 34880

      7 See infra note 5.


      Text Of Amendments To Schedules D And G To The NASD By-Laws And The Rules Of Practice And Procedure For ITS/CAES

      (Note: New text is underlined; deleted text is bracketed.)

      Schedule D, Part VII Consolidated Quotation Service (CQS)

      Sec. 1 Registration as a CQS Market Maker

      (a) through (d) No change.
      (e) All COS market makers registered in reported securities shall be registered as market makers in the Computer Assisted Execution System (CAES): all COS market makers registered in reported securities that are eligible for inclusion in the Intermarket Trading System/ Computer Assisted Execution System (ITS/CABS') shall be registered as market makers in ITS/CAES and shall be subject to the Rules of Practice and Procedure for the ITS/CAES System Automated Interface.

      Sec. 2 Obligations of CQS Market Makers

      (a) Pursuant to SEC Rule 1 lAcl-1, a CQS market maker's quotation in reported securities are required to be firm for the size displayed or, if no size is displayed, for a normal unit of trading. If a market maker displays quotations in a reported security on both a national securities exchange and the NASD's CQS [and the Nasdaq] System, the market maker shall maintain identical quotations in each system [service].
      (b) COS market makers shall be required to input a minimum quotation size of 200 or 500 shares in each reported security (as established and published from time to time by the Association) depending on trading characteristics of the security, and shall be subject to the excess spread parameters established for Nasdaq market makers in Part VI. Schedule D of the NASD By-Laws.

      Schedule G

      Reporting Transactions In Listed Securities

      This Schedule has been adopted pursuant to Article VII, Section 1(a)(6) of the Corporation's By-Laws and shall apply to all over-the-counter transactions in listed securities that are required to be reported to the Consolidated Tape ("eligible securities") as provided in the Plan filed by the Association pursuant to Rule HAa3-1 under the Securities Exchange Act of 1934 ("Plan"). Section (2) of this Schedule shall not apply to transactions executed through CAES (Computer Assisted Execution System) or ITS/CAES (Intermarket Trading System/Computer Assisted Execution System) by market makers registered as COS market makers.

      Rules Of Practice And Procedure For The ITS/CAES Automated Interface

      (a) Definitions
      (1) No change.
      (2) The term "ITS/CAES Market Maker" shall mean a member of the Corporation that is registered as a market maker with the Corporation for the purposes of participation in ITS through CAES with respect to one or more specified ITS securities in which he is then actively registered. Registration as an ITS/CAES market maker is mandatory for all registered COS market makers in securities eligible for inclusion in the ITS/CAES linkage.

    • 94-80 SEC Approves NASD Proposal Requiring Members To Annotate Their Affirmative Determinations As To Stock Availability Made In Connection With Short Sales

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      Executive Summary

      On September 12, 1994, the Securities and Exchange Commission (SEC) approved an NASD rule change that amends the Prompt Receipt and Delivery of Securities Interpretation (Interpretation) issued by the NASD Board of Governors under Article III, Section 1 of the NASD Rules of Fair Practice. Specifically, the Interpretation, as amended, requires members to annotate their affirmative determinations as to stock availability that are required to be made when effecting short sales for their own proprietary account or the account of a customer. The rule change will become effective November 30, 1994.

      Background And Description

      Under the Interpretation, members are required to make certain affirmative determinations as to stock availability when effecting sale transactions. Specifically, for long sales by customers, members must make an affirmative determination that the customer owns the security and will deliver it in good deliverable form within 5 business days of execution of the order. For customer short sales, the Interpretation requires members to make an affirmative determination that it will receive delivery of the security from the customer or that it can borrow the security on behalf of the customer for delivery by settlement date. Similarly, for short sales effected in a member's proprietary account, a member must make an affirmative determination that it can borrow the securities or otherwise provide for delivery of the securities by settlement date.

      While members must make affirmative determinations as to stock availability when effecting long sales and short sales, the Interpretation presently only requires members to annotate their affirmative determinations made in connection with long sales.1 Accordingly, to enhance member firm compliance with the affirmative determination requirements already imposed by the Interpretation in connection with short sales and to enable the NASD to more effectively examine for compliance with the affirmative determination requirements, the NASD proposed, and the SEC approved, an amendment to the Interpretation that requires members to annotate their affirmative determinations as to stock availability that are required to be made when effecting short sales for their own proprietary account or the account of a customer. Thus, with this rule change, members will be required to annotate activities that they are already performing in connection with the execution of short sales.2

      In particular, the Interpretation, as amended, will require members to annotate, on the trade ticket or on some other record maintained for that purpose by the member firm, the following information:

      1. if a customer assures delivery, the member must annotate that conversation noting the present location of the securities; whether the securities are in good deliverable form; and whether they will be delivered to the firm within time for settlement; or
      2. if the member locates the stock, the member must annotate the identity of the individual and firm contacted who offered assurance that the shares would be delivered or were available for borrowing by settlement date; and the number of shares needed to cover the short sale.

      The manner by which a member or person associated with a member annotates compliance with the "affirmative determination" requirements for short sales (for example, marking the order ticket, recording inquiries in a log, etc.) is not specified by this Interpretation and, therefore, shall be decided by each member. However, an affirmative determination and annotation of that affirmative determination must be made for each and every transaction because a "blanket" or standing assurance that securities are available for borrowing is not acceptable to satisfy the affirmative determination requirement.

      Accordingly, with this rule change, the NASD has made clear its longstanding policy that firms cannot rely on daily fax sheets of "borrowable stocks" to satisfy their affirmative determination requirements under the Interpretation. The annotation requirement will preclude this practice as members will have to annotate the name of the person contacted and number of shares for each short sale. Requiring annotation of affirmative determinations in connection with short sales also will enhance the NASD's ability to examine for compliance with various other NASD short-sale rules including those in Article III, Section 21 of the Rules of Fair Practice (recordkeeping) and in the Uniform Practice Code, Section 71 (mandatory delivery requirements for certain restricted securities). Further, the annotation requirement will assist in examining for compliance with the NASD's recently adopted short-sale rule.

      Questions regarding this Notice should be directed to NASD Market Surveillance, at (301) 590-6080, or Thomas R. Gira, Assistant General Counsel, at (202) 728-8957.


      1 Specifically, Section (b)(4) of the Interpretation requires that a member or person associated with a member "must make a notation on the order ticket at the time he takes the order which reflects his conversation with the customer as to the present location of the securities in question, whether they are in good deliverable form and his ability to deliver them to the member within five (5) business days."

      2 The NASD notes, however, that the rule change does not modify any exemptions from the affirmative determination requirements that are presently in the Interpretation. Specifically, transactions in corporate debt securities, bona fide market making transactions by members in securities in which they are registered as Nasdaq® market makers, bona fide market-maker transactions in non-Nasdaq securities in which the market maker publishes two-sided quotations in an independent quotation medium, and proprietary transactions by members that result in fully hedged or arbitraged positions, are still exempt from the affirmative determination requirements for short sales.


      Text Of Amendments To The Prompt Receipt And Delivery Of Securities Interpretation Issued By The NASD Board Of Governors Under Article III, Section 1 Of The NASD Rules Of Fair Practice

      (Note: New text is underlined; deleted text is bracketed.)

      • • • Interpretation Of The Board Of Governors

      Prompt Receipt And Delivery Of Securities

      .04 It shall be deemed a violation of Article in, Section 1 of the Rules of Fair Practice of the Association for a member or person associated with a member to violate the provisions of the following interpretation thereof:
      (a) Purchases: No member or person associated with a member may accept a customer's purchase order for any security unless it has first ascertained that the customer placing the order or its agent agrees to receive securities against payment in an amount equal to any execution, even though such an execution may represent the purchase of only a part of a larger order.
      (b) Sales:
      (1) Long Sales

      No member or person associated with a member shall accept a long sale order from any customer in any security unless:
      (A) No change.
      (B) No change
      (C) The member or person associated with a member makes an affirmative determination that the customer owns the security and will deliver it in good deliverable form within five (5) business days of the execution of the order; or
      (D) No change.
      (2) "Short Sales"
      (A) Customer short sales. No member or person associated with a member shall accept a "short" sale order for any customer in any security unless the member or person associated with a member makes an affirmative determination that the member [it] will receive delivery of the security from the customer or that the member [it] can borrow the security on behalf of the customer for delivery by settlement date. This requirement shall not apply, however, to transactions in corporate debt securities.
      (B) Proprietary short sales. No member or person associated with a member shall effect a "short" sale for its own account in any security unless the member or person associated with a member makes an affirmative determination that the member [it] can borrow the securities or otherwise provide for delivery of the securities by settlement date. This requirement will not apply to transactions in corporate debt securities, to bona fide market making transactions by a member in securities in which it is registered as a NASDAQ market maker, to bona fide market maker transactions in non-NASDAQ securities in which the market maker publishes a two-sided quotation in an independent quotation medium, or to transactions which result in fully hedged or arbitraged positions.
      (3) Public Offering

      No change.
      (4) "Affirmative Determination"
      (A) To satisfy the requirements for an "affirmative determination" contained in subsection (b)(1)(C) above for long sales, the member or person associated with a member must make a notation on the order ticket at the time [he takes] the order is taken which reflects [his] the conversation with the customer as to the present location of the securities in question, whether they are in good deliverable form and [his] the customer's ability to deliver them to the member within five (5) business days.
      (B) To satisfy the requirement for an "affirmative determination" contained in subsection (b)(2) above for customer and proprietary short sales, the member or person associated with a member must keep a written record which includes:
      (i) if a customer assures delivery, the present location of the securities in question, whether they are in good deliverable form and the customer's ability to deliver them to the member within five (5) business days; or
      (ii) if the member or person associated with a member locates the stock, the identity of the individual and firm contacted who offered assurance that the shares would be delivered or that were available for borrowing by settlement date and the number of shares needed to cover the short sale.
      (C) The manner by which a member or person associated with a member annotates compliance with the "affirmative determination" requirement contained in subsection (b)(2) above (e.g., marking the order ticket. recording inquiries in a log, etc.) is not specified by this Interpretation and, therefore, shall be decided by each member. However, an affirmative determination and annotation of that affirmative determination must be made for each and every transaction since a "blanket" or standing assurance that securities are available for borrowing is not acceptable to satisfy the affirmative determination requirement.
      (5) "Bona Fide Fully Hedged" and "Bona Fide Fully Arbitraged"

      No change.

    • 94-79 NASD Solicits Member Comment On Board Proposals To Extend Customer Limit-Order Protection;

      Comment Period Expires November 7, 1994

      SUGGESTED ROUTING

      Senior Management
      Institutional
      Legal & Compliance
      Systems
      Trading

      Executive Summary

      On September 19, 1994, the Board of Governors approved issuance of a Notice to Members soliciting comment on proposals to expand the scope of limit-order protection beyond that presently afforded by member firms to their customers in The Nasdaq Stock Market™. Currently, the NASD's Interpretation to the Rules of Fair Practice makes it a violation of just and equitable principles of trade for a member firm to trade ahead of its own customer's limit orders. The new proposals would extend this protection to the customer of a firm that sends a limit order of 1,000 shares or less to another member for execution (so-called member-to-member trades). In addition, the proposals would prohibit trading ahead of all other customer limit orders sent from one member to another when the member firm accepting the order trades for its own account at prices that are superior but not equal to the limit order price.

      The NASD is soliciting comment on these specific proposals, described in more detail below, as well as any other concerns this action raises for members or interested parties. Comments received on or before November 7, 1994, will be considered by the Board at its November meeting.

      Background

      In July 1994, a Limit Order Protection Rule became effective for NASD members accepting limit orders in Nasdaq securities.1 Under the Limit Order Interpretation to the Rules of Fair Practice, a member firm cannot accept and hold its customer's limit order in a Nasdaq security and continue to trade that security for its own account at prices that would satisfy the customer's limit order without filling that order.

      The rule renders such trading activity ahead of the customer's order a violation of just and equitable principles of trade.

      When the NASD initially proposed the limit-order rule, it solicited comment from members on the advisability of implementing trading-ahead restrictions for all customer limit orders, including those passed from one member firm to another for execution.2 The vast majority of members commented that limit-order protection for a firm's own customers was appropriate and beneficial to the market, but several cautioned against the potential adverse impact that could result from application of a rule to member-to-member orders. In recognition of the concerns raised, the Board deferred broader application of the rule and commissioned a special Limit Order Task Force to review the issue.

      To gather information on the subject of limit-order protection in the Nasdaq market, the Limit Order Task Force held two roundtables with participation from various segments of the industry including discount brokers, wholesale market makers, integrated broker/dealers, the Security Traders Association (STA), and the STA of New York (STANY). Each of the participants supported the trading-ahead prohibition that would prohibit a market maker from executing transactions for its own account at prices equal to or better than its own customer's limit order. The participants expressed concerns, however, that NASD rulemaking expanding this prohibition to inter-dealer trades would interfere with a market maker's ability to manage risk and would reduce liquidity in the marketplace.

      Roundtable participants believed that dealers would be reluctant to fill large buy orders (by shorting the stock) if their ability to cover short positions was curtailed by the requirement to execute pending customer limit orders before their own buying interest.

      The Task Force devoted considerable attention to discussions of the impact such additional rulemaking would have upon the financial viability of the competing dealer system and the potential adverse impacts upon the quality and efficiency of that market structure. To balance the desire to extend limit-order protection to all customer limit orders with the concerns regarding potential disruptive effects of such an action on liquidity and market structure, the Task Force proposed a requirement that members not trade ahead of customer limit orders if members were allowed the opportunity for profit on such trades. Accordingly, the Task Force recommended limit-order protections for member-to-member trades that would make it a violation to trade ahead of customer limit orders when the market makers traded at a price superior to the limit-order price.

      Discussion

      The Board of Governors accepted the recommendation of the Limit Order Task Force (which received Trading Committee approval) as it applied to large-sized customer orders. However, its concerns with respect to ensuring protections of all small-investor limit orders led it to its proposal to require equivalent limit-order protection for any customer orders of 1,000 shares or less whether held by the customer's firm or entrusted to another member for execution. The Board took this action after carefully weighing the ramifications of their actions on the liquidity in The Nasdaq Stock Market.

      In a competitive dealer environment, institutional customers expect that market makers be willing to deal in large sizes at the best prices displayed in Nasdaq. Limit-order protection, in its broadest sense, means placing the customer's trading interest ahead of the dealer's interest. This is easily accomplished in a monopolistic environment, as an exchange specialist is compensated for its handling of customer limit orders, and the size reflected in the specialist's quote is frequently indicative of a small-customer limit order. There are few institutional expectations of depth or liquidity beyond the size of the displayed quote and customers interested in executing large trades negotiate in an upstairs, dealer environment. Because the Nasdaq dealer market is based on a competitive design rather than a monopolistic model, there is no readily apparent remuneration mechanism for dealers handling a limit order from another broker/dealer over and above potential profit from its trading activity. Removal of profit potential from inter-dealer trading involving large-sized limit orders would constitute a clear disincentive to the handling of limit orders.

      Further, requiring dealers to yield precedence in all circumstances to the execution of large-sized customer interest ahead of their own trading position may have a profound effect on the market makers' ability to offer liquidity at the limit-order price. Market makers may not be willing to fill large orders out of their inventory positions since their activity to buy stock back will necessarily trigger obligations to fill limit orders. Thus it is foreseeable that limit-order protection for large-sized orders may cause a reduction in the liquidity currently available to institutional customers.

      The Board believes that such restrictions on dealers would be onerous and would not be in the best interests of investors who rely on the Nasdaq market for depth and liquidity. Accordingly, the Board has determined that it is appropriate to propose limit-order protection standards which appropriately differentiate between small-sized and large-sized customer limit orders. For small limit orders (1,000 shares or less), the Board proposes to implement the same limit-order protection that is currently in place for a market maker's own customers — that a market maker may not trade ahead for its own account at a price that would satisfy the limit-order price. For larger-sized orders, however, the Board believes it is appropriate to impose a different standard. When a member accepts and holds a customer limit order greater than 1,000 shares from another member firm, the dealer's obligation to fill that limit order is triggered when the market maker trades at a price that is superior to the limit order price.

      To illustrate, if the inside market in a Nasdaq issue were 20 – 20 1/4 and the market maker accepted a customer buy order from another broker/dealer priced at 20 for 2,000 shares, a firm, buying at any price superior to 20 (that is, purchases at a price lower than a buy limit order, in this example, purchasing at 19 7/8 or 19 15/16), would be required to sell to the customer at 20 or better. Using the same example, if the customer limit order were for 500 shares at 20, the rule would prohibit members from trading ahead at 20 without filling the customer order at 20. Accordingly, the proposal would require protection for orders greater than 1,000 shares when the dealer trades at a superior price, and protection for orders 1,000 shares or less when the dealer trades at a price that would satisfy the limit-order price.

      The Board also believes that adopting such an approach to limit-order protection constructively addresses recent concerns that have been expressed with regard to market structure and competitive issues. It has been argued that mandating limit-order protection for all member-to-member trades will act as an incentive to vertical integration of member firms, to the detriment of non-integrated firms (wholesale dealers), because an integrated firm accepting a limit order from its customer would be able to protect that order at its market-making quote and still retain the opportunity to assess a sales charge on the order. Non-vertically integrated firms, on the other hand, have no privity with the ultimate customer and thus no opportunity to assess a sales charge to cover their expenses.

      Similarly, arguments have been advanced that the rule will result in concentrations of orders being placed with large, active market makers because customers will look to maximize the probability that their limit orders will be triggered by market-maker activity. Such concentration of order flow, it could be argued, will create barriers to entry to smaller market makers. Comments have also been received indicating that market makers in less liquid Nasdaq securities may cease their sponsorship in those issues because of the negative impact on dealer profit that may result if a broader limit-order protection rule were implemented. The Board is concerned with diminution of sponsorship for the less active Nasdaq issues as well as barriers to entry and believes that structuring the limit-order proposals based on the size of the customer's order should respond to these concerns.

      The Board also discussed a member request to commission an economic study on expansion of limit-order protection. Because a study reviewing handling of limit orders would necessarily involve many variables that could not be adequately weighted, the Board determined that a study would not provide useful quantitative information. A review of limit-order handling, using data from a time when a rule was not in effect, would not reflect modifications in trading techniques, order-entry firm adjustments to routing mechanisms, or alterations in payment-for-order-flow arrangements. Extrapolations from such a review could not accurately forecast future trading practices or order-routing modifications, nor could the NASD rely on the study to predict economic or structural upheavals. Accordingly, the Board believed that an economic analysis would not provide sufficient justification to defer the Board's recommendations for action. Nevertheless, if members wish to offer statistical or economic analyses on the issues, the Board will consider such information when making its final determination.

      Finally, the Board's proposals for rulemaking reiterate that the proposed Interpretation would not interfere with a member's ability to establish specific terms and conditions with regard to the acceptance of limit orders provided that the member makes those conditions clear to the customer. Similarly, nothing in the proposed Interpretation obligates market makers to accept limit orders from any or all customers or member firms. The Board has also decided that the proposals would be reviewed after one year so that the market impact and economic ramifications of any future actions could be adequately assessed.

      Request For Comments

      The Board is soliciting comments from members and interested parties so that the proposals under consideration by the Board may be thoroughly reviewed. Comments must be received no later than November 7, 1994, and addressed to Joan C. Conley, Secretary, NASD, 1735 K Street, N.W., Washington, D.C. 20006-1500.


      1 See Notice to Members 94-58 and Securities Exchange Act Release No. 34279 (June 29, 1994).

      2 See Notice to Members 93-49 (July 23, 1993).

    • 94-78 Fixed Income Pricing System Additions, Changes, And Deletions As Of August 29, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Institutional
      Legal & Compliance
      Municipal
      Operations
      Systems
      Trading

      As of August 29, 1994, the following bonds were added to the Fixed Income Pricing System (FTPSSM). These bonds are not subject to mandatory quotation:

      Symbol

      Name

      Coupon

      Maturity

      HNTC.GA

      Huntsman Corp.

      10.625

      3/31/01

      SCTI.GA

      SCI Tele Inc.

      11.000

      6/30/05

      DTC.GA

      Domtar Inc.

      12.000

      4/15/01

      HTT.GC

      Healthtrust Hosp.

      10.250

      4/15/04

      USG.GH

      USG Corp.

      9.250

      9/15/01

      HNTC.GB

      Huntsman Corp.

      11.000

      3/3/04

      JPSA.GA

      JPS Auto Motive Prod. Corp.

      11.125

      4/1/01

      SPX.GA

      Spx Corp.

      11.750

      6/1/02

      RCCA.GB

      Rogers Cablesystems Ltd.

      9.625

      8/1/02

      VDOH.GA

      Videotron Holdings Pic.

      11.125

      7/1/04

      WHEN.GA

      Wherehouse Entertainment Inc.

      13.000

      8/1/02

      THPY.GA

      Thrifty Payless Inc.

      12.250

      4/15/04

      FLES.GB

      Food 4 Less

      13.750

      6/15/01

      RVW.GE

      Riverwood Intl. Corp.

      10.375

      6/30/04

      FERL.GC

      Ferrellgas L.P/Finance

      10.000

      8/1/01

      SQA.GE

      Sequa

      9.375

      12/15/03

      GOU.GA

      Gulf Canada Resource

      9.250

      1/15/04

      GNV.GB

      Geneva Steel Co.

      0.000

      1/15/04

      MFST.GA

      MFS Communications

      0.000

      1/15/04

      VIA.GA

      Viacom Inc.

      8.000

      7/7/06

      ELPF.GA

      El Paso FDG Corp.

      10.750

      4/1/13

      REVL.GE

      Revlon Consumer Prods. Corp.

      9.375

      4/1/01

      DLNF.GA

      Del Norte FDG Corp.

      11.250

      1/2/14

      ERCF.GA

      Empress River Casino Fin. Corp.

      11.500

      10/15/01

      KCC.GB

      K-III Communications Corp.

      10.250

      6/1/04

      COLA.GE

      Collins & Aikman Group

      10.000

      1/31/05

      MESA.GC

      Mesa Capital Cp.

      12.750

      6/30/98

      MESA.GD

      Mesa Capital Corp.

      12.750

      6/30/96

      CLHB.GA

      Clean Harbors

      12.500

      5/15/01

      RPWI.GA

      Repap Wisconsin Inc.

      9.250

      2/1/02

      As of August 29, 1994, the following changes to the list of FTPS symbols occurred:

      New/Old Symbol

      Name

      Coupon

      Maturity

      SGNT.GA/SIGN.GA

      Signet

      9.625

      6/1/99

      All bonds listed above are subject to trade-reporting requirements. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-77 Nasdaq National Market Additions, Changes, And Deletions As Of August 29, 1994

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      As of August 29, 1994, the following 56 issues joined the Nasdaq National Market®, bringing the total number of issues to 3,707:

      Symbol

      Company

      Entry Date

      SOES Execution Level

      DSYT

      Dorsey Trailers, Inc.

      7/28/94

      500

      RFMI

      R F Monolithics, Inc.

      7/28/94

      200

      CIMA

      OMA LABS INC.

      7/29/94

      1000

      CSCC

      Cascade Communications Corp.

      7/29/94

      500

      MINSF

      MiniStor Peripherals International Limited

      7/29/94

      500

      MINWF

      MiniStor Peripherals International Limited (Wts 6/20/99)

      7/29/94

      500

      RMCF

      Rocky Mountain Chocolate Factory, Inc.

      7/29/94

      200

      WOFC

      Western Ohio Financial Corp.

      7/29/94

      200

      BGLV

      Bally's Grand, Inc.

      8/1/94

      200

      BGLVW

      Bally's Grand, Inc. (Wts exp 8/19/2000)

      8/1/94

      200

      STND

      Standard Financial Inc.

      8/1/94

      200

      CAST

      Citation Corporation

      8/2/94

      500

      SCALR

      Health o Meter Products, Inc. (Rights)

      8/2/94

      200

      MILL

      Miller Industries, Inc.

      8/2/94

      200

      MOVI

      Movie Gallery, Inc.

      8/2/94

      500

      ARTS

      Media Arts Group, Inc.

      8/3/94

      200

      SPCT

      Spectrian Corporation

      8/3/94

      200

      Tin

      TTI Industries, Inc.

      8/3/94

      200

      SYSF

      SystemSoft Corporation

      8/4/94

      200

      FACE

      Facelifters Home Systems, Inc.

      8/8/94

      200

      TCOMP

      Tele-Communications, Inc. (Pfd B)

      8/8/94

      500

      FVNB

      First Victoria National Bank

      8/9/94

      200

      ADTN

      ADTRAN, Inc.

      8/10/94

      200

      CPSS

      Consumer Portfolio Services, Inc.

      8/10/94

      200

      WAVT

      Wave Technologies International Inc.

      8/10/94

      500

      GMKTW

      Global Market Information Inc. (Wts exp 8/10/97)

      8/11/94

      500

      GMKT

      Global Market Information Inc.

      8/11/94

      500

      HMGC

      HMG Worldwide Corp.

      8/11/94

      200

      MLFB

      MLF Bancorp

      8/11/94

      1000

      ALNK

      AmeriLink Corporation

      8/12/94

      200

      HRBF

      Harbor Federal Bancorp, Inc.

      8/12/94

      500

      NEOG

      Neogen Corporation

      8/12/94

      200

      PMTS

      PMT Services, Inc.

      8/12/94

      200

      SIRN

      The Sirena Apparel Group, Inc.

      8/12/94

      200

      TWER

      Tower Automotive, Inc.

      8/12/94

      200

      MRKR

      Marker International

      8/16/94

      200

      FIBC

      Financial Bancorp, Inc. (N.Y.)

      8/17/94

      200

      FBST

      Fiberstars, Inc.

      8/18/94

      500

      JEBC

      Jefferson Bancorp, Inc.

      8/18/94

      200

      TBUD

      Team Rental Group, Inc.

      8/18/94

      200


      IMMI

      Inphynet Medical Management, Inc.

      8/19/94

      500

      MISS

      Mississippi Chemical Corporation

      8/19/94

      500

      OFCP

      Ottawa Financial Corporation

      8/19/94

      200

      CFON

      Target Technologies, Inc.

      8/19/94

      500

      TRCK

      Truck Components, Inc.

      8/19/94

      200

      BFSB

      Bedford Bancshares, Inc.

      8/22/94

      200

      CHGR

      Concord Health Group, Inc.

      8/22/94

      200

      CHGRW

      Concord Health Group, Inc. (Wts 4/19/00)

      8/22/94

      200

      CMTTF

      Comet Software International Ltd. (Ord. Shrs.)

      8/23/94

      200

      ERLY

      ERLY Industries, Inc.

      8/23/94

      200

      TJSY

      TJ Systems Corporation

      8/23/94

      200

      PRES

      Prime Residential, Inc.

      8/24/94

      500

      LORX

      Loronix Information Systems, Inc.

      8/25/94

      200

      VISNZ

      NewVision Technology, Inc. (Redeem Wts 8/25/99)

      8/25/94

      200

      VISN

      NewVision Technology, Inc.

      8/26/94

      200

      VISNW

      NewVision Technology, Inc. (Wts exp 3/30/95)

      8/26/94

      200

      Nasdaq National Market Symbol and/or Name Changes

      The following changes to the list of Nasdaq National Market securities occurred since July 28, 1994:

      New/Old Symbol

      New/Old Security

      Date of Change

      CBSA/CBSA

      Coastal Bancorp Inc/Coastal Bane Savings Assn.

      8/1/94

      CBSAP/CBSAP

      Coastal Bancorp Inc. (Pfd A)/Coastal Bane Savings Assn. (Pfd A)

      8/1/94

      BBIOY/BBIOY

      British Biotech pic (ADR)/British Biotechnology (ADR)

      8/2/94

      DFCO/DIDI

      Destron Fearing Corporation/Destron/TDI Inc.

      8/3/94

      SUMX/SUIN

      Summa Industries, Inc/Summa Industries, Inc.

      8/8/94

      COOP/COOP

      Cooperative Bankshares, Inc/Cooperative Bank for Savings Inc.

      8/9/94

      BBOX/MCBX

      Black Box Corporation/MB Communications, Inc.

      8/11/94

      SYLN/SYLN

      Sylvan Inc/Sylvan Foods Holdings Inc.

      8/11/94

      NACC/AGNC

      National Auto Credit Inc/Agency Rent A Car Inc.

      8/15/94

      CSLI/CSLH

      Cotton States Life Insurance Company/ Cotton States Life & Health Insurance Company

      8/15/94

      ITSWTSI

      International Lottery & Totalizer, Inc./ International Totalizer Systems Inc.

      8/25/94

      JBOH/RKSF

      JB Oxford Holdings, Inc/RKS Financial Group Inc.

      8/25/94

      LVSB/LVSB

      Lakeview Financial Corp./Lakeview Savings Bank

      8/26/94

      SHOW/SHOW

      Showscan Entertainment, Inc/Showscan Corp.

      8/29/94

      Nasdaq National Market Deletions

      Symbol

      Security

      Date

      FKFD

      Frankford Corporation (The)

      8/1/94

      FLOGE

      Falcon Oil & Gas Company, Inc.

      8/2/94

      ICSI

      International Container Systems, Inc.

      8/3/94

      MTECQ

      Machine Technology, Inc.

      8/4/94

      LBTYA

      Liberty Media Corporation (Cl A)

      8/5/94

      LBTYB

      Liberty Media Corporation (Cl B)

      8/5/94

      LBTYP

      Liberty Media Corporation (Pfd Cl E)

      8/5/94

      WTXT

      Wheatly TXT Corp.

      8/8/94

      TVXTF

      TVX Gold Inc.

      8/10/94

      CPER

      Consolidated Papers, Inc.

      8/12/94

      IBSC

      Image Business Systems Corporation

      8/12/94

      RESTW

      Restore Industries, Inc. (Wts 8/12/94)

      8/15/94

      LNBC

      Liberty National Bancorp, Inc.

      8/16/94

      STLG

      Sterling Bancshares Corporation

      8/16/94

      SCALR

      Health o Meter Products (Rts 8/16/94)

      8/17/94

      MTK

      Mechanical Technology, Inc.

      8/18/94

      MVIQC

      Media Vision Technology, Inc.

      8/18/94

      JAVA

      Mr. Coffee

      8/18/94

      PACEE

      Pace American Group

      8/18/94

      LINN

      Lincoln Food Service Products, Inc.

      8/19/94

      PDAS

      PDA Engineering

      8/19/94

      FIBI

      First Inter-Bancorp Inc.

      8/22/94

      ARBC

      Republic Bank

      8/23/94

      SUNT

      Sunward Technologies, Inc.

      8/23/94

      COBAP

      Commerce Bancorp Inc. (Ser B Cum.Cov.Pfd)

      8/24/94

      PTRO

      Petrominerals Corporation

      8/25/94

      STCX

      Signal Technology Corporation

      8/25/94

      CMBK

      Cumberland Federal Bancorpation Inc. (The)

      8/29/94

      Questions regarding this notice should be directed to Mark A. Esposito, Supervisor, Market Listing Qualifications, at (202) 728-8002. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-76 Columbus Day: Trade Date-Settlement Date Schedule

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      The schedule of trade dates-settlement dates below reflects the observance by the financial community of Columbus Day, Monday, October 10, 1994. On this day, The Nasdaq Stock MarketSM and the securities exchanges will be open for trading. However, it will not be a settlement date because many of the nation's banking institutions will be closed.

      Trade Date

      Settlement Date

      Reg. T Date*

      Sept. 29

      Oct. 6

      Oct. 10

      30

      7

      11

      Oct. 3

      11

      12

      4

      12

      13

      5

      13

      14

      6

      14

      17

      7

      17

      18

      10

      17

      19

      11

      18

      20

      *Pursuant to Sections 220.8(b)(1) and (4) of Regulation T of the Federal Reserve Board, a broker/dealer must promptly cancel or otherwise liquidate a customer purchase transaction in a cash account if full payment is not received within seven (7) business days of the date of purchase or, pursuant to Section 220.8(d)(1), make application to extend the time period specified. The date by which members must take such action is shown in the column entitled "Reg. T Date."

      Note: October 10, 1994, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board.

      Transactions made on Monday, October 10, 1994, will be combined with transactions made on the previous business day, October 7, for settlement on October 17. Securities will not be quoted ex-dividend, and settlements, marks to the market, reclamations, and buy-ins and sell-outs, as provided in the Uniform Practice Code, will not be made and/or exercised on October 10.

      Brokers, dealers, and municipal securities dealers should use these settlement dates to clear and settle transactions pursuant to the NASD Uniform Practice Code and Municipal Securities Rulemaking Board Rule G-12 on Uniform Practice.

      Questions regarding the application of these settlement dates to a particular situation may be directed to the NASD Uniform Practice Department at (203) 375-9609.

    • 94-75 NASD Requests Comment On Standardized Forms Proposed For DPP Securities;

      Comment Period Expires October 17, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Internal Audit
      Legal & Compliance
      Operations
      Systems
      Trading

      Executive Summary

      The NASD® requests comment on a proposal to require the use of Standard Transferor and Transferee Applications for Transfer of Direct Participation Programs (DPP) Securities, Standard Registration Confirmation Form, and modification to the Uniform Practice Code requiring members to accept the use of the forms when transferring a DPP security.

      Background

      In October 1990, the DPP Committee initiated a study of the nature and function of the secondary market for public partnership securities. Data gathered by the DPP Committee indicated that approximately $90 billion was invested in public DPPs in the 1970s and 1980s. These funds represent the investments of more than 10 million people. The programs were organized to invest in a variety of industries including, but not limited to, real estate, oil and gas, cable television, commodities, and equipment leasing. Although these securities were not generally intended to be liquid and tradeable, a developing secondary market in partnership securities nevertheless exists. The DPP Committee estimated that approximately two dozen participants (both NASD members and non-members) act as principal or agent for customers in a fragmented secondary market that transfers ownership of an estimated $250 to $300 million in public partnership securities annually.

      In its report and subsequent Notice to Members (NTM 91-69), the DPP Committee stated that one of the major problems in the secondary market for DPP securities is the inefficient transfer of limited partnership interests between investors and on the books and records of members and partnerships. Transfer problems also have led to delays or mistakes in the allocation of cash distributions between buyers and sellers. There appear to be two primary reasons for these difficulties: (1) general partners and broker/dealers use different forms and procedures, charge varying fees, and effect transfers at undisclosed times; and (2) in many cases, a general partner is disinterested in assisting or facilitating these transfers in a security that was intended to be held for the life of the program (especially when the transfer may take place at a deep discount from the original offering price or may jeopardize the tax treatment of the partnership).

      In November 1991, the NASD Board of Governors established the Ad Hoc Committee on Uniform Settlement and Transfer Procedures for Direct Participation Program Securities to study, among other issues, the settlement and transfer procedures of DPP securities. In an effort to eliminate delays and inefficiencies in the settlement and transfer procedure for DPP securities, the Committee and working groups established by the Committee designed standard transfer forms for the transferor and the transferee, as well as the confirmation form to be used by members, general partners, or transfer agents. The goal of the Committee was to develop a standard one-page form that would replace twenty- and thirty-page transfer documents. The purpose of this Notice is to request comment on the forms and on modification to the Uniform Practice Code requiring that members accept the use of the forms when transferring a DPP security.

      Transferor's (Seller's) Application For Transfer

      The Transferor's (Seller's) Application for Transfer indicates that the form is to be sent to the general partner or transfer agent together with the Transferee's Form and the required fees (see Instruction number 1 on page 2 of the form) and that it contains an optional transaction reference number for use by the financial services firms to identify and track the transfer as indicated in Instruction number 2. This number should be the same reference number used on the transferee's form.

      The first full paragraph on the form indicates also that the transfer of ownership will take place subject to the general partner's approval, and space has been provided on the form for the full name of the partnership. At least one identification item needs to be completed in order to properly identify the unit sold or transferred. Instruction number 3 advises the parties that the NASD symbol needed to complete this form may be obtained from the NASD Symbol Directory, a new publication to be issued in conjunction with this endeavor. The quantity section of the form specifically states the number of units (not dollar values) to be transferred and the number of units the transferor (seller) will continue to hold after the transfer is completed. This information will not only ensure that the proper number of units are transferred, but that all books and records of the general partner, transfer agent, and broker/dealers are kept current.

      The registration information section of the form requests the exact name of the registered owner as well as custodial information, including the custodian account number and address of record. This section of the form will provide information as to how the partnership interests are currently registered, as well as a Social Security or tax ID number and the custodian/trustees tax ID number (see Instructions 4 and 5). In addition, this portion of the form contains the necessary disclosure advising California residents of the restrictions on the sale or transfer of their interest without the prior written consent of the Commissioner of Corporations of the state of California.

      The broker/dealer information section, which is optional, does not need to be completed by an individual investor involved in a transaction directly with the partnership.

      Next, the top of page 2 of the form requires that the transferor certify possession of valid title and all requisite power to assign the interest and to state specifically the reason for the transfer.

      Finally, the form requires the exact signature of the registered holder, and the name, address, and capacity of the signer if the signature is by a trustee, executor, administrator, guardian, attorney in fact, agent or officer of the corporation, or someone acting in a fiduciary or representative capacity. This will ensure, as stated in Instruction number 7, that persons acting as a representative or in another fiduciary capacity present satisfactory evidence of their authority to so act. In addition, space has been provided for a signature guarantee by a Medallion stamp.

      In addition, the Committee is aware that several major general partners require limited partners, when they sell, to give up any rights that they have under the limited partnership agreement to dividends that have not yet been declared or paid. They accomplish this through a written affirmation that is part of their "transferor" forms. The affirmation is specific in that the seller agrees to give up rights to distributions that they are entitled to under the partnership agreement. Comment is requested on whether such an affirmation would be useful in this form or whether it should be optional.

      Transferee's (Buyer's) Application For Transfer

      The Transferee's (Buyer's) Application for Transfer is similar to the transferor's form. The form is to be sent to the general partner or transfer agent with the transferor's form and provides space for the optional reference number. Instruction number 2 to the form describes the purpose of the transaction reference number. The first full paragraph of the form indicates that the transferee makes application to transfer and assign, subject to the general partner's rights, all rights and interests to the partnership units as a Substitute Limited Partner/Assignee and agrees to accept all terms and conditions of the partnership agreement and related documents. This is intended to ensure that the general partner reserves the right to deny the transfer. The full name of the partnership is required on this form.

      The partnership information section of this form is identical to the transferor's form and requests at least one identification item for the units being acquired. As required on the transferor's form, this form requests the number of units to be acquired but also requests that the transferees indicate if they already own units in the partnership.

      The transferee also must indicate the tax status of the requested registration and alert the buyer that additional documentation may be required.

      The next section of the form requires information regarding the buyer and how the partnership interests are to be registered. Instruction numbers 3, 4, and 5 refer to this section of the form and indicate that if this is to be a custodial account, the address of record should be that of a custodian/trustee, and that if the purchaser is an individual, only a Social Security number is required.

      A secondary address may be provided by the buyer, which may be used to direct distributions to an address other than the address provided in the registration information section. If this is a custodial account, the investor's mailing address is necessary. This section also contains the necessary disclosure advising California residents of the restrictions on the sale or transfer of the interest without the prior written consent of the Commissioner of Corporations of the state of California.

      The Certification section of the form requires the transferee to certify the accuracy of the information contained in the form. An additional undertaking by the transferee grants the general partner the power of attorney under the laws of the applicable state. Space has been provided for the transferee's signature and a co-transferee's signature if necessary, and for a signature guarantee by a Medallion stamp. The instructions for these sections indicate that the signatures must correspond with the name of the transferee as it appears in the registration section. Persons signing as representatives or in fiduciary capacities must indicate this capacity when signing and, unless waived by the partnership or its agent in its sole discretion, must present satisfactory evidence of then-authority to so act.

      Registration Confirmation Form

      The Registration Confirmation Form was developed as an acknowledgement by a general partner or an agent that a registrant has been admitted as a limited partner in the partnership as a result of a purchase, transfer, or account transfer. The first section is standard while the second section contains specific information regarding the admission, the name of the partnership, the number of units held by the limited partner, the effective date of admission, the exact registration, and information about the limited partner and his or her financial services firm. Space for a secondary address was added to the form to provide for a custodian/ trustee account. As stated, the form is non-negotiable, and should be kept with the new limited partner's permanent records. The form will replace the variety of instruments used throughout the industry and will help eliminate the need for partnership certificates.

      Request For Comments

      The NASD asks members and other interested parties to comment on the proposed standard forms.

      Comments should be addressed to:

      Joan C. Conley
      Office of the Secretary
      National Association of Securities
      Dealers, Inc.
      1735 K St., N.W.
      Washington, D.C. 20006-1506

      Comments must be received no later than October 17, 1994. Comments received by this date will be considered by the Board. Prior to becoming mandatory for use by NASD members, the forms must be approved by the Board and the membership and then filed with the Securities and Exchange Commission for approval.

      Questions concerning this Notice should be directed to Charles L. Bennett, Director, or Carl R. Sperapani, Assistant Director, Corporate Financing Department, at (301) 208-2700, or Dorothy L. Kennedy, Assistant Director, Nasdaq Market Operations, at (203) 385-6243.

    • 94-74 NASAA Publishes Form Revisions For Public Comment:

      Comment Period Expires October 1, 1994

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance
      Registration
      Training

      Executive Summary

      The North American Securities Administrators Association (NASAA) has published form revisions in draft format for public comment in the September 1994 edition of the Commerce Clearing House (CCH) NASAA Reports. The comment period expires October 1, 1994, and is the first opportunity for the public to comment on revisions to Forms U-4 and U-5. The forms are being revised for implementation scheduled to coincide with the start up of the redesigned Central Registration Depository (CRD). A proposed revision to existing Item 7 of Form BD with disclosure detail that parallels the Form U-4 was also published for comment. NASAA is seeking comment and approval now because these changes are critical to the continuation of the design and construction phases of the new CRD. The NASD urges members to review this Notice and the text of the form revisions. The September NASAA Reports will contain a full description of the changes to the forms along with the text of the revisions.

      Background

      The NASD has undertaken an extensive redesign effort to improve the CRD and move toward total electronic filing of registration-related forms. Currently scheduled for pilot phase during fall 1995, the redesigned CRD will offer efficient processing of registration-related filings and user friendly access to information contained in those filings for all industry and regulatory participants. Of critical importance to the form revisions and redesign process is the uniform collection and organization of disclosure information. Input at this time will allow the NASD to move forward with the design and construction phases of the new CRD based on the changes made to the uniform forms.

      To that end the NASD, NASAA, the Securities and Exchange Commission (SEC), and other self-regulatory organizations have undertaken a joint effort to review and revise the Forms U-4, U-5, and BD. NASAA is publishing the revisions for public comment as part of their form revision approval process. This is the first opportunity the public has to comment on the revised Forms U-4 and U-5 and gain insight into how the information will be collected and stored in the revised CRD. Implementation of the new forms will coincide with implementation of the redesigned CRD. Prior to implementation the NASD Board must first approve and then the SEC must publish the form revisions for comment and subsequent approval. Members are urged to review and comment at this time. Comments made will be considered for their impact on the form revisions and CRD redesign process.

      Overview Of Disclosure Revisions

      The most significant changes relate to the disclosure questions on Forms U-4, U-5, and BD. The revisions will provide more precise detail reporting to support new functionality created by CRD's redesign.

      The changes include:

      • Item 22, Form U-4, and Item 7, Form BD, and the parallel disclosure items on the Form U-5, have been made consistent with each other to the extent possible.

      • The questions relating to disclosure have been categorized to provide a uniform format to collect, display, and sort disclosure detail.

      • Each category of disclosure has its own custom Disclosure Reporting Page (DRP) soliciting detail unique to that category.

      • Specific data are requested on each custom DRP in detail to provide the information that regulators have indicated they need to make informed registration decisions. The revised DRPs require more detail than the current DRPs, which will reduce the number of requests for additional disclosures that prolong the review and registration process.

      "Customer Complaint" Question

      Regulators have not yet reached a consensus as to how the current "Customer Complaint" item on the Forms U-4 and U-5 should be revised. Regulatory and industry representatives will continue to develop enhancements to this question. Given the current status, the revised versions of Forms U-4 and U-5 have temporarily retained the current language. Any revised text will be published for public comment as part of the final approval and implementation process.

      Other revisions include:

      • Expansion of Page 1 of Form U-4 and the parallel items on Form U-5 to handle the registration of non-members and to accommodate multiple types of registration or notices of termination for Investment Adviser Representative and Agent of Issuer registrations.

      • Addition of a statement to Page 4 of Form U-4 that will be executed by the applicant and retained by the member firm, that authorizes the member firm to make electronic filings on behalf of the applicant.

      • An option for the applicant and member firm to request on the Form U-4 processing under a Temporary Registration Program. This program is intended to replace the existing Temporary Agent Transfer (TAT) Program. The new program will result in expedited handling for eligible per sons including most individuals with "Yes" answers on their Form U-4 who have no new disclosure upon transfer. If there is new disclosure, the applicant may have an opportunity to gain a Temporary Registration while that disclosure is reviewed.

      • An opportunity for an individual to provide a summary of the circumstances relating to an internal review disclosure submitted by the individual's former employer on the Form U-5. Individuals already have the opportunity to provide responses to other Form U-5 disclosures on their next U-4 firing upon transfer to a new employer.

      Other changes planned for Form BD, but not completed at this time, will be offered for comment before form implementation.

      The NASAA comment period will conclude October 1, 1994.

      Direct any comments to:

      Ms. Renee Erdmann
      Securities Department
      Post Office Box 4009
      Helena, Montana 59604

      or FAX at (406) 444-5558.

      Questions regarding this Notice should be directed to John F. Vaughn, Assistant Director, NASD Membership Department at (301) 590-6865.

    • 94-73 SEC Approves Clearance And Settlement Proposal For Nasdaq And OTCBB Market Makers

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance
      Operations
      Systems
      Trading

      Executive Summary

      On July 28, 1994, the Securities and Exchange Commission (SEC) approved an NASD rule change that deals with clearance and settlement requirements applicable to NASD member firms functioning as market makers in The Nasdaq Stock Market™ (Nasdaq) or the OTC Bulletin Board Service (OTCBB®).1 Specifically, the rule change eliminates the "25-mile exception" from Section 7(a) in Part V, Schedule D to the NASD By-Laws and adds a new paragraph (d) to Section 4 of the OTCBB Rules.2 As a result, Nasdaq and OTCBB market makers must participate in the facilities of a registered clearing agency either directly or through another NASD member. Since most Nasdaq and OTCBB market makers already have clearing arrangements, this rule change affects few firms. The text of the amended language follows the discussion below. This rule change takes effect October 11, 1994.

      Background And Description

      The SEC recently approved an NASD rule change requiring market makers to use the facilities of a registered clearing agency to ensure efficient clearance and settlement of securities transactions effected between member firms. For Nasdaq securities, the rule change eliminates the 25-mile exception from Section 7(a) in Part V, Schedule D to the NASD By-Laws. Until now, this exception was only available to market makers that were located more than 25 miles from a clearing facility and that limited their market-making activity to The Nasdaq SmallCap Market™ securities that do not participate in the Small Order Execution System (SOESSM).3 Section 7(a) now states that a market maker must clear and settle transactions in Nasdaq securities through a registered clearing agency located within 25 miles of the market maker. In addition, Section 7(b) states that regardless of its proximity to a particular clearing facility, a market maker must clear and settle all SOES transactions via a registered clearing facility that uses a continuous net settlement system. This requirement can be satisfied either by directly participating in such a clearing facility or by entering into a corresponding clearing arrangement with a member that clears through such a facility.

      For equity securities quoted in the OTCBB, the NASD had not mandated market-maker participation in a registered clearing agency. A new requirement mandates that market makers participate in a registered clearing agency for transactions in the approximately 95 percent of OTCBB securities that are clearing eligible. Implementation of these requirements will maximize use of the Automated Confirmation Transaction (ACTSM) Service for trade-reporting and comparison purposes.

      ACT is the primary facility for collecting, processing, and disseminating transaction reports on Nasdaq securities and equity issues quoted in the OTCBB. ACT also facilitates the clearance and settlement of inter-member transactions by locking in trade details for transmission to the National Securities Clearing Corporation (NSCC). By generating locked-in trades, ACT enhances clearing efficiency by virtually eliminating a member's risk exposure from uncompared trades. These benefits cannot be fully realized, however, unless the broker/dealers on both sides of a trade have some form of participation in a registered clearing agency. In sum, these changes minimize risk exposure from uncompared trades and foster optimal use of ACT to lock in trades before submission to a registered clearing agency.

      The rules take effect on October 11, 1994. Questions regarding this matter may be directed to Michael J. Kulczak, Associate General Counsel, The Nasdaq Stock Market, Inc., at (202) 728-8811.


      1 See Release No. 34-34457, July 28, 1994; 59 FR 39797, August 4, 1994.

      2 Part V, Schedule D contains the basic requirements applicable to Nasdaq market makers while Section 4 contains the corresponding requirements for OTCBB market makers.

      3 Although registered market makers in Nasdaq National Market® securities must be SOES participants, SOES participation is voluntary for market makers in Nasdaq SmallCap market issues.


      Approved Amendments To Part V, Schedule D Of The NASD By-Laws

      (Note: New text is underlined. Deleted text is in brackets.)

      Part V

      Requirements Applicable To Nasdaq Market Makers

      Sec. 1-6. No change.

      Sec 7. Clearance and Settlement

      (a) A market maker shall clear and settle transactions in [NASDAQ] Nasdaq securities [other than securities in SOES] through the facilities of a registered clearing agency [where clearing facilities are located within 25 miles of the market maker.] that uses a continuous net settlement system. This requirement may be satisfied by direct participation, use of direct clearing services, or by entry into a correspondent clearing arrangement with another member that clears trades through such an agency.
      (b) [Notwithstanding its proximity to a particular clearing facility, a market maker may also clear and settle its transactions in a security that is not a SOES security through any registered clearing facility using a continuous net settlement system; enter into a correspondent clearing arrangement with a member that clears through a continuous net settlement clearing facility; settle transactions "ex-clearing" provided both parties to the transaction agree; or use direct clearing services.] Notwithstanding paragraph (a), transactions in Nasdaq securities may be settled "ex-clearing" provided that both parties to the transaction agree.
      (c) No change.

      * * *

      OTC Bulletin Board® Service Rules

      Sec. 1-3. No change.

      Sec. 4. Requirements Applicable to Market Makers

      No change.

      (a)–(c) No change.
      (d) Clearance and Settlement
      (1) A market maker shall clear and settle transactions in OTCBB-quoted securities through the facilities of a registered clearing agency that uses a continuous net settlement system. This requirement applies only to transactions in OTCBB securities that are clearing eligible.
      (2) The foregoing requirement may be satisfied by direct participation, use of direct clearing services, or by entry into a correspondent clearing arrangement with another member that clears trades through such an
      (3) Notwithstanding paragraph (d)(1), transactions in OTCBB-quoted securities may be settled "ex-clearing" provided that both parties to the transaction agree.

    • 94-72 SEC Approves Elimination Of Access Market-Maker Procedures

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Trading

      Executive Summary

      On July 22, 1994, the Securities and Exchange Commission (SEC) approved an NASD rule change that deletes Part IX, Schedule D to the NASD By-Laws. The deleted provision permitted NASD members to access The Nasdaq Stock Market (Nasdaq) in a market-making capacity without subscribing to Level 3 Nasdaq Workstation Service (Level 3 Service).1 These access market makers would enter into a contractual arrangement with a Level 3 Service subscriber, who would insert quotes for them. Effective August 1, 1994, member firms may no longer function as Nasdaq market makers without subscribing to Level 3 Service. The text of the deleted language follows the discussion below.

      Background And Description

      The SEC recently approved an NASD rule change to eliminate an outmoded procedure that allowed certain NASD member firms to participate in Nasdaq without subscribing to Level 3 Service. Under the deleted provision, Part IX, Schedule D to the NASD By-Laws, member firms that did not receive Level 3 Service could qualify as an access market maker by entering into a suitable arrangement with another member that was a Level 3 Subscriber (entering subscriber).

      After the NASD's approval of such an arrangement, the entering subscriber could input two-sided quotations reflecting the dealer interest of the access market maker. These quotations would be displayed with the entering subscriber's market-maker identifier; a special indicator would also be displayed to inform other dealers that an access arrangement existed for the quotations displayed in the subject security. In this circumstance, the entering subscriber assumed responsibility for executing trades at the displayed bid/offer; yet, both the entering subscriber and the access market maker were jointly responsible for complying with the market-maker obligations in Part V, Schedule D to the NASD By-Laws.

      This rule change was prompted in part by the technology migration that the NASD has undertaken to upgrade the Nasdaq market facilities and communications network. After careful analysis of the costs and feasibility of supporting access-market-maker functionality in the new environment, Nasdaq decided not to offer this functionality. Among other things, the staff's analysis revealed that recent changes in market-making practices and procedures had dramatically reduced the use of the access-market-maker arrangement. Indeed, when the NASD filed the proposal with the SEC, no such arrangements were in effect.

      Given the lack of arrangements as well as any regulatory purpose, the NASD determined that the access-market-maker functionality did not warrant the expenditure of resources necessary to provide it in the new environment. Consequently, only Level 3 Service subscribers may function as Nasdaq market makers. This rule change took effect on August 1, 1994, the date that the SEC published its approval order in the Federal Register. The deleted text appears below. Questions regarding this rule change may be directed to Michael J. Kulczak, Associate General Counsel, The Nasdaq Stock Market, Inc., at (202) 728-8811.


      1 See Release No. 34-34428, July 22, 1994; 59 FR 38992, August 1, 1994.


      Text Of Part IX, Schedule D Of The NASD By-Laws

      (Note: Deleted text is in brackets.)

      Part IX [Procedures For Access To The Nasdaq System By Non-Nasdaq Market Makers]

      [These procedures permit a registered NASDAQ market maker, upon approval by the Corporation, to enter quotations into the NASDAQ System on behalf of another market maker who does not subscribe to Level 3 NASDAQ Service.]

      [A. Definitions ]
      [1. An "access market maker" is a member of the Association who does not subscribe to Level 3 NASDAQ service, but is or intends to be a market maker in a security for which quotations are displayed on the NASDAQ System.]
      [2. An "entering subscriber" is a registered NASDAQ market maker who has entered into an arrangement with an access market maker to enter quotations in the NASDAQ System on behalf of such access market maker.]
      [B. The entering subscriber may enter quotations in the NASDAQ System on behalf of an access market maker only upon submission and approval by the Association of the following:]
      [1. A fully executed copy of the access arrangement agreement which shall contain all agreements and conditions concerning the access arrangement.]
      [2. An application for registration as an access market maker for each security.]
      [C. Access market makers and entering subscribers shall be limited to one access arrangement in each security.]
      [D. Quotations displayed by the entering subscriber on behalf of the access market maker shall be accompanied by the entering subscriber's market maker identifier and a special symbol designating that an access arrangement exists. The identity of the access market maker must be made available by the entering subscriber upon request.]
      [E. All transactions resulting from the display of quotations in the NASDAQ System by the entering subscriber shall be executed by the entering subscriber and he shall be responsible for the transaction. Both the entering subscriber and the access market maker shall be subject to and be responsible for compliance with the provisions of Schedule D.]
      [F. Access market makers shall pay to the Corporation an access fee of $70 per month for the first security and $52.50 per month for each additional security which is subject to an approved access arrangement.]

    • 94-71 SEC Approves Amendments To Trade-Reporting Requirements For Trades Executed Outside Normal Market Hours

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      Executive Summary

      On August 11, 1994, the SEC approved a series of related changes to NASD rules governing transaction reporting in Nasdaq National Market® securities, The Nasdaq SmallCapSM Market securities, Nasdaq convertible debt securities ("Nasdaq convertibles"), over-the-counter equity securities (OTC equities), and exchange-listed securities eligible for inclusion in the Consolidated Quotation Service (CQS issues).1 These amendments will eliminate the manually prepared Form T as the principal means of reporting transactions in the foregoing securities when executed outside normal market hours (9:30 a.m. to 4 p.m., Eastern Time (ET)) or outside the hours of the Automated Confirmation Transaction Service (ACT) (currently 9 a.m. to 5:15 p.m. ET). Instead, the covered transactions will be reported electronically through ACT on either trade date or the next business day. The amendments also recognize that the morning window for reporting contemporaneous trades in Nasdaq-listed securities and OTC equities into ACT will expand by one hour, starting at 8 a.m. ET. Member firms can input the required trade reports via a Nasdaq Workstation® unit or a computer-to-computer interface. These changes take effect December 12, 1994. The language of the rule change follows this Notice.

      Background And Description

      Since inception of real-time trade reporting, the NASD has relied on members' submission of a paper Form T to collect transactional data on off-hours trades. This information was compiled and reviewed solely for regulatory purposes without public dissemination. Subsequently, the NASD introduced the .T function to enable the electronic entry of trade reports for trades executed between 9 and 9:30 a.m. ET2 or between 4 and 5:15 p.m. ET. This rule change continues the progression by expanding the morning window for .T entries to 1 1/2 hours (8 a.m. to 9:30 a.m. ET) and by establishing procedures for electronic reporting of trades executed outside of ACT's normal operating hours.

      This rule change is meant to achieve the electronic capture of virtually every round-lot trade executed by NASD members in the covered securities, regardless of execution time. Currently, the only off-hours trades that are reportable electronically are those executed between 9 and 9:30 a.m. ET and between 4 and 5:15 p.m. ET. Such trades are designated .T trades to denote execution outside normal market hours. At present, trades done outside these hours are reportable only via paper Form T.

      This latest initiative also will permit .T trades (except .T trades in the subset of OTC equities comprised of foreign issues, Canadian issues, and American Depositary Receipts (ADRs)) to be disseminated to market data vendors and to subscribers of Level 2/3 Nasdaq Workstation service. However, any "as/of trades reported under the amended rules will be collected solely for audit-trail and regulatory purposes. After implementation, NASD staff will evaluate member firms' overall compliance with the new requirements; examine various alternatives for public dissemination of "as/of trade data; consider the feasibility of expanding the time period for reporting "as/of trades on T +1; and focus on the complete elimination of paper Form T as a trade-reporting vehicle. Meanwhile, the paper Form T will be maintained solely as a back-up mechanism for reporting last-sale information to the NASD.

      Ultimately, these enhanced procedures will enable the NASD to compile and publish comprehensive volume data for individual securities, including block-size and other round-lot trades reported electronically by NASD members.

      Rule Changes

      By implementing the following procedures, this rule change will substantially reduce the need for reporting any trades via the paper Form T:

      • The morning .T window for reporting contemporaneous trades in Nasdaq National Market issues, The Nasdaq SmallCap Market issues, Nasdaq convertibles, and domestic OTC equities (including Canadian issues and ADRs) will be expanded by one hour to run from 8 a.m. to 9:30 a.m. ET. Trades executed during this interval must be reported into ACT within 90 seconds of execution and be designated .T to denote execution outside normal market hours (See Schedule D, Parts X, XI, XII, and XIII);

      • Trades executed between midnight and 8 a.m. ET in Nasdaq National Market issues, The Nasdaq SmallCap Market issues, Nasdaq convertibles, and domestic OTC equities (including Canadian issues and ADRs) must be reported into ACT on trade date during the expanded .T period (8 a.m. to 9:30 a.m. ET); these trades must be designated .T trades to denote execution outside normal hours and be accompanied by time of execution since they are not being reported in real-time (See Schedule D, Parts X, XI, XII, and XIII);

      • Trades executed in Nasdaq National Market issues, The Nasdaq SmallCap Market issues, Nasdaq convertibles, and domestic OTC equities (including Canadian issues and ADRs) between 5:15 p.m. and midnight ET must be reported into ACT on the next business day (T+1) between 8 a.m. and 1:30 p.m. ET; these entries must be designated "as/of trades to denote execution on a prior day and be accompanied by a time of execution (See Schedule D, Parts X, XI, XII, and XIII);

      • Trades executed in foreign OTC equities (excluding Canadian issues and ADRs) shall be reported into ACT on T+1 between 8 a.m. and 1:30 p.m. ET regardless of the time the trade was actually executed; such trade reports must be designated "as/of trades and be accompanied by a time of execution (See Schedule D, Part XIII, (3)(ii)(C));

      • Trades executed in CQS issues outside the hours of 9:30 a.m. and 5:15 p.m. ET must be reported into ACT on T+1 between 8 a.m. and 1:30 p.m. ET, be designated "as/of trades, and be accompanied by a time of execution (See Schedule G, Section

      Electronic trade reporting will result in greater and more timely dissemination of reliable information for transactions executed outside normal market hours. This will provide broker/dealers and investors with additional information to facilitate investment decisions.

      Questions regarding this Notice can be directed to Michael J. Kulczak, Associate General Counsel, Office of General Counsel, at (202) 728-8811; Bernard Thompson, Assistant Director, Market Surveillance; (301) 590-6436; or Nasdaq Market Operations at (203) 378-0284.

      Following is a chronicle of the revised reporting requirements to be implemented on December 12, 1994:


      Nasdaq National Market, Nasdaq SmallCap, Nasdaq Convertible Bonds, And Domestic OTC Equities (Including Canadian Issues And ADRs)

      If the trade was executed between:

      Report to ACT:

      Midnight - 8 a.m.

      Between 8 and 9:30 a.m.; enter .T modifier and include execution time.

      8 -9:30 a.m.

      Enter .T modifier and include execution time if not reported within 90 seconds.

      4 -5:15 p.m.

      Enter .T modifier and include execution time if not reported within 90 seconds.

      5:15 p.m. - midnight

      On T+1 between 8 a.m. and 1:30 p.m.; enter execution time and designate "as/of."

      CQS Trades:

       

      Midnight - 9:30 a.m.

      On T+1 between 8 a.m. and 1:30 p.m.; enter execution time and designate "as/of."

      5:15 p.m. - midnight

      On T+1 between 8 a.m. and 1:30 p.m.; enter execution time and designate "as/of."

      Foreign OTC Equities (Excluding Canadian Issues and ADRs)

      Any time on trade date†

      On T+1 between 8 a.m. and 1:30 p.m.; enter execution time and designate "as/of."

      † Member firms that have the operational capability to report transactions in foreign securities within 90 seconds of execution, between 8 a.m. and 5:15 p.m. ET, may do so at their option. If a firm chooses this option, it need not report the same transaction(s) on T+1.


      1 See Securities and Exchange Act Release No. 34-34527 (August 11, 1994); 59 FR. 42613 (August 18, 1994).

      2 The morning .T window cannot be used to enter trade reports on contemporaneous transactions in CQS issues because the central processor (The Securities Industry Automation Corporation) of such information does not open until 9:30 a.m. ET. This situation will not change as a result of the NASD's new trade-reporting requirements. However, it will now be possible to report, electronically, trades in CQS issues that are executed outside the hours of 9:30 to 5:15 p.m. ET on the next business day. These will be designated "as/of trades.


      Text Of Amendments To Schedule D And G Of The NASD By-Laws

      (Note: New text is underlined; deleted text is in brackets.)

      Schedule D

      Part X

      REPORTING TRANSACTIONS IN NASDAQ NATIONAL MARKET [SYSTEM DESIGNATED] SECURITIES

      * * *

      Sec. 2. Transaction Reporting

      (a) When and How Transactions are Reported
      2(a)(1)-2(a)(3) No change.
      (4) Transaction Reporting Outside Normal Market Hours
      (i) Last sales reports of transactions in designated securities executed between [9:00] 8:00 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT within 90 seconds after execution and shall be designated as ".T" trades to denote their execution outside normal market hours. Additionally, last sale reports of transactions in designated securities executed between the hours of 4:00 p.m. and 5:15 p.m. Eastern Time shall be transmitted through ACT within 90 seconds after execution; trades executed and reported after 4:00 p.m. Eastern Time shall be designated as ".T" trades to denote their execution outside normal market hours. Transactions not reported within 90 seconds must include the time of execution on the trade report.
      (ii) Last sale reports of transactions in designated securities executed outside the hours of 8:00 a.m. and 5:15 p.m. Eastern Time shall be reported as follows:
      (A) Last sale reports of transactions executed between midnight and 8:00 a.m. Eastern Time shall be transmitted through ACT between 8:00 a.m. and 9:30 a.m. Eastern Time on trade date, be designated as ".T" trades to denote their execution outside normal market hours, and be accompanied by the time of execution. The party responsible for reporting on trade date, the information to be reported, and the applicable procedures shall be governed, respectively, by subsections (b), (c), and (d) below:
      (B) Last sale reports of transactions executed between 5:15 p.m. and midnight Eastern Time shall be transmitted through ACT on the next business day ("T+1") between 8:00 a.m. and 1:30 p.m. Eastern Time, be designated "as/of trades to denote their execution on a prior day, and be accompanied by the time of execution. The party responsible for reporting on T+1, the trade details to be reported, and the applicable procedures shall be governed, respectively, by subsections (b), (c), and (d) below.
      (5) All members shall report weekly to the Market Operations Department in [New York City] Trumbull. Connecticut, on [a] Form T [designated by the Board of Governors], last sale reports of transactions in designated securities [executed outside the hours of 9:00 a.m. and 5:15 p.m. Eastern Time.] that were not transmitted through ACT, for whatever reason, either on the trade date or the next business day. Form T shall be used exclusively as a backup mode whenever electronic entry of trade data is not feasible due to system malfunctions or other unusual conditions.

      Part XI

      REPORTING TRANSACTIONS IN NASDAQ SMALL[-]CAPSM SECURITIES

      * * *

      Sec. 2. Transaction Reporting

      (a) When and How Transactions are Reported
      2(a)(1)-2(a)(3) No change.
      (4) Transaction Reporting Outside Normal Market Hours
      (i) Last sales reports of transactions in designated securities executed between [9:00] 8i0Q a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT within 90 seconds after execution and shall be designated as ".T" trades to denote their execution outside normal market hours. Additionally, last sale reports of transactions in designated securities executed between the hours of 4:00 p.m. and 5:15 p.m. Eastern Time shall be transmitted through ACT within 90 seconds after execution; trades executed and reported after 4:00 p.m. Eastern Time shall be designated as ".T" trades to denote their execution outside normal market hours. Transactions not reported within 90 seconds must include the time of execution on the trade report.
      (ii) Last sale reports of transactions in designated securities executed outside the hours of 8:00 a.m. and 5:15 p.m. Eastern Time shall be reported as follows:
      (A) Last sale reports of transactions executed between midnight and 8:00 a.m. Eastern Time shall be transmitted through ACT between 8:00 a.m. and 9:30 a.m. Eastern Time on trade date, be designated as ".T" trades to denote their execution outside normal market hours, and be accompanied by the time of execution. The party responsible for reporting on trade date, the information to be reported, and the applicable procedures shall be governed, respectively, by subsections (b), (c), and (d) below:
      (B) Last sale reports of transactions executed between 5:15 p.m. and midnight Eastern Time shall be transmitted through ACT on the next business day CT+D between 8:00 a.m. and 1:30 p.m. Eastern Time, be designated "as/of trades to denote their execution on a prior day, and be accompanied by the time of execution. The party responsible for reporting on T+1, the trade details to be reported, and the applicable procedures shall be governed, respectively, by subsections (b), (c) and (d) below.
      (5) All members shall report weekly to the Market Operations Department in [New York City] Trumbull. Connecticut on [a] Form T [designated by the Board of Governors], last sale reports of transactions in designated securities [executed outside the hours of 9:00 a.m. and 5:15 p.m. Eastern Time.] that were not transmitted through ACT, for whatever reason, either on the trade date or the next business day. Form T shall be used exclusively as a back-up mode whenever electronic entry of trade data is not feasible due to system malfunctions or other unusual conditions.

      Part XII

      REPORTING TRANSACTIONS IN OVER-THE-COUNTER EQUITY SECURITIES

      Sec. 2. Transaction Reporting

      (a) When and How Transactions are Reported
      2(a)(1)-2(a)(2) No change.
      (3) Transaction Reporting Outside Normal Market Hours
      (i) Last sale reports of transactions in OTC Equity Securities executed between [9:00] 8:00 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT within 90 seconds after execution and shall be designated as ".T" trades to denote their execution outside normal market hours. Last sale reports of transactions in OTC Equity Securities executed between the hours of 4:00 p.m. and 5:15 p.m. Eastern Time shall also be transmitted through ACT within 90 seconds after execution; trades executed and reported after 4:00 p.m. Eastern Time shall be designated as ".T" to denote their execution outside normal market hours. Transactions not reported within 90 seconds must include the time of execution on the trade report.
      (ii) Last sale reports of transactions in OTC Equity Securities executed outside the hours of 8:00 a.m. and 5:15 p.m. Eastern Time shall be reported as
      (A) Last sale reports of transactions in American Depositary Receipts ("ADRs"). Canadian issues, or domestic OTC Equity Securities that are executed between midnight and 8:00 a.m. Eastern Time shall be transmitted through ACT between 8:00 a.m. and 9:30 a.m. Eastern Time on trade date, be designated as ".T" trades to denote their execution outside normal market hours, and be accompanied by the time of execution. The party responsible for reporting on trade date, the trade details to be reported, and the applicable procedures shall be governed, respectively, by subsections (b). (c"). and (d) below:
      (B) Last sale reports of transactions in ADRs. Canadian issues, or domestic OTC Equity Securities that are executed between 5:15 p.m. and midnight Eastern Time shall be transmitted through ACT on the next business day ("T+1") between 8:00 a.m. and 1:30 p.m. Eastern Time, be designated "as/of trades to denote their execution on a prior day, and be accompanied by the time of execution. The party responsible for reporting on T+1, the trade details to be reported, and the applicable procedures shall be governed, respectively, by subsections (b), (c), and (d) below: and
      (C) Last sale reports of transactions in foreign securities (excluding ADRs and Canadian issues) shall be transmitted through ACT on T+1 regardless of time of execution.† Such reports shall be made between 8:00 a.m. and 1:30 p.m. Eastern Time in the same manner as described in subsection (ii)(B) above.
      (4) All members shall report weekly to the Market Operations Department in [New York City] Trumbull. Connecticut, on [a] Form T [designated by the Board of Governors], last sale reports of transactions in OTC Equity Securities that [are executed outside the hours of 9:00 a.m. and 5:15 p.m. Eastern Time.] were not transmitted to ACT, for whatever reason, either on trade date or the next business day. Form T shall be used exclusively as a back-up mode whenever electronic entry of trade data is not feasible due to system malfunctions or other unusual conditions.

      Part XIII

      REPORTING TRANSACTIONS IN NASDAQ CONVERTIBLE DEBT SECURITIES

      * * *

      Sec. 2. Transaction Reporting

      (a) When and How Transactions are Reported
      2(a)(1)-2(a)(3) No change.
      (4) Transaction Reporting Outside Normal Market Hours
      (i) Last sales reports of transactions in designated securities executed between [9:00] 8£Q a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT within 90 seconds after execution and shall be designated as ".T" trades to denote their execution outside normal market hours. Additionally, last sale reports of transactions in designated securities executed between the hours of 4:00 p.m. and 5:15 p.m. Eastern Time shall be transmitted through ACT within 90 seconds after execution; trades executed and reported after 4:00 p.m. Eastern Time shall be designated as ".T" trades to denote their execution outside normal market hours. Transactions not reported within 90 seconds must include the time of execution on the trade report.
      (ii) Last sale reports of transactions in designated securities executed outside the hours of 8:00 a.m. and 5:15 p.m. Eastern Time shall be reported as follows:
      (A) Last sale reports of transactions executed between midnight and 8:00 a.m. Eastern Time shall be transmitted through ACT between 8:00 a.m. and 9:30 a.m. Eastern Time on trade date, be designated as ".T" trades to denote their execution outside normal market hours, and be accompanied by the time of execution. The party responsible for reporting on trade date, the information to be reported, and the applicable procedures shall be governed, respectively, by subsections (b). (c). and (d) below:
      (B) Last sale reports of transactions executed between 5:15 p.m. and midnight Eastern Time shall be transmitted through ACT on the next business day ("T+1") between 8:00 a.m. and 1:30 p.m. Eastern Time, be designated "as/of trades to denote their execution on a prior day, and be accompanied by the time of execution. The party responsible for reporting on T+1, the trade details to be reported, and the applicable procedures shall be governed, respectively. by subsections (b), (c), and (d) below.
      (5) All members shall report weekly to the Market Operations Department in [New York City] Trumbull. Connecticut, on [a] Form T [designated by the Board of Governors], last sale reports of transactions in designated securities [executed outside the hours of 9:00 a.m. and 5:15 p.m. Eastern Time.] that were not transmitted through ACT, for whatever reason, either on the trade date or the next business day. Form T shall be used exclusively as a backup mode whenever electronic entry of trade data is not feasible due to system malfunctions or other unusual conditions.

      Schedule G

      REPORTING TRANSACTIONS IN LISTED SECURITIES

      * * *

      Sec. 2. Transaction Reporting

      (a) When and How Transactions are Reported
      2(a)(1)-2(a)(2) No change.
      [(3) Non-Registered Reporting Members shall report weekly to the Market Operations Department in New York City, on Form T, last sale reports of transactions in eligible securities that are not required to be reported under paragraph (2).]
      [(4)] (3) All Members shall report [weekly to the NASDAQ Department in New York City, on Form T, last sale reports of] transactions in eligible securities executed outside the hours of 9:30 a.m. and 5:15 p.m. Eastern Time[.] as follows: (T) by transmitting the individual trade reports through ACT on the next business day ("T+1") between 8:00 a.m. and 1:30 p.m. Eastern Time: (ii) by designating the entries "as/of trades to denote their execution on a prior day: and (iii) by including the time of execution. The party responsible for reporting on T+1 the trade details to be reported, and the applicable procedures shall be governed, respectively by subsections (b), (c), and (d) below.

      All members shall report weekly to the Market Operations Department in Trumbull. Connecticut, on Form T. last sale reports of transactions in eligible securities that were not transmitted through ACT, for whatever reason, either on the trade date or the next business day. Form T shall be used exclusively as a back-up mode whenever electronic entry of trade data is not feasible due to system malfunctions or other unusual conditions.

      † Member firms that have the operational capability to report transactions in foreign securities (excluding ADRs and Canadian issues) within 90 seconds of execution, between the hours of 8:00 a.m. and 5:15 p.m. Eastern Time, may do so at their option. If a firm chooses this option, it need not report the same transaction(s) on T+1 as prescribed by subsection (ii)(C).

    • 94-70 SEC Approves Adoption Of NASD Limited Partnership Rollup Transaction Rules;

      Effective Date: November 1, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Legal & Compliance
      Syndicate
      Trading
      Training

      Executive Summary

      On August 15, 1994, the Securities and Exchange Commission (SEC or Commission) approved amendments, in part, to Article III, Section 34 (Section 34), of the NASD Rules of Fair Practice prohibiting NASD members or associated persons from participating in "limited partnership rollup transactions" (rollup or rollup transactions) unless the transaction includes certain specified provisions designed to protect the rights of limited partners, and amendments to Schedule D to the By-Laws (Schedule D) prohibiting the authorization for quotation on the Nasdaq National Market® of any security that results from a "limited partnership rollup transaction" unless the transaction was conducted in accordance with certain specified procedures designed to protect the rights of limited partners (together, rollup rules). Simultaneously, the Commission solicited public comment on proposed amendments to Section 34 which would apply the new definition of "limited partnership roilup transaction" to Subsections (A) and (B) of Article III, Section 34(b)(6) that regulate the receipt of differential compensation for the solicitation of sales or tenders in a rollup transaction.1 The amendments approved by the SEC take effect November 1, 1994. The full text of the amendments follows this Notice.

      Background

      During the 1980s, more than $150 billion of public limited partnership interests were sold to U.S. investors, most of whom were small investors with an average investment of about $10,000. Limited partners, unlike general partners, received many of the tax benefits of business ownership without the resultant responsibility and liability. Partnerships "passed through" tax benefits to the limited partners who were not involved in the day-to-day management of the limited partnership and usually could not lose more than their capital contributions. Some partnerships financed limited partner contributions through recourse or non-recourse loans, thereby generating an additional layer of tax writeoffs for the investor.

      Limited partnership interests, however, were typically illiquid, due to the nature of the investment and the lack of an active trading market for such interests. Federal tax reform in 1986 eliminated most tax benefits for limited partner investors by, among other things, lowering the marginal tax rate to 28 percent, eliminating preferential treatment for capital gains, limiting the offsetting use of losses generated from passive activity to passive income only, lengthening depreciation schedules, extending the at-risk rules to include real estate investments, and altering the method for calculating depreciation. Subsequently, economic developments contributed to the deterioration of partnership performance. Some general partners responded by restructuring the limited partnerships or "rolling" them up into new entities.

      Use Of Rollups

      A limited partnership rollup either reorganizes an existing limited partnership or combines multiple limited partnerships into a new entity to take advantage of larger asset pools and economies of scale. However, many rollups resulted in newly traded securities that immediately traded at a discount to its net asset value, as the cash flow from the stronger partnerships supported losses from weaker partnerships. Also, many investors in rollups found that the terms of the original partnership agreement had changed significantly as to voting rights, term of existence of the entity, management compensation, or investment objectives. Rollups were solicited in many cases with the help of proxy solicitation firms that were paid to solicit only "yes" votes for approval of the rollup.

      Federal Legislation

      The Limited Partnership Reform Act of 1993, (Rollup Reform Act), enacted in December 17, 1993, as part of the Government Securities Act Amendments of 1993, is the legislative response to rollup transactions. Section 3(a) of the Rollup Reform Act amended Section 15A(b) of the Securities Exchange Act of 1934 (Exchange Act) to require that NASD rules prohibit members from participating in any limited partnership rollup transaction that does not provide procedures to protect the rights of limited partners. Section 3(c) of the Rollup Reform Act also amended Section 15A(b) of the Exchange Act to require that the rules of the Nasdaq National Market prohibit the authorization for quotation of any security resulting from a rollup transaction unless the transaction provides certain rights for limited partners. The NASD believes these new rollup rules comply with this Congressional mandate.

      Amendments

      DEFINITIONS

      Subsection 34(b)(2)(B) and Part I, Schedule D have been amended to add as new definitions the following terms:

      • Cash Available for Distribution: cash flow of a limited partnership less amounts set aside for restoration or creation of reserves.

      • Cash Flow: cash provided from limited partnership operations, including lease payments on net leases from builders and sellers, without deduction for depreciation, but after deducting cash funds used to pay all other expenses, debt payments, capital improvements and replacements.

      • Dissenting Limited Partner: a per son who, on the date rollup solicitation material is mailed to investors, holds a beneficial interest in a limited partnership that is the subject of the limited partnership rollup transaction and who voted against the transaction and complies with procedures established by the NASD to assert dissenters' rights, except that for purposes of an exchange or tender offer, a person must file an objection in writing with the party responsible for tabulating the votes or tenders during the period in which the offer is outstanding. Consequently, a per son who abstains from voting cannot qualify as a dissenting limited partner, and a person who purchases a limited partner interest after the date on which soliciting material is mailed will be prevented from asserting dissenters' rights.

      • Limited Partner or Investor in a Limited Partnership: the purchaser of an interest in a direct participation program that is a limited partnership, and who is not involved in the day-to-day management of the limited partnership and bears limited liability. The term "direct participation program" is defined in Section 34 as a program that provides for flow-through tax consequences regardless of the structure of the legal entity.

      • Limited Partnership: an unincorporated association that is a direct participation program organized as a limited partnership, whose partners are one or more general partners and one or more limited partners, that conforms to the provisions of the Revised Uniform Limited

      Partnership Act or the applicable state statute that regulates the organization of such partnership.

      • Limited Partnership Rollup Transaction: a transaction involving the combination or reorganization of one or more limited partnerships, either directly or indirectly, in which: 1) some or all of the investors in any of the limited partnerships will receive new securities reported under a transaction reporting plan (i.e., Nasdaq National Market, the New York Stock Exchange, and the American Stock Exchange); 2) any of the investors' limited partnership securities are not, as of the date of the filing, reported under a transaction reporting plan; 3) investors in any of the limited partnerships are subject to a significant adverse change as to voting rights, the term of existence of the entity, management compensation, or investment objectives; and 4) any such investors are not provided an option to receive or retain a security under substantially the same terms and conditions as the original issue.2

      The first and second requirements are intended to include those limited partnership rollup transactions where the limited partners are not able to dispose of their interests in an active trading market before the rollup transaction and then, as a result of a rollup, receive new listed securities. The third and fourth requirements are intended to exclude limited partnership rollup transactions that are not subject to significant adverse change or have the option to retain a similar security. As for the fourth requirement, the standards for determining whether the security to be received by all investors are substantially the same as the standards that are included in the requirements applicable to the rights of dissenting limited partners in Subsection 34(b)(6)(C)(i)b and Subsection 3(a)(2)(ii) to Part III, Schedule D.

      The inclusion of the terms "directly or indirectly" in the preamble to the definition are intended to include multiple-step transactions in the definition of limited partnership rollup transactions. The definition also covers indirect rollup transactions, such as those in which a single non-traded partnership first undergoes a simple reorganization and then, in a subsequent transaction or series of transactions, the successor entity is either reorganized or merged with other business entities and, as a consequence of this reorganization or merger, there is a publicly traded security with a significant adverse change in voting rights, the term of existence of the entity, management compensation, or investment objectives. Thus, the definition covers not only transactions in which new securities are received directly by limited partners in single or multiple partnership rollups, but also transactions in which securities are received indirectly through a step transaction, such as umbrella partnership real estate investment trusts, discussed below.

      • Exclusions from the Definition of "Limited Partnership Rollup Transaction": The definition of "limited partnership rollup transaction" also incorporates six exclusions that conform to the Rollup Reform Act. The first is for transactions involving partnerships with an operating policy or practice of retaining cash available for distribution and reinvesting proceeds from the sale, financing, or refinancing of assets in accordance with such criteria as the Commission determines appropriate. This exception is similar to the exclusion recognized by the SEC in adopting a definition of "finite-life" in Item 901 (b) of Regulation S-K.3 Such reinvesting partnerships closely resemble ordinary operating businesses and have not been subject to the criticism associated with limited partnership rollup transactions. Investors in such partnerships, like investors in other operating businesses, have no expectation that the partnership will distribute its cash from operations or sell its assets and distribute the proceeds to investors. Moreover, rollups of reinvesting partnerships do not involve many of the fundamental changes associated with finite-life partnerships, such as changes in management compensation and investor voting rights.

      The second exclusion is for transactions involving only limited partnerships wherein the interests of the limited partners are repurchased, recalled, or exchanged in accordance with the terms of the pre-existing partnership agreement for securities in an operating company specifically identified at the time of the formation of the original limited partnership. Such partnerships with a pre-existing agreement include, for example, limited partnerships established solely for the purpose of conducting research and development that were always intended to be merged with a parent or other affiliate and are generally not available to the retail public. These are rollup transactions to which the investor agreed at the time of the investor's original investment decision and are not the types of transactions where abuses have been reported.

      The third exclusion is for transactions involving securities to be issued or exchanged that are not required to be and are not registered under the Securities Act of 1933 (1933 Act). This provision excludes public issuances of securities, therefore, under Sections 3(a)(9) and (10) of the 1933 Act as well as Section 1145 of the Bankruptcy Code.4

      The fourth exclusion is for transactions involving only issuers that are not required to register or report under Section 12 of the Exchange Act, both before and after the transaction.

      The fifth exclusion is for transactions involving a proposal by an independent, non-affiliated third party to succeed to a general partner or sponsor interest only if the transaction is approved by not less than 66-2/3 percent of the outstanding units of each of the participating partnerships and the existing general partners receive only compensation expressly provided for in the pre-existing partnership agreements of the partnerships being rolled up. This last provision is intended to prohibit payments to the general partners to secure their approval of the transaction. The fifth exclusion is intended to exclude transactions resembling either a "hostile" or "white knight" acquisition by a third-party without extraordinary financial remuneration to the current general partner., In such situations, the limited partners have a bona fide choice of retaining current management or tendering or exchanging their shares in a limited partner rollup transaction that changes the management of the current general partners.

      The sixth exclusion is for transactions, except as the Commission may by rule deem to fall within the definition of "limited partnership rollup transaction," in which the securities offered to investors are securities of another entity that are listed on the Nasdaq National Market, the New York Stock Exchange or the American Stock Exchange, if: 1) such other entity was formed, and such class of securities was regularly reported and traded, not less than 12 months before the date on which soliciting material is mailed to investors; and 2) the securities of that entity issued to investors in the transaction do not exceed 20 percent of the total outstanding securities of the entity, exclusive of any securities of such class held by or for the account of the entity or a subsidiary of the entity.

      • Management Fee: fee paid to a sponsor, general partner(s), their affiliates, or other persons for management and administration of a direct participation program. The definition uses the term "direct participation program" rather than "limited partnership" because the term "management fee" is used in provisions in Section 34 that are applicable generally to direct participation programs offerings. The definition in Schedule D uses the term "limited partnership."

      • Solicitation Expenses: direct marketing expenses, incurred by a member in a rollup transaction, such as telephone calls, broker/dealer fact sheets, legal and other fees related to the solicitation, and direct solicitation compensation to members. Since the expenses must be incurred by or for a member, the definition does not cover solicitation expenses incurred by general partners or proxy solicitation firms that are not NASD members. These expenses are included, however, in transaction costs.

      • Transaction Costs: costs incurred in a limited partnership rollup transaction, including printing and mailing the proxy, prospectus and other documents; legal fees not related to the solicitation of votes or tenders; financial advisory fees; investment banking fees; appraisal fees; accounting fees; independent committee expenses; travel expenses; and all other fees related to the preparatory work of the transaction, but not costs that would have been otherwise incurred by the subject limited partnerships in the ordinary course of business or solicitation expenses. As set forth in the definitions, the total costs related to a limited partnership rollup transaction are comprised of solicitation expenses and transaction costs.

      Substantive Requirements

      The NASD has adopted new Subsection 34(b)(6)(C) to prohibit a member or person association with a member from participating in a limited partnership rollup transaction in any capacity if the transaction is unfair and unreasonable.5 Subsection 34(b)(6)(C) contains two basic subdivisions. The first subdivision, Subsection 34(b)(6)(C)(i), defines a series of circumstances and conditions that create a presumption that a limited partnership rollup transaction is not unfair or unreasonable; the second subdivision, Subsection 34(b)(6)(C)(ii), defines a series of circumstances and conditions under which limited partnership rollup transactions are presumed to be unfair or unreasonable. For an applicable limited partnership rollup transaction to comply with Section 34, the transaction must both include one of the provisions set forth in Subsection 34(b)(6)(C)(i) and not violate any of the provisions of Subsection

      The NASD has also adopted amendments to Part III, Schedule D that establish listing standards for Nasdaq National Market securities resulting from a limited partnership rollup transaction in new Section 3 thereof.6 With minor contextual exceptions, the rule language is the same as that adopted in Section 34(b)(6)(C). To simplify the following discussion of the substantive requirements of the rollup rules, section designations reference the provisions in new Section 34(b)(6)(C).

      Limited Partnership Rollup Transactions Presumed Not To Be Unfair Or Unreasonable

      New Subsection (b)(6)(C)(i) defines a series of circumstances under which limited partnership rollup transactions are presumed not to be unfair and unreasonable. It is presumed not to be unfair or unreasonable if dissenting limited partners are offered one of the following:

      • Compensation Based on Appraisal—New paragraph a. of Subsection (b)(6)(C)(i) provides that dissenting limited partners may receive compensation based on the appraisal of an independent appraiser, unaffiliated with the sponsor or general partner of the program, who values the assets as if sold in an orderly manner in a reasonable period of time, plus or minus other balance sheet items, and less the cost of sale or refinancing. The appraisal should accurately reflect the current value of the assets and be done in a manner consistent with appropriate industry practice.

      The methodology for valuing partnership assets should be that methodology that is appropriate for a particular industry, so that partnerships in real estate, oil and gas, and equipment leasing, for example, may use different valuation models. The professionals in each industry should use whatever appraisal methods are appropriate to that industry. The requirement that the appraisal be performed "in a manner consistent with industry practice" implies that the appraiser must meet certain logical qualifications for the performance of the appraisal. Such qualifications would include consideration of the experience and financial stability of the appraiser, as well as whether the appraiser meets the standards of a qualifying organization.

      Forms of compensation based on appraisal include cash, secured or unsecured debt instruments, and freely-tradeable securities. All debt instruments must provide for a trustee and an indenture, and provide for prepayment with 80 percent of the net proceeds of any sale or refinancing of the assets of the entity. All debt instruments must provide the holders with a market rate of interest equal to at least 120 percent of the applicable federal rate as determined by the Internal Revenue Service, have a term no greater than eight years, and allow for the use of unsecured debt instruments only when the entity issuing the debt has a limitation on total leverage of 70 percent of the appraised value of its assets. Freely tradeable securities utilized as compensation must be previously listed on a national securities exchange or previously traded on The Nasdaq Stock MarketSM prior to the transaction. Nasdaq securities used as compensation include all securities traded in The Nasdaq SmallCap Market™ and the Nasdaq National Market, thus permitting freely tradeable securities of any Nasdaq company to be utilized as compensation to dissenting limited partners.

      The number of freely tradeable securities offered in return for partnership interests would be determined in relation to the average last-sale price of the securities in the 20-day period following the date of the meeting at which the vote on the rollup occurs. If the issuer of the freely tradable securities and the sponsor or general partner are affiliated, and the securities issued as compensation are new securities, such securities must not represent more than 20 percent of the issued and outstanding securities of that class after the issuance. A definition solely for purposes of this provision provides that a sponsor or general partner is deemed affiliated with the issuer if the sponsor or general partner receives any material compensation from the issuer or its affiliates in conjunction with the rollup transaction or the purchase of the general partner's interest. The 20 percent limitation on the amount of securities offered as compensation by an affiliate helps to establish a threshold below which significant dilution is be presumed to have not occurred.

      • Receipt of a Security With Substantially the Same Terms and Conditions—New paragraph b. of Subsection 34(b)(6)(C)(i) provides that dissenting limited partners may receive or retain a security with substantially the same terms and conditions as the original issue because there is no material adverse change as to the business plan or the investment, distribution, and liquidation policies of the partnership and the dissenting limited partners receive or retain substantially the same rights, preferences, and priorities they had in their original security. Where reliance on this provision is proposed, the NASD Corporate Financing Department will review the terms of a new security to determine if it has substantially the same terms and conditions as the original issue.

      • Comparable Rights—New paragraph c. of Subsection 34(b)(6)(C)(i) provides for other comparable rights so that sponsors and general partners have the flexibility to propose other protections for limited partners. The comparable rights options include, but are not limited to, the right to supermajority approval of the transaction and the right to review of the transaction by an independent committee.

      • Comparable Rights – Supermajority Approval—New paragraph c.l. of Subsection 34(b)(6)(C)(i) provides that approval of the limited partnership rollup transaction by 75 percent of the outstanding units of each of the individual participating partnerships provides dissenting limited partners with the presumption that the rollup is fair. The criticism of many limited partner ship rollups is that a simple majority of limited partners voting for the rollup can deprive other limited partners of the business and financial opportunities they bargained for when they originally invested. New paragraph c.l. provides that this assumption is no longer reasonable where 75 percent of the partnership interests (supermajority) take affirmative action to approve the transaction, since such an overwhelming approval of the transaction provides an indication of its fairness and beneficial nature. Even though new paragraph c.l. allows a particular limited partnership transaction to be consummated even though individual partnerships did not approve the transaction, any limited partnership that fails to reach the 75 percent threshold is excluded from the transaction.

      • Comparable Rights – Review by Independent Committee—New paragraph c.2. to Subsection 34(b)(6) (C)(i) provides for a right of review by an independent committee not affiliated with the general partner(s) or sponsors. The independent committee has certain rights and obligations. The independent committee's rights are that it: 1) shall have access to the books and records of the partnerships; 2) shall have the authority to negotiate the proposed transaction with the general partner or sponsor for the limited partners, but not the authority to approve the transaction for the limited partners; 3) shall have the ability to retain independent counsel and financial advisers to represent all limited partners at the limited partnerships' expense and may be compensated and reimbursed by the limited partnerships subject to the rollup transaction; and 4) shall be entitled to indemnification to the maximum extent permitted by law from the limited partnerships subject to the rollup transaction against claims, causes of action, or lawsuits related to any action or decision made in furtherance of their responsibilities; provided, however, that the general partner may also agree to indemnify the independent committee.



      • The independent committee's obligations are that it: 1) shall be approved by a majority of the outstanding securities of each of the participating partnerships; 2) shall prepare a report to the limited partners subject to the limited partnership rollup transaction that presents its findings and recommendations, including any minority views; 3) shall deliberate for a period no longer than 60 days unless unanimously extended by the members of the independent committee or if approved by the NASD.
      • Comparable Rights – Other Comparable Rights—New paragraph c.3. to Subsection 34(b)(6)(C)(i) provides for other comparable rights for dissenting limited partners that are not limited to supermajority approval or the establishment of an independent committee, but include any other comparable rights proposed by general partners or sponsors, provided that the general partners or sponsors demonstrate to the satisfaction of the NASD or, if the NASD determines appropriate, to the satisfaction of an independent committee, that the rights proposed are comparable.

      Limited Partnership Rollup Transactions Presumed To Be Unfair And Unreasonable

      New Subsection 34(b)(6)(C)(ii) defines a series of circumstances under which limited partnership rollup transactions, regardless of compliance with Subsection 34(b)(6)(C)(i), are presumed to be unfair or unreasonable7 if: 1) certain actions taken by the general partner result in the unfair conversion and valuation of general partner interests in a limited partnership rollup transaction; 2) a limited partnership rollup transaction fails to protect the voting rights of the limited partners; 3) the transaction costs of a rejected limited partnership rollup transaction are unfairly apportioned or allocated; or 4) the payment of fees to general partners in limited partnership rollup transactions are unfair, unreasonable, or inappropriate.

      • Actions Taken By the General Partner—New paragraph a. of Subsection 34(b)(6)(C)(ii) provides that it is presumptively unfair and unreasonable for general partners, when determining their interest in the new entity resulting from a limited partnership rollup transaction, to: 1) convert an equity interest for which consideration has not been paid into a voting interest in the new entity if the equity interest was not otherwise provided for in the limited partnership agreement and disclosed to limited partners; 2) fail to follow the valuation methods, if any, in the partnership agreements when valuing their partnership interests; or 3) utilize a projected value of their equity interest rather than the appraised current value of their equity interest when determining then-interest in the new entity.

      • Voting Rights—New paragraph b. of Subsection 34(b)(6)(C)(ii) contains four provisions for the protection of investors with respect to voting rights. New subparagraph b.l. provides that it is presumptively unfair if the voting rights in the entity resulting from the limited partnership rollup transaction do not follow the original voting rights of the limited partnerships participating in the transaction. However, the NASD recognizes that certain material changes to voting rights may be necessary to conform disparate rights that may exist among participating partnerships. Material changes may be effected only if the NASD determines that such changes are not unfair or if an independent committee approves such changes.

      New subparagraph b.2. provides that it is presumptively unfair if a majority of the interests in an entity resulting from a limited partnership rollup transaction is prevented from voting to take certain actions unless the sponsor, general partner(s), board of directors or trustee concur, such as voting to: amend the limited partnership agreement, articles of incorporation, by-laws or indenture; dissolve the entity; remove and elect new management; and approve or disapprove the sale of substantially all the assets of the entity, unless such voting actions would be inconsistent with state law.

      New subparagraph b.3. provides that it is presumptively unfair as to voting rights if the sponsor or general partner proposing a limited partnership rollup transaction is not required to provide a document that clearly delineates instructions and procedures of voting against or dissenting from a proposed transaction.

      New subparagraph b.4. provides that it is presumptively unfair if the general partner or sponsor fails to utilize an independent third party to receive and tabulate all votes and dissents or fails to require the third party to make the tabulation available to the general partner and any limited partner upon request at any time during and after voting occurs.

      • Transaction Costs—New paragraph c. of Subsection 34(b)(6)(C)(ii) provides that it is presumptively unfair if transaction costs of a rejected limited partnership rollup transaction are not apportioned between the general and limited partners in accordance with the final vote as follows: 1) in the case of a limited partnership rollup transaction that is not approved, the general partner/sponsor bears transaction costs in proportion to the total number of abstentions and votes to reject the transaction, and the limited partners bear transaction costs in proportion to the number of votes to approve the transaction; or 2) in the case of a rollup transaction that is approved, but where some individual partnerships do not approve and are not included in the approved transaction, the general partner is not required to pay costs for the limited partnerships who have voted not to approve the transaction.

      • Fees of the General Partners—New paragraph d. of Subsection 34(b)(6)(C)(ii) protects limited partners against the assessment of fees by a general partner that are unfair, unreasonable, or inappropriate. New sub paragraph d.1. provides that it is presumptively unfair for general partners to receive or convert unearned management fees discounted to a present value while also proposing to receive new asset-based fees. A similar presumption of unfairness applies if property management fees and other fees are inappropriate, unreasonable, or more than, or not competitive with, what would be paid to third parties for performing similar services under new subparagraph d.2. New subparagraph d.3. provides that substantial and adverse changes in fees are presumed unreasonable if not submitted to and approved by an independent committee.

      Applicability Of Rollup Rules To UPREITs

      During the period when the NASD rule proposal to adopt the rollup rules was under consideration by the SEC, questions were raised concerning the applicability of the proposed rules to umbrella partnership real estate investment trust (UPREIT) transactions.8 As a result of an understanding reached between the staffs of the NASD and the SEC, the NASD Corporate Financing Department intends to work closely with the SEC Division of Corporation Finance to review all direct, indirect, and multi-step limited partnership rollup transactions in their entirety, including UPREITS, for an initial determination of whether a transaction constitutes a "limited partnership rollup transaction."

      Implementation

      The new rules take effect November 1, 1994, for: 1) any rollup transaction that has not been declared effective by the SEC, regardless of whether the NASD Corporate Financing Department has previously issued an opinion of "no objections" to the proposed underwriting terms and arrangements; and 2) any application for inclusion of a security in the Nasdaq National Market that has not been designated for inclusion.

      * * *

      Questions regarding this Notice as to the general applicability of the rollup rules may be directed to Richard J. Fortwanger, Associate Director, Corporate Financing Department at (301) 208-2700. Questions concerning applications to the Nasdaq National Market may be directed to Tim Pupo, Issuer Services, at (202) 728-8115.


      1 Securities Exchange Act Release No. 34533 (August 15, 1994); 59 F.R. 43147 (August 22, 1994).

      2 The SEC has published for comment whether the current definition of "rollup or rollup of a direct participation program" should continue to apply to Subsections 34(b)(6)(A) and 34(b)(6)(B) which regulate the receipt of differential compensation in the solicitation of votes and tenders in a rollup. These provisions were adopted in 1991. See Notice to Members 91-56 (September 1991). The SEC has approved the new definition of "limited partnership rollup transaction" to apply to new Subsection 34(b)(6)(C). The SEC's comment period expired on September 12, 1994. The text of the rollup rules attached to this Notice show Subsections (A) and (B) as if the proposed amendments published for comment were adopted.

      3 See, Securities Act Rel. No. 6922 (October 30, 1991); 56 FR 217 (November 8, 1991).

      4 This provision also excludes securities issued pursuant to Sections 3(a)(l 1), 3(b), 4(2) and 4(6) of the 1933 Act.

      5 The term of "participation" is defined in Article III, Section 44(a)(5) to include acting in "any advisory or consulting capacity to the issuer related to the offering" and would include any member acting as a financial adviser.

      6 Current Section 3 is redesignated as Section 4 and is amended to reference the limited partnership rollup criteria. Current Section 4 is redesignated Section 5.

      7 Where a limited partnership rollup transaction is determined by NASD staff to include one of the arrangements considered to be unfair or unreasonable, the burden of proof is borne by the member to rebut the presumption by demonstrating that the arrangement is not unfair or unreasonable or that the arrangement does not come within one of the enumerated unfair and unreasonable arrangement provisions.

      8 See, discussion of the applicability of the rollup rules to UPREITS accompanying footnotes 32 and 50 in Securities Exchange Act Release No. 34533 (August 15, 1994); 59 F.R. 43147 (August 22, 1994).


      Text Of Amendments To Article III, Section 34 Of The Rules Of Fair Practice And Schedule D Of The By-Laws

      (Note: New language is underlined; deletions are in brackets.)

      Direct Participation Programs Sec. 34.

      (a) No change.
      (b)

      Application
      (1) No member or person associated with a member shall participate in a public offering of a direct participation program or a limited partnership rollup transaction [of a direct participation program] except in accordance with this subsection.
      Definitions
      (2)
      (A) No change.
      (B) The following terms shall have the stated meaning when used in this subsection:
      (i) Cash Available For Distribution—cash flow less amount set aside for restoration or creation of reserves.
      (ii) Cash Flow—cash funds provided from operations, including lease payments on net leases from builders and sellers, without deduction for depreciation, but after deducting cash funds used to pay all other expenses, debt payments, capital improvements and replacements.
      (iii) Dissenting Limited Partner—a person who, on the date on which soliciting material is mailed to investors, is a holder of a beneficial interest in a limited partnership that is the subject of a limited partnership rollup transaction, and who casts a vote against the transaction and complies with procedures established by the Association, except that for purposes of an exchange or tender offer, such person shall file an objection in writing under the rules of the Association during the period in which the offer is outstanding. Such objection in writing shall be filed with the party responsible for tabulating the votes or tenders.
      [(i)] (iv) Fair Market Net Worth (Unchanged.)
      (v) Limited Partner or Investor in a Limited Partnership—the purchaser of an interest in a direct participation program that is a limited partnership who is not involved in the day-to-day management of the limited partnership and bears limited liability.
      (vi) Limited Partnership—an unincorporated association that is a direct participation program organized as a limited partnership whose partners are one or more general partners and one or more limited partners, which conforms to the provisions of the Revised Uniform Limited Partnership Act or the applicable statute that regulates the organization of such partnership.
      (vii) [Rollup or] Limited Partnership Rollup Transaction [of a Direct Participation Program]—a transaction involving [an acquisition, merger or consolidation of at least one direct participation program, not currently listed on a registered national securities exchange or the NASDAQ System, into another public direct participation program or a public corporation or a public trust.] the combination or reorganization of one or more limited partnerships, directly or indirectly, in which:
      a. some or all of the investors in any of such limited partnerships will receive new securities, or securities in another entity, that will be reported under a transaction reporting plan declared effective before January 1, 1991, by the Securities and Exchange Commission under Section 11A of the Securities Exchange Act of 1934:*
      b. any of the investors' limited partner ship securities are not, as of the date of the filing, reported under a transaction reporting plan declared effective before January 1, 1991, by the Securities and Exchange Commission under Section 11A of the Securities Exchange Act of 1934:*
      c. investors in any of the limited partnerships involved in the transaction are subject to a significant adverse change with respect to voting rights, the term of existence of the entity, management compensation, or investment objectives: and
      d. any of such investors are not provided an option to receive or retain a security under substantially the same terms and conditions as the original issue.
      Notwithstanding the foregoing definition, a "limited partnership rollup transaction" does not include:
      1. a transaction that involves only a limited partnership or partnerships having an operating policy or practice of retaining cash available for distribution and reinvesting proceeds from the sale, financing, or refinancing of assets in accordance with such criteria as the Securities and Exchange Commission determines appropriate:
      2. a transaction involving only limited partnerships wherein the interests of the limited partners are repurchased, recalled or exchanged pursuant to the terms of the pre-existing limited partnership agreements for securities in an operating company specifically identified at the time of the formation of the original limited partnership:
      3. a transaction in which the securities to be issued or exchanged are not required to be and are not registered under the Securities Act of 1933:
      4. a transaction that involves only issuers that are not required to register or report under Section 12 of the Securities Exchange Act of 1934. both before and after the transaction:
      5. a transaction, except as the Securities and Exchange Commission may otherwise provide for by rule for the protection of investors, involving the combination or reorganization of one or more limited partnerships in which a non-affiliated party succeeds to the interests of the general partner or sponsor, if:
      A. such action is approved by not less than 66-2/3 percent of the out standing units of each of the participating limited partnerships: and
      B. as a result of the transaction, the existing general partners will receive only compensation to which they are entitled as expressly provided for in the pre-existing partnership agreements: or
      6. a transaction, except as the Securities and Exchange Commission may otherwise provide for by rule for the protection of investors, in which the securities offered to investors are securities of another entity that are reported under a transaction reporting plan declared effective before January 1, 1991. by the Securities and Exchange Commission under Section 11A of the Securities Exchange Act of 1934*: if:
      A. such other entity was formed, and such class of securities was reported and regularly traded, not less than 12 months before the date on which soliciting material is mailed to investors: and
      B. the securities of that entity issued to investors in the transaction do not exceed 20 percent of the total out standing securities of the entity, exclusive of any securities of such class held by or for the account of the entity or a subsidiary of the entity,
      (viii) Management Fee—a fee paid to the sponsor, general partner(s), their affiliates, or other persons for management and administration of a direct participation program.
      [(ii)] (ix) Organization and Offering Expenses—Unchanged.
      [(iii)] (x) Participant—Unchanged,
      [(iv)] (xi) Person—Unchanged,
      [(v)] (xii) Prospectus—Unchanged.
      [(vi)] (xiii) Registration Statement—Unchanged.
      (xiv) Solicitation Expenses—direct marketing expenses incurred by a member, in connection with a limited partnership rollup transaction-such as telephone calls, broker/dealer fact sheets, members' legal and other fees related to the solicitation, as well as direct solicitation compensation to members.
      (xv) Transaction Costs—costs incurred in connection with a limited partnership rollup transaction, including printing and mailing the proxy, prospectus or other documents: legal fees not related to the solicitation of votes or tenders: financial advisory fees: investment banking fees: appraisal fees: accounting fees: independent committee expenses: travel expenses: and all other fees related to the preparatory work of the transaction, but not including costs that would have otherwise been incurred by the subject limited partnerships in the ordinary course of business or solicitation expenses.
      * * * Participation in Rollups
      (6)
      (A) No member or person associated with a member shall participate in the solicitation of [receive compensation for soliciting] votes or tenders from limited partners [participants] in connection with a limited partnership rollup transaction [of a direct participation program or programs], irrespective of the form of the resulting entity [resulting from the rollup] (i.e., a partnership, real estate investment trust or corporation), unless [such] any compensation received by the member:
      (i) is payable and equal in amount regardless of whether the limited partner [participant] votes affirmatively or negatively in the proposed limited partnership rollup transaction:
      (ii) in the aggregate, does not exceed 2% of the exchange value of the newly-created securities; and
      (iii) is paid regardless of whether the limited partners [participants] reject the proposed limited partnership rollup transaction.
      (B) No member or person associated with a member shall participate in the solicitation of votes or tenders from limited partners in connection with [the] a limited partnership rollup transaction [of a direct participation program] unless the general partner(s) or sponsor(s) proposing the limited partnership rollup transaction agrees to pay all solicitation expenses related to the limited partnership rollup transaction, including all preparatory work related thereto, in the event the limited partnership rollup transaction is [not approved] rejected.
      (C) No member or person associated with a member shall participate in any capacity in a limited partnership rollup transaction if the transaction is unfair or unreasonable.
      (i) A limited partnership rollup transaction will be presumed not to be unfair or unreasonable if the limited partnership rollup transaction provides for the right of dissenting limited partners:
      a. to receive compensation for their limited partnership units based on an appraisal of the limited partnership assets performed by an independent appraiser unaffiliated with the sponsor or general partner of the program which values the assets as if sold in an orderly manner in a reasonable period of time, plus or minus other balance sheet items, and less the cost of sale or refinancing and in a manner consistent with the appropriate industry practice. Compensation to dissenting limited partners of limited partnership rollup transactions may be cash, secured debt instruments, unsecured debt instruments, or freely-tradeable securities: provided, however, that:
      1. limited partnership rollup transactions which utilize debt instruments as compensation must provide for a trustee and an indenture to protect the rights of the debt holders and provide a rate of interest equal to at least 120% of the applicable federal rate as determined in accordance with Section 1274 of the Internal Revenue Code of 1986:
      2. limited partnership rollup transactions which utilize unsecured debt instruments as compensation, in addition to the requirements of sub-paragraph L, must limit total leverage to 70% of the appraised value of the assets:
      3. all debt securities must have a term no greater than 8 years and provide for prepayment with 80% of the net proceeds of any sale or refinancing of the assets previously owned by the partnership entities subject to the limited partnership rollup transaction or any part thereof: and
      4. freely-tradeable securities utilized as compensation to dissenting limited partners must be previously listed on a national securities exchange or previously traded on the Nasdaq System prior to the limited partnership rollup transaction, and the number of securities to be received in return for limited partnership interests must be determined in relation to the average last sale price of the freely-tradeable securities in the 20-day period following the date of the meeting at which the vote on the limited partnership rollup transaction occurs. If the issuer of the freely-tradeable securities is affiliated with the sponsor or general partner, newly issued securities to be utilized as compensation to dissenting limited partners shall not represent more than 20 percent of the issued and outstanding shares of that class of securities after giving effect to the issuance. For purposes of the preceding sentence, a sponsor or general partner is "affiliated" with the issuer of the freely-tradeable securities if the sponsor or general partner receives any material compensation from the issuer or its affiliates in conjunction with the limited partnership rollup transaction or the purchase of the general partner's interest: provided, however, that nothing herein shall restrict the ability of a sponsor or general partner to receive any payment for its equity interests and compensation as otherwise provided by this subparagraph:
      b. to receive or retain a security with substantially the same terms and conditions as the security originally held. Securities received or retained will be considered to have the same terms and conditions as the security originally held if:
      1. there is no material adverse change to dissenting limited partners' rights with respect to the business plan or the investment, distribution and liquidation policies of the limited partner ship: and
      2. the dissenting limited partners receive substantially the same rights-preferences and priorities as they had pursuant to the security originally held; or
      c. to receive other comparable rights including, but not limited to:
      1. approval of the limited partnership rollup transaction by 75% of the outstanding units of each of the individual participating limited partnerships and the exclusion of any individual limited partnership from the limited partnership rollup transaction which fails to reach the 75% threshold. The third-party appointed to tabulate votes and dissents pursuant to sub-paragraph (C)(ii)b.4. hereof shall submit the results of such tabulation to the NASD:
      2. review of the limited partnership rollup transaction by an independent committee of persons not affiliated with the general partner or sponsor. Whenever utilized, the independent committee:
      A. shall be approved by a majority of the outstanding securities of each of the participating partnerships:
      B. shall have access to the books and records of the partnerships:
      C. shall prepare a report to the limited partners subject to the limited partnership rollup transaction that presents its findings and recommendations, including any minority views;
      D. shall have the authority to negotiate the proposed transaction with the general partner or sponsor on behalf of the limited partners, but not the authority to approve the transaction on behalf of the limited partners:
      E. shall not deliberate for a period longer than 60 days, although extensions will be permitted if unanimously agreed upon by the members of the independent committee or if approved by the NASD;
      F. may be compensated and reimbursed by the limited partnerships subject to the limited partnership rollup transaction and shall have the ability to retain independent counsel and financial advisors to represent all limited partners at the limited partnerships' expense provided the fees are reasonable; and
      G. shall be entitled to indemnification to the maximum extent permitted by law from the limited partnerships subject to the limited partnership rollup transaction from claims, causes of action or lawsuits related to any action or decision made in furtherance of their responsibilities: provided, however, that general partners or sponsors may also agree to indemnify the independent committee: or
      3. any other comparable rights for dissenting limited partners proposed by general partners or sponsors, provided, however, that the general partners') or sponsor demonstrates to the satisfaction of the NASD or. if the NASD determines appropriate, to the satisfaction of an independent committee, that the rights proposed are comparable.
      (ii) Regardless of whether a limited partnership rollup transaction is in compliance with subparagraph (C)(i). a limited partnership rollup transaction will be presumed to be unfair and unreasonable:
      a. if the general partner(s):
      1. converts an equity interest in any limited partnership(s') subject to a limited partnership rollup transaction for which consideration was not paid and which was not otherwise provided for in the limited partnership agreement and disclosed to limited partners, into a voting interest in the new entity (provided, however, an interest originally obtained in order to comply with the provisions of Internal Revenue Service Revenue Proclamation 89-12 may be converted):
      2. fails to follow the valuation provisions, if any, in the limited partner ship agreements of the subject limited partnerships when valuing their limited partnership interests: or
      3. utilizes a future value of their equity interest in the limited partnership rather than the current value of their equity interest, as determined by an appraisal conducted in a manner consistent with subparagraph (C)(i) a, when determining their interest in the new entity:
      b. as to voting rights, if:
      1. the voting rights in the entity resulting from a limited partnership rollup transaction do not generally follow the original voting rights of the limited partnerships participating in the limited partnership rollup transaction: provided, however, that changes to voting rights may be effected if the NASD determines that such changes are not unfair or if the changes are approved by an independent committee:
      2. a majority of the interests in an entity resulting from a limited partnership rollup transaction may not. without concurrence by the sponsor, general partner's), board of directors, trustee, or similar governing entity, depending on the form of entity and to the extent not inconsistent with applicable state law, vote to:
      A. amend the limited partnership agreement articles of incorporation or by-laws, or indenture:
      B. dissolve the entity:
      C. remove the general partner, board of directors, trustee or similar governing entity, and elect a new general partner: board of directors, trustee or similar governing entity: or
      D. approve or disapprove the sale of substantially all of the assets of the entity:
      3. the general partner(s) or sponsors*) proposing a limited partnership rollup transaction do not provide each limited partner with a document which instructs the limited partner on the proper procedure for voting against or dissenting from the transaction: or
      4. the general partner(s) or sponsor(s) does not utilize an independent third party to receive and tabulate all votes and dissents in connection with the limited partnership rollup transaction, and require that the third party make the tabulation available to the general partner and any limited partner upon request at any time during and after voting occurs:
      c. as to transaction costs, if:
      1. transaction costs of a rejected limited partnership rollup transaction are not apportioned between general and limited partners of the subject limited partnerships according to the final vote on the proposed transaction as follows:
      A. the general partner(s) or sponsor(s) bear all transaction costs in proportion to the total number of abstentions and votes to reject the limited partnership rollup transaction: and
      B. limited partners bear transaction costs in proportion to the number of votes to approve the limited partner ship rollup transaction: or
      2. individual limited partnerships that do not approve a limited partnership rollup transaction are required to pay any of the transaction costs, and the general partner or sponsor is not required to pay the transaction costs on behalf of the non-approving limited partnerships, in a limited partner ship rollup transaction in which one or more limited partnerships determines not to approve the transaction, but where the transaction is consummated with respect to one or more approving limited partnerships: or
      d. as to fees of general partners, if:
      1. general partners are not prevented from receiving both unearned management fees discounted to a present value (if such fees were not previously provided for in the limited partnership agreement and disclosed to limited partners') and new asset-based fees:
      2. property management fees and other general partner fees are inappropriate, unreasonable and more than, or not competitive with, what would be paid to third parties for performing similar services; or
      3. changes in fees which are substantial and adverse to limited partners are not approved by an independent committee according to the facts and circumstances of each transaction.

      * * *

      Schedule D

      PART I

      Definitions

      For purposes of Schedule D, unless the context requires otherwise:

      (1)–(4) No change.
      (5) "Cash available for distribution" means cash flow of a limited partnership less amount set aside for restoration or creation of reserves.
      (6) "Cash flow" means cash funds provided from limited partnership operations, including lease payments on net leases from builders and sellers, without deduction for depreciation, but after deducting cash funds used to pay all other expenses, debt payments, capital improvements and replacements.
      [(5)] (7) "Capital and surplus" Unchanged.
      [(6)] (8) "Consolidated Quotations Service" Unchanged.
      (9) "Dissenting Limited Partner"—a person who, on the date on which soliciting material is mailed to investors, is a holder of a beneficial interest in a limited partnership that is the subject of a limited partnership rollup transaction, and who casts a vote against the transaction and complies with procedures established by the Association, except that for purposes of an exchange or tender offer, such person shall file an objection in writing under the rules of the Association during the period in which the offer is outstanding. Such objection in writing shall be filed with the party responsible for tabulating the votes or tenders.
      [(7)] (10) "Firm commitment offering" Unchanged.
      [(8)] (11) "Index warrants" Unchanged.
      (12) "Limited partner" or "investor in a limited partnership" means the purchaser of an interest in a direct participation program, as defined in Article m. Section 34 of the Rules of Fair Practice, that is a limited partnership who is not involved in the day-to-day management of the limited partner ship and bears limited liability.
      (13) "Limited partnership" means an unincorporated association that is a direct participation program, as defined in Article IP. Section 34 of the Rules of Fair Practice, organized as a limited partnership whose partners are one or more general partners and one or more limited partners, which conforms to the provisions of the Revised Uniform Limited Partnership Act or the applicable statute that regulates the organization of such partnership.
      (14) "Limited Partnership Rollup Transaction" means a transaction involving the combination or reorganization of one or more limited partnerships, directly or indirectly, in which:
      (A) some or all of the investors in any of such limited partnerships will receive new securities, or securities in another entity, that will be reported under a transaction reporting plan declared effective before January 1. 1991. by the Securities and Exchange Commission under Section 11A of the Securities Exchange Act of 1934:*
      (B) any of the investors' limited partnership securities are not as of the date of the filing, reported under a transaction reporting plan declared effective before January 1, 1991, by the Securities and Exchange Commission under Section 11A of the Securities Exchange Act of
      (C) investors in any of the limited partnerships involved are subject to a significant adverse change with respect to voting rights, the term of existence of the entity, management compensation, or investment objectives: and
      (D) any of such investors are not provided an option to receive or retain a security under substantially the same terms and conditions as the original
      Notwithstanding the foregoing definition, a "limited partnership rollup transaction" does not include:
      (i) a transaction that involves only a limited partnership or partnerships having an operating policy or practice of retaining cash available for distribution and reinvesting proceeds from the sale, financing, or refinancing of assets in accordance with such criteria as the Securities and Exchange Commission determines appropriate:
      (ii) a transaction involving only limited partnerships wherein the interests of the limited partners are repurchased, recalled or exchanged pursuant to the terms of the pre-existing limited partnership agreements for securities in an operating company specifically identified at the time of the formation of the original limited partnership;
      (iii) a transaction in which the securities to be issued or exchanged are not required to be and are not registered under the Securities Act of 1933:
      (iv) a transaction that involves only issuers that are not required to register or report under section 12 of the Securities Exchange Act of 1934. both before and after the transaction;
      (v) a transaction, except as the Securities and Exchange Commission may otherwise provide for by rule for the protection of investors, involving the combination or reorganization of one or more limited partnerships in which a non-affiliated party succeeds to the interests of the general partner or sponsor, if:
      a. such action is approved by not less than 66-2/3 percent of the outstanding units of each of the participating limited partnerships: and
      b. as a result of the transaction, the existing general partners will receive only compensation to which they are entitled as expressly provided for in the pre-existing partnership agreements; or
      (vi) a transaction, except as the Securities and Exchange Commission may otherwise provide for by rule for the protection of investors, in which the securities offered to investors are securities of another entity that are reported under a transaction reporting plan declared effective before January 1, 1991. by the Securities and Exchange Commission under Section 11A of the Securities Exchange Act of 1934*: if:
      a. such other entity was formed, and such class of securities was reported and regularly traded, not less than 12 months before the date on which soliciting material is mailed to investors: and
      b. the securities of that entity issued to investors in the transaction do not exceed 20 percent of the total out standing securities of the entity, exclusive of any securities of such class held by or for the account of the entity or a subsidiary of the entity.
      (15) "Management fee" means a fee paid to the sponsor, general partner(s), their affiliates, or other persons for management and administration of a limited partnership.
      [(9)] (16) "Member" Unchanged.
      [(10)] (17) "NASDAQ Market Maker" Unchanged.
      [(11)] (18) "NASDAQ National Market System security" Unchanged.
      [(12)] (19) "NASDAQ System" Unchanged.
      [(13)] (20) "Net Tangible Assets" Unchanged.
      [(14)] (21) "Normal unit of trading" Unchanged.
      [(15)] (22) "Penalty bid" Unchanged.
      [(16)] (23) "Pre-effective stabilizing bid" Unchanged.
      [(17)] (24) "Reported security," Unchanged.
      (25) "Solicitation expenses" means direct marketing expenses incurred by a member in connection with a limited partnership rollup transaction, such as telephone calls, broker/dealer fact sheets, members' legal and other fees related to the solicitation, as well as direct solicitation compensation to members.
      [(18)] (26) "Stabilizing bid" Unchanged.
      (27) "Transaction costs" means costs incurred in connection with a limited partnership rollup transaction, including printing and mailing the proxy, prospectus or other documents: legal fees not related to the solicitation of votes or tenders: financial advisory fees: investment banking fees; appraisal fees: accounting fees: independent committee expenses: travel expenses: and all other fees related to the preparatory work of the transaction, but not including costs that would have otherwise been incurred by the subject limited partnerships in the ordinary course of business or solicitation expenses.

      * * *

      PART III

      * * *

      Designation Of Nasdaq National Market System Securities

      Sec. 1. Sec. 2. No change.

      Sec. 3. Limited Partnership Rollup Designation Criteria

      In addition to meeting the quantitative criteria for Nasdaq/NMS inclusion, an issuer that is formed as a result of a limited partnership rollup transaction, as defined in Part I, Section (13) hereof, must meet the criteria set forth below in order to be designated.

      (a) The limited partnership rollup transaction must provide for the right of dissenting limited partners:
      (1) to receive compensation for their limited partnership units based on an appraisal of the limited partnership assets performed by an independent appraiser unaffiliated with the sponsor or general partner of the program which values the assets as if sold in an orderly manner in a reasonable period of time, plus or minus other balance sheet items, and less the cost of sale or refinancing and in a manner consistent with the appropriate industry practice. Compensation to dissenting limited partners of limited partnership rollup transactions may be cash, secured debt instruments-unsecured debt instruments, or freely-tradeable securities: provided, however, that:
      (i) limited partnership rollup transactions which utilize debt instruments as compensation must provide for a trustee and an indenture to protect the rights of the debt holders and provide a rate of interest equal to at least 120% of the applicable federal rate as determined in accordance with Section 1274 of the Internal Revenue Code of 1986:
      (ii) limited partnership rollup transactions which utilize unsecured debt instruments as compensation, in addition to the requirements of sub-paragraph (i), must limit total leverage to 70% of the appraised value of the assets:
      (iii) all debt securities must have a term no greater than 8 years and provide for prepayment with 80% of the net proceeds of any sale or refinancing of the assets previously owned by the partnership entities subject to the limited partnership rollup transaction or any part thereof: and
      (iv) freely-tradeable securities utilized as compensation to dissenting limited partners must be issued by a company listed on a national securities exchange or traded on the Nasdaq System prior to the limited partnership rollup transaction, and the number of securities to be received in return for limited partnership interests must be determined in relation to the average last sale price of the freely-tradeable securities in the 20-day period following the date of the meeting at which the vote on the limited partnership rollup transaction occurs. If the issuer of the freely-tradeable securities is affiliated with the sponsor or general partner, newly issued securities to be utilized as compensation to dissenting limited partners shall not represent more than 20 percent of the issued and outstanding shares of that class of securities after giving effect to the issuance. For purposes of the preceding sentence, a sponsor or general partner is "affiliated" with the issuer of the freely tradeable securities if the sponsor or general partner receives any material compensation from the issuer or its affiliates in conjunction with the limited partnership rollup transaction or the purchase of the general partner's interest: provided, however, that nothing herein shall restrict the ability of a sponsor or general partner to receive any payment for its equity interests and compensation as otherwise provided by this section:
      (2) to receive or retain a security with substantially the same terms and conditions as the security originally held. Securities received or retained will be considered to have the same terms and conditions as the security originally held if:
      (i) there is no material adverse change to dissenting limited partners' rights with respect to the business plan or the investment, distribution and liquidation policies of the limited partnership: and
      (ii) the dissenting limited partners receive substantially the same rights, preferences and priorities as they had pursuant to the security originally held: or
      (3) to receive other comparable rights including, but not limited to:
      (i) approval of the limited partnership rollup transaction by 75% of the outstanding units of each of the individual participating limited partnerships and the exclusion of any individual limited partnership from the limited partnership rollup transaction which fails to reach the 75% threshold. The third-party appointed to tabulate votes and dissents pursuant to sub-paragraph (W2)(iv) to Section 3 shall submit the results of such tabulation to the NASD:
      (ii) review of the limited partnership rollup transaction by an independent committee of persons not affiliated with the general partner(s) or sponsor. Whenever utilized, the independent committee:
      a. shall be approved by a majority of the outstanding securities of each of the participating partnerships:
      b. shall have access to the books and records of the partnerships:
      c. shall prepare a report to the limited partners subject to the limited partnership rollup transaction that presents its findings and recommendations, including any minority views:
      d. shall have the authority to negotiate the proposed transaction with the general partner or sponsor on behalf of the limited partners, but not the authority to approve the transaction on behalf of the limited partners:
      e. shall not deliberate for a period longer than 60 days, although extensions will be permitted if unanimously agreed upon by the members of the independent committee or if approved by the NASD;
      f. may be compensated and reimbursed by the limited partnerships subject to the limited partnership rollup transaction and shall have the ability to retain independent counsel and financial advisors to represent all limited partners at the limited partnerships' expense provided the fees are reasonable; and
      g. shall be entitled to indemnification to the maximum extent permitted by law from the limited partnerships subject to the limited partnership rollup transaction from claims, causes of action or lawsuits related to any action or decision made in furtherance of their responsibilities: provided, however, that general partners or sponsors may also agree to indemnify the independent committee: or
      (iii) any other comparable rights for dissenting limited partners proposed by general partners or sponsors, provided, however, that the general partner(s) or sponsor demonstrates to the satisfaction of the NASD or. if the NASD determines appropriate, to the satisfaction of an independent committee, that the rights proposed are comparable.
      (b) Regardless of whether a limited partnership rollup transaction meets the requirements set forth in Subsection 3(a) above, a limited partnership rollup transaction will not be designated:
      (1) if the general partner(s):
      (i) converts an equity interest in any limited partnership(s) subject to a limited partnership rollup transaction for which consideration was not paid and which was not otherwise provided for in the limited partnership agreement and disclosed to limited partners, into a voting interest in the new entity (provided, however, an interest originally obtained in order to comply with the provisions of Internal Revenue Service Revenue Proclamation 89-12 may be converted):
      (ii) fails to follow the valuation provisions, if any, in the limited partnership agreements of the subject limited partnerships when valuing their limited partnership interests: or
      (iii) utilizes a future value of their equity interest rather than the current value of their equity interest, as determined by an appraisal conducted in a manner consistent with sub-paragraph (a)(1) of Part III. Section 3 hereof, when determining their interest in the new entity:
      (2) as to voting rights, if:
      (i) the voting rights in the entity resulting from a limited partnership rollup transaction do not generally follow the original voting rights of the limited partnerships participating in the limited partnership rollup transaction: provided, however, that changes to voting rights may be effected if the NASD determines that such changes are not unfair or if the changes are approved by an independent committee:
      (ii) a majority of the interests in an entity resulting from a limited partnership rollup transaction may not without concurrence by the sponsor, general partner(s). board of directors, trustee, or similar governing entity, depending on the form of entity and to the extent not inconsistent with state law, vote to:
      a. amend the limited partnership agreement, articles of incorporation or by laws, or indenture;
      b. dissolve the entity;
      c. remove the general partner, board of directors, trustee or similar governing entity, and elect a new general partner, board of directors, trustee or similar governing entity: or
      d. approve or disapprove the sale of substantially all of the assets of the entity;
      (iii) the general partners') or sponsor(s) proposing a limited partnership rollup transaction do not provide each person whose equity interest is subject to the transaction with a document which instructs the person on the proper procedure for voting against or dissenting from the rollup: or
      (iv) the general partner(s) or sponsor(s) does not utilize an independent third party to receive and tabulate all votes and dissents in connection with the limited partnership rollup transaction, and require that the third party make the tabulation available to the general partner and any limited partner upon request at any time during and after voting occurs:
      (3) as to transaction costs, if:
      (1) transaction costs of a rejected limited partnership rollup transaction are not apportioned between general and limited partners of the subject limited partnerships according to the final vote on the proposed transaction as follows:
      a. the general partner(s) or sponsor(s) bear all transaction costs in proportion to the total number of abstentions and votes to reject the limited partnership rollup transaction: and
      b. limited partners bear transaction costs in proportion to the number of votes to approve the limited partnership rollup transaction: or (2) individual limited partnerships that do not approve a limited partnership rollup transaction are required to pay any of the transaction costs, and the general partner or sponsor is not required to pay the transaction costs on behalf of the non-approving limited partnerships, in a limited partnership rollup transaction in which one or more limited partnerships determines not to approve the transaction, but where the transaction is consummated with respect to one or more approving limited partnerships: or
      (4) as to fees of general partners, if:
      (i) general partners are not prevented from receiving both unearned management fees discounted to a present value (if such fees were not previously provided for in the limited partnership agreement and disclosed to limited partners) and new asset-based fees:
      (ii) property management fees and other general partner fees are inappropriate, unreasonable and more than, or not competitive with, what would be paid to third parties for performing similar services: or
      (iii) changes in fees which are substantial and adverse to limited partners are not approved by an independent committee according to the facts and circumstances of each transaction.

      Sec. [3.] 4. Registration Standards

      In addition to meeting the quantitative criteria and the limited partnership rollup criteria, if applicable, for NASDAQ/NMS inclusion, the issue must also be:

      * * *

      Sec. [4.] 5. Quantitative Maintenance Criteria

      * * *

      Sec. [5.] 6. Non-Quantitative

      Designation Criteria for Issuers Excepting Limited Partnerships

      * * *

      Sec. [6.] 7. Non-Quantitative Designation Criteria for Issuers That Are Limited Partnerships1

      (a) Applicability

      No provision of this Section shall be construed to require any foreign issuer that is a limited partnership to do any act that is contrary to a law, rule, or regulation of any public authority exercising jurisdiction over such issuer or that is contrary to generally accepted business practices in the issuer's country of domicile. The Association shall have the ability to provide exemptions from applicability of these provisions as may be necessary or appropriate to carry out this intent.
      (b) Distribution of Annual and Interim Reports
      (1) Each NASDAQ/NMS issuer that is a limited partnership shall distribute to limited partners copies of an annual report containing audited financial statements of the limited partnership. The report shall be distributed to limited partners within a reasonable period of time after the end of the limited partnership's fiscal year end and shall be filed with the Association at the time it is distributed to limited partners.
      (2)
      (i) Each NASDAQ/NMS issuer that is a limited partnership which is subject to SEC Rule 13a-13 shall make available copies of quarterly reports including statements of operating results to limited partners either prior to or as soon as practicable following the partnership's filing of its Form 10-Q with the Securities and Exchange Commission. Such reports shall be distributed to limited partners if required by statute or regulation in the state in which the limited partnership is formed or doing business or by the terms of the partnership's limited partnership agreement. If the form of such quarterly report differs from the Form 10-Q, the issuer shall file one copy of the report with the Association in addition to filing its Form 10-Q pursuant to Section 1(c)(12) of Part II. The statement of operations contained in quarterly reports shall disclose, at a minimum, any substantial items of an unusual or nonrecurrent nature and net income before and after estimated federal income taxes or net income and the amount of estimated federal taxes.
      (ii) Each NASDAQ/NMS issuer that is a limited partnership which is not subject to SEC Rule 13a-13 and which is required to file with the Securities and Exchange Commission, or another federal or state regulatory authority, interim reports relating primarily to operations and financial position, shall make available to limited partners reports which reflect the information contained in those interim reports. Such reports shall be distributed to limited partners if required by statute or regulation in the state in which the limited partnership is formed or doing business or by the terms of the partnership's limited partnership agreement. Such reports shall be distributed to limited partners either before or as soon as practicable following filing with the appropriate regulatory authority. If the form of the interim report provided to limited partners differs from that filed with the regulatory authority, the issuer shall file one copy of the report to limited partners with the Association in addition to the report to the regulatory authority that is filed with the Association pursuant to Section 1(c)(12) of Part II.
      (c) Corporate General Partner/Independent Directors

      Each NASDAQ/NMS issuer that is a limited partnership shall maintain a corporate general partner or co-general partner, which shall have the authority to manage the day-to-day affairs of the partnership. Such corporate general or co-general partner shall maintain two independent directors on its board of directors. An issuer that is a limited partnership may be designated for inclusion in NASDAQ/NMS upon demonstrating that it has one independent director and undertaking to elect a second such director within 12 months of designation. For purposes of this section, "independent director" shall mean a person other than an officer or employee of the company or its subsidiaries or any other individual having a relationship which, in the opinion of the board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.
      (d) Audit Committee

      The corporate general partner or co-general partner of each NASDAQ/NMS issuer that is a limited partnership shall establish and maintain an Audit Committee, a majority of the members of which shall be independent directors.
      (e) Limited Partner Meetings

      A NASDAQ/NMS issuer that is a limited partnership shall not be required to hold an annual meeting of limited partners unless required by statute or regulation in the state in which the limited partnership is formed or doing business or by the terms of the partnership's limited partnership agreement.
      (f) Quorum

      In the event that a meeting of limited partners is required pursuant to paragraph (e), the quorum for such meeting shall be not less than 33-1/3 percent of the limited partnership interests outstanding.
      (g) Solicitation of Proxies

      In the event that a meeting of limited partners is required pursuant to paragraph (e), the issuer shall provide all limited partners with proxy or information statements and if a vote is required shall solicit proxies thereon.
      (h) Listing Agreement

      Each NASDAQ/NMS issuer that is a limited partnership shall execute a Listing Agreement in the form designated by the Association.
      (i) Conflicts of Interest

      Each NASDAQ/NMS issuer which is a limited partnership shall conduct an appropriate review of all related party transactions on an ongoing basis and shall utilize the Audit Committee or a comparable body for the review of potential material conflict of interest situations where appropriate.

      * * *


      * Transaction reporting plans under Section 11A were declared effective prior to January 1, 1991, for the Nasdaq National Market, the New York Stock Exchange, and the American Stock Exchange.

      1 The NASD has pending at the SEC rule filing SR-NASD-91-58 that proposes to adopt corporate governance rules for limited partnerships. This proposed rule change was published for comment in Securities Exchange ActRel. No. 30811 (June 15, 1992); 57 F.R. 28542 (June 25, 1992). The rule language of this proposed rule change is set forth herein as if adopted.

    • 94-69 Committee On Compensation Practices Requests Comment;

      Comment Period Expires October 14, 1994

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance

      An Open Letter To Members Of The Financial Services Industry Regarding Compensation Of Retail Brokers And Their Supervisors August 29, 1994

      As you may be aware, Securities and Exchange Commission Chairman Arthur Levitt asked us to serve on a committee to examine the securities industry's compensation practices and to highlight areas of potential conflicts of interest as well as examples of particularly effective procedures for managing the broker-investor relationship. The Committee is seeking to identify practices that most effectively eliminate, reduce, or mitigate these conflicts of interest.

      Specifically, the Committee's mission is to:

      • Review industry compensation practices.

      • Identify actual and perceived conflicts of interest for both brokers and managers.

      • Identify the "best practices" used in the industry to eliminate, reduce, or mitigate such conflicts.

      The Committee is particularly interested in any conflicts that exist at the time of sale. Simply stated: When a responsible broker can choose among a large number of reasonable investments, what influences his/her recommendation? Does the broker place the investor's interest first? To what extent do compensation practices influence a broker's recommendation?

      We hope that this Committee's work will initiate a dialogue within the industry about the best compensation practices and encourage firms to compete on the basis of how they manage these real and perceived conflicts.

      As part of the Committee's process, we would like your help and your views on these issues. We are not seeking information about any specific compensation program at any particular firm. Rather, we are seeking examples of how current compensation practices affect sales behavior, as well as examples of practices that eliminate or reduce conflicts.

      The Committee would like your thoughts on what impact, if any, the following compensation practices have on sales behavior: differentiating compensation by product; flat fees versus transactional commissions; recruitment practices (e.g., up-front payments and increased payouts); compensation for fixed income products (e.g., credits); sales contests or other incentive programs; and supervisor compensation.

      Similarly, many in the industry have developed practices designed to align closely the broker's interest with that of the client. The Committee is interested in your observations regarding such practices, including supervision and other management techniques, compliance and training programs, and disclosure.

      We want to emphasize that the above are only examples of the kinds of practices that we are interested in examining; they are in no way intended to limit any observations or comments you may have on this subject. The Committee welcomes any insights you may wish to provide, including those based on your experiences with experimental or pilot programs.

      We hope you will take the time to respond and share your views with us. Please forward your comments to:

      Professor Samuel L. Hayes III
      Jacob H. Schiff Professor of Investment Banking
      Harvard Business School, Morgan 375
      Soldiers Field Road
      Boston, MA 02163
      Fax: (617) 496-6592

      Please respond by Friday, October 14, 1994. Thank you in advance for your assistance. Sincerely,

      Daniel P. Tully
      Chairman, Committee on Compensation Practices
      Chairman and Chief Executive Officer
      Merrill Lynch & Co., Inc.

      Warren Buffett
      Chairman and Chief Executive Officer
      Berkshire Hathaway Inc.

      Samuel L. Hayes III
      Jacob H. Schiff Professor of Investment Banking
      Harvard University, Graduate School of Business Administration

      Raymond A. Mason
      Chairman and Chief Executive Officer
      Legg Mason, Inc.

      Thomas O'Hara
      Chairman of the Board
      National Association of Investors Corp.

      John F.Welch, Jr.
      Chairman and Chief Executive Officer
      General Electric Company

    • 94-68 SEC Approves Short-Sale Rule For The Nasdaq Stock Market

      SUGGESTED ROUTING

      Senior Management
      Institutional
      Legal & Compliance
      Operations
      Systems
      Trading

      Executive Summary

      On June 29, 1994, the Securities and Exchange Commission (SEC) approved a new short-sale rule for Nasdaq National Market® securities traded on The Nasdaq Stock Market™ (Nasdaq). The rule takes effect September 6, 1994, for an 18-month pilot period.

      The Nasdaq® short-sale rule prohibits member firms from effecting short sales at or below the current inside bid as disseminated by Nasdaq whenever that bid is lower than the previous inside bid.1 The rule will be in effect during normal domestic market hours (9:30 a.m. to 4 p.m., Eastern Time). During the first year the rule is in effect, Nasdaq market makers who have maintained quotations in a particular Nasdaq National Market security for 20 consecutive business days without interruption will be exempt from the rule for short sales in that security, provided all exempted short sales are made in connection with bona fide market-making activity. Effective September 6, 1995, the "20-day" test for exemption of Nasdaq market makers will be replaced with a multipart quantitative test.

      The rule also contains certain limited exemptions for options market makers and warrant market makers as well as exemptions similar to those provided under the SEC's short-sale rule for exchange-listed securities, Rule 10a-1. In addition, there are three interpretations to the rule that address: (1) what constitutes "bona fide" market-making activity; (2) the prices at which "legal" short sales may be effected; and (3) examples of specific conduct that will be deemed to violate the rule. In conjunction with adoption of the rule, the NASD also amended the rules for Nasdaq's Automated Confirmation Transaction Service (ACTSM) to require members to append a short-sale identifier to their ACT trade reports for certain short sales.

      The implementation of a short-sale rule for Nasdaq National Market securities reflects the ongoing effort of the NASD and The Nasdaq Stock Market, Inc., to ensure investor protection and the integrity of The Nasdaq Stock Market. Adoption of a short-sale rule also will prevent abusive short selling and enhance the quality of the Nasdaq market for investors and issuers.

      The NASD hopes this Notice helps members understand the new obligations that will apply to them after September 6, 1994. The NASD also recognizes that additional assistance may be needed to respond to specific areas of concern to the membership. Inquiries should be directed to the staff members listed after the "Questions and Answers" section below.

      Description Of The Rule

      Nasdaq's short-sale rule prohibits short sales in Nasdaq National Market securities at or below the inside bid when the current inside bid is below the previous inside bid. Nasdaq calculates the inside or best bid from all market makers in the security (including bids for exchanges trading Nasdaq securities on an unlisted trading privileges basis), and disseminates symbols to denote whether the current inside bid is an "up bid" or a "down bid" so that members will have that information at their fingertips when effecting short sales. Specifically, an "up bid" is denoted by a green "up" arrow symbol and a "down bid" is denoted by a red "down" arrow. Accordingly, absent an exemption from the rule, a member cannot effect a short sale at or below the inside bid in a security in its proprietary account or an account of a customer if there is a red down arrow next to the security's symbol on the screen. To effect a "legal" short sale on a down bid, the short sale must be executed at a price at least 1/16th above the current inside bid. Conversely, if the security's symbol has a green up arrow next to it, members can effect short sales in the security without any restrictions.

      To determine whether a sale is long or short, members must adhere to the definition of a "short sale" contained in SEC Rule 3b-3, which is incorporated into Nasdaq's short-sale rule. Under SEC Rule 3b-3, the term "short sale" means any sale of a security that the seller does not own or any sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller.2 To determine whether the seller is long or short overall, the seller must net all positions in the security, just as is required in short sales for exchange-listed securities.

      Following is a description of the exemptions to the rule and other significant provisions of the rule. The full text of the short-sale rule follows the "Questions and Answers" section below.

      Qualified Market-Maker Exemption

      To ensure that market-making activities providing liquidity and continuity to the market are not adversely constrained by implementation of the short-sale rule, the rule provides an exemption to "qualified" Nasdaq market makers. Even if a market maker is able to avail itself of the qualified market-maker exemption, it can only utilize the exemption from the short-sale rule for transactions that are made in connection with bona fide market-making activity. If a market maker does not satisfy the requirements for a qualified market maker, it would remain a Nasdaq market maker, however, it could not take advantage of the exemption from the rule. During the first year the rule is in effect, a "qualified" Nasdaq market maker is defined to be a registered market maker that has entered quotations in the relevant security into Nasdaq on an uninterrupted basis for the preceding 20 business days. On the first day of the short-sale rule's implementation, all market makers will be "grandfathered" and considered qualified market makers. Thereafter, market makers that register and begin quoting a Nasdaq National Market issue must wait 20 business days before becoming a qualified market maker. Each market maker is then qualified on the 21st day.

      During the last six months of the pilot period for the rule (September 6, 1995, to March 5, 1996) a "qualified" market maker must satisfy the criteria for a "Primary Nasdaq Market Maker" found in new Section 49 of Article III of the NASD Rules of Fair Practice. To qualify as a Primary Nasdaq market maker, market makers must satisfy at least two of the following four criteria:3

      • The market maker must be at the best bid or best offer as displayed in Nasdaq no less than 35 percent of the time.

      • The market maker must maintain a spread no greater than 102 percent of the average dealer spread.

      • No more than 50 percent of the market maker's quotation updates may occur without being accompanied by a trade execution of at least one unit of trading.

      • The market maker executes one and a half times its "proportionate" volume in the stock.4

      The review period for satisfaction of the Primary Nasdaq market maker performance standards is one calendar month. If a Primary Nasdaq market maker has not satisfied the threshold standards after a particular review period, the Primary Nasdaq market maker designation will be removed commencing on the next business day following notice of failure to comply with the standards. Market makers may requalify for designation as a Primary Nasdaq market maker by satisfying the threshold standards for the next review period. It is important to note that the Primary Nasdaq market maker standards will go into effect on September 6, 1995, and market makers will have to satisfy the new standards during August 1995 to be eligible for designation as a Primary Nasdaq market maker on September 6, 1995.

      Qualified Market-Maker Registration

      In An Existing Nasdaq Security

      Phase I (September 6, 1994, to September 6, 1995) During this period a market maker seeking to become a qualified market maker in an existing Nasdaq National Market security must maintain, without interruption, quotations in the security for the preceding 20 business days. On September 6, 1994, however, all market makers will be "grandfathered" and considered qualified market makers. Thereafter, market makers that register and begin quoting a Nasdaq National Market issue must wait 20 business days before becoming a qualified market maker. Each market maker is then qualified on the 21st day.
      Phase II (September 6, 1995, to March 5, 1996) During this period, if a market maker is a Primary Nasdaq market maker in 80 percent or more of the securities in which it has registered, it may immediately become a Primary Nasdaq market maker (i.e., a qualified market maker) in a Nasdaq National Market security by registering and entering quotations in that issue. If the market maker is not a Primary Nasdaq market maker in at least 80 percent of its stocks, it may qualify as a Primary Nasdaq market maker in that stock if the market maker registers in the stock but does not enter quotes for five days or the market maker registers in the stock as a regular Nasdaq market maker and satisfies the qualification criteria for the next review period.

      In Initial Public Offerings (IPOs)

      Phase I (September 6, 1994, to September 5, 1995) During this period, a market maker may immediately become a qualified market maker in an IPO by immediately registering and entering quotations in the issue. However, if the market maker withdraws from the security on an unexcused basis within the first 20 calendar days after the offering, it will not be eligible for designation as a qualified market maker in any subsequent IPO for the next 10 business days following the unexcused withdrawal.
      Phase II (September 6, 1995, to March 5, 1996) During this period, a market maker may immediately become a Primary Nasdaq market maker (i.e., qualified market maker) in an IPO issue by immediately registering and entering quotations in the issue, provided it has obtained Primary Nasdaq market maker status in 80 percent or more of the stocks in which it has registered. However, if at the end of the first review period a market maker has failed to satisfy the qualification criteria or has withdrawn on an unexcused basis from the security, it is prohibited from becoming a Primary Nasdaq market maker in any other IPO for the next 10 business days.

      In Secondary Offerings

      Phase I (September 6, 1994, to September 5, 1995) During this period, unless a market maker was registered in a security before a secondary offering in that stock has been publicly announced or a registration statement has been filed, it cannot become a qualified market maker in the stock unless the secondary offering has become effective and the market maker has been registered in the security and maintained quotations without interruption for 40 calendar days.
      Phase II (September 6, 1995, to March 5, 1996) During this period, unless a market maker was registered in a security before a secondary offering in that stock has been publicly announced or a registration statement has been filed, it cannot become a Primary Nasdaq market maker, (i.e., a qualified market maker) in the stock unless the secondary offering has become effective and the market maker has satisfied the Primary Nasdaq market maker qualification criteria between the time the market maker registered in the security and the time the offering became effective or the market maker has satisfied the Primary Nasdaq market maker qualification standards for 40 calendar days.

      In Merger And Acquisition Situations

      Phase I (September 6, 1994, to September 5, 1995) During this period, after a merger or acquisition involving an exchange of stock has been publicly announced and not yet consummated or terminated, a market maker may register and begin entering quotations in either or both of the two affected securities and immediately become a qualified market maker in either or both of the issues. However, if the market maker withdraws on an unexcused basis from any stock in which it has so registered within 20 calendar days, the market maker will not be eligible for immediate designation as a qualified market maker for any merger or acquisition announced within three months after the unexcused withdrawal.
      Phase II (September 6, 1995, to March 5, 1996) During this period, after a merger or acquisition is announced, a Primary Nasdaq market maker in one stock may immediately become a Primary Nasdaq market maker in the other stock by registering and entering quotations in that issue.

      Exemptions Comparable To Those In SEC Rule 10a-1

      To reduce compliance burdens for members, Nasdaq's short-sale rule incorporates the exemptions in SEC Rule 10a-1 that are relevant to trading in the Nasdaq market. Specifically the rule exempts:

      • Sales by a broker/dealer for an account in which it has no interest and that are marked long.

      • Sales by a market maker to offset odd-lot orders of customers.

      • Sales by any person, for an account in which he has an interest, if such person owns the security sold and intends to deliver such securities as soon as possible without undo inconvenience or expense.

      • Sales by a member to liquidate a long position that is less than a round lot, provided the sale does not change the member's position by more than one unit of trading (100 shares).

      • Short sales effected by a person in a special arbitrage account if the per son effecting the short sale then owns another security by virtue of which the person is, or presently will be, entitled to acquire an equivalent number of securities of the same class of securities sold; provided such sale, or the purchase that such sale offsets, is effected for the bona fide purpose of profiting from a cur rent difference between the price of the security sold and the security owned and that such right of acquisition was originally attached to or rep resented by another security or was issued to all the holders of any such class of securities of the issuer.

      • Short sales effected by a person in a special international arbitrage account for the bona fide purpose of profiting from a current difference between the price of such security on a securities market not within or subject to the jurisdiction of the United States and on such a securities market subject to the jurisdiction of the United States; provided the person at the time of such sale knows or, by virtue of information currently received, has reasonable grounds to believe that an offering enabling a person to cover such sale is then available to the person in such foreign securities markets and intends to accept such offer immediately.

      • Short sales by an underwriter or any member of the distribution syndicate in the over-allotment of securities, or any lay-off sale by such a person in a distribution of securities rights pursuant to SEC Rule 10b-8 or a standby underwriting commitment.

      The rule also provides that a member not currently registered as a market maker in a security it has acquired while acting as a block positioner will be deemed to own the security for the purposes of the rule. Thus, even if such member may not have a net long position in such security, the rule would not apply if and to the extent that such member's short position in such security is subject to one or more offsetting positions created in the course of bona fide arbitrage, risk arbitrage, or bona fide hedge activities. In addition, the NASD recognizes that an SEC staff interpretation to SEC Rule 10a-1 dealing with the liquidation of index arbitrage positions is equally applicable to Nasdaq's short-sale rule.5 Further, the NASD recognizes that an SEC staff no-action position with respect to SEC Rule 10a-1 dealing with an "international equalizing exemption" for exchange-listed foreign securities and American Depositary Receipts (ADRs) applies equally to Nasdaq's short-sale rule.6 Specifically, the NASD has interpreted its short-sale rule to provide that any person can sell a foreign security, or a depositary share or depositary receipt relating to such a security, on a down bid at the opening, provided the inside bid is equal to or above the last reported sale price (adjusted for current exchange rates and ADR multiples) of that security in the principal foreign market for the security.

      Options Market-Maker Exemption An NASD member may execute a short sale for the account of an equity option market maker or an index option market maker that would otherwise violate the Nasdaq short-sale rule so long as the short sale is an "exempt hedge transaction" and the options market maker is registered with a "qualified options exchange" as a "qualified options market maker" in a stock options class on a Nasdaq National Market security or in an options class on a "qualified" stock index. The NASD notes, however, that an NASD member would not be in violation of the Nasdaq short-sale rule if it executed an order for the account of an options market maker in the good faith belief that the order was in full compliance with the Nasdaq short-sale rule and it was subsequently determined that the order was either not entitled to the exemption or it was incorrectly marked long.

      For equity option market makers, an "exempt hedge transaction" is defined as a short sale that was effected to hedge, and in fact serves to hedge, an existing offsetting options position or an offsetting options position created in a transactions) that was contemporaneous with the short sale,7 provided that when establishing the short position the options market maker receives, or is eligible to receive, good faith margin pursuant to Section 220.12 of Regulation T under the Securities Exchange Act of 1934.

      For index option market makers, an "exempt hedge transaction" is defined as a short sale in a Nasdaq National Market security that was effected to hedge, and in fact serves to hedge, an existing offsetting stock index options position or an offsetting stock index options position created in a transaction(s) that was contemporaneous with the short sale, provided certain conditions are satisfied. These conditions are as follows: the security sold short must be a component security of the index underlying such index option; the index underlying such offsetting index options position must be a "qualified stock index"; and the dollar value of all exempt short sales effected to hedge the offsetting stock index options position(s) does not exceed the aggregate current index value of the offsetting options position(s). A "qualified stock index" is defined as a stock index that includes one or more Nasdaq National Market securities, provided that more than 10 percent of the weight of the index is accounted for by Nasdaq National Market securities. In addition, qualified stock indexes will be reviewed as of the end of each calendar quarter, and the index will cease to qualify if the value of the index represented by one or more Nasdaq National Market securities is less than 8 percent at the end of any subsequent calendar quarter.

      Any short sale unrelated to normal options market-making activity, such as index arbitrage or risk arbitrage that in either case is independent of an options market maker's market-making functions, however, will not be considered an "exempt hedge transaction."

      A "qualified options exchange" is defined as a national securities exchange that has received SEC approval of its rules and procedures governing: the designation of options market makers as qualified options market makers; the surveillance of its market makers' utilization of the exemption; and authorization of the NASD to withdraw, suspend, or modify the designation of a qualified options market maker in the event that the options exchange determines that the qualified options market maker has failed to comply with the terms of the exemption and the exchange believes that such action is warranted in light of the substantial, willful, or continuing nature of the violation. Thus, an options market maker would become a "qualified options market maker" for certain classes of stock options only if it has received an appointment as such from a qualified options exchange. All of the options exchanges have submitted proposals to the SEC that would make them eligible to become qualified options exchanges and it is the NASD's understanding that the SEC will approve these proposals before the short-sale rule goes into effect.

      Warrant Market-Maker Exemption

      The rule contains an exemption for warrant market makers similar to the one available for options market makers. To be eligible for the exemption, the warrant market maker must be registered as a market maker in the warrant and the short sale must be an "exempt hedge transaction" that results in a fully hedged position. An "exempt hedge transaction" is a short sale in a Nasdaq National Market security that was effected to hedge, and in fact serves to hedge, an existing offsetting warrant position created in a transaction that was contemporaneous with the short sale.

      Any short sale by a warrant market maker unrelated to normal warrant market-making activity, such as index arbitrage or risk arbitrage that in either case is independent of a warrant market maker's market-making functions, however, will not be considered an "exempt hedge transaction."

      Rule Interpretations

      There are three Interpretations by the Board of Governors of the NASD dealing with the short-sale rule. Interpretation A clarifies some of the factors that will be taken into consideration when reviewing market-making activity that may not be deemed to be bona fide market-making activity and, therefore, not exempt from the rule's application. Specifically, Interpretation A provides that bona fide market-making activity does not include activity unrelated to market-making functions, such as index arbitrage and risk arbitrage that is independent from a member's market-making functions. Similarly, Interpretation A states that bona fide market making would exclude activity that is related to speculative selling strategies of the member or investment decisions of the firm and is disproportionate to the usual market-making patterns or practices of the member in that security. In addition, Interpretation A provides guidance for what constitutes bona fide market making in the context of a merger or acquisition (this issue also is examined in the "Questions and Answers" section below).

      Interpretation B defines a "legal" short sale on a down bid as one that is executed at a price at least 1/16th above the current inside bid. The last-sale report for such a trade would, therefore, be above the inside bid by at least 1/16th.

      Interpretation C clarifies some of the circumstances under which a member would violate the rule. Specifically, Interpretation C contains the following non-exhaustive list of activities that would be considered manipulative acts and violations of the rule:

      • In instances where the current best bid is below the preceding best bid, a market maker alone at the inside best bid may not lower its bid and then raise it to create an "up bid" for the purpose of facilitating a short sale.

      • A market maker with a long stock position may not raise its bid above the inside bid and then lower it to create a "down bid" for the purpose of precluding market participants from selling short.

      • A market maker may not arrange with a member or a customer to raise its bid in Nasdaq to effect a short sale for the other party while being protected against any loss on the trade or on any other executions effected at its new bid price.

      • A market maker may not arrange with a member or a customer to use its exemption from the rule to sell short at the bid at successively lower prices, accumulate a short position, and then offset those sales through a transaction at a prearranged price, to avoid compliance with the rule, and with the understanding that the member or customer would guarantee the market maker against losses on the trades.

      Amendments To ACT Rules

      In addition to approving Nasdaq's short-sale rule, the SEC also approved a requirement that members append a designator to their ACT reports indicating whether certain sales are short sales or short sales exempt from the rule. Specifically, a "sell short" designator is required for all proprietary short sales by members who are not qualified market makers and short sales by customers, even when a qualified market maker facilitates a short sale for a customer (i.e., buys as principal from a customer selling short). In addition, if a short sale by a customer or a nonqualified market maker is exempt from the rule, a "sell short exempt" designator must be appended to the ACT report.


      1 A short sale is a sale of a security that the seller does not own or any sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller.

      2 A person is deemed to own a security if: (1) he or his agent has title to it; (2) he has purchased, or has entered into an unconditional contract, binding on both parties thereto, to purchase it but has not yet received it; (3) he owns a security convertible into or exchangeable for it and has tendered such security for conversion or exchange; (4) he has an option to purchase or acquire it and has exercised such option; (5) he has rights or warrants to subscribe to it and has exercised such rights or warrants.

      3 In response to concerns raised by the Securities Traders Association and certain member firms, the NASD has indicated its willingness to consider alternative standards which may more effectively identify those market makers that make a significant contribution to the market for a Nasdaq stock. While, to date, none have been suggested, NASD staff continues to be willing to consider alternative standards advanced by industry participants.

      4 For example, if there are 10 market makers in a stock, each dealer's proportionate share volume would be 10 percent; therefore, one and a half times proportionate share volume would mean 15 percent of overall volume.

      5 In 1986, the SEC took a "no-action" position that allows broker/dealers to sell short on a down tick while liquidating index arbitrage positions under certain conditions. This no-action position was clarified in a later SEC Release and the SEC has proposed to amend Rule 10a-1 to incorporate this interpretation. See Securities Exchange Act Release No. 30772 (June 3, 1992) 57 FR 24415.

      6 Id 57 FR 24418.

      7 The phrase contemporaneously established is meant to include transactions occurring simultaneously as well as transactions occurring within the same brief period of time.


      Questions And Answers

      Scope and Effective Date

      Question #1: To what stocks will the short-sale rule apply?
      Answer: Nasdaq's short-sale rule applies only to Nasdaq National Market securities.
      Question #2: Does Nasdaq's short-sale rule apply to preferred securities or convertible preferred securities traded on the Nasdaq National Market?
      Answer: Yes. Nasdaq's short-sale rule applies to all securities traded on the Nasdaq National Market, unless otherwise provided by the NASD.
      Question #3: When will the short-sale rule become effective?
      Answer: The short-sale rule will become effective September 6, 1994, for an 18-month pilot period. On September 6, 1995, one year after the rule is in effect, the Primary Nasdaq market maker standards will take effect.

      Operation Of The Rule

      Question #4: When the inside bid is lower than the preceding bid, are customers and members precluded from selling short?
      Answer: Absent an exemption from the rule, customers and members may not sell short at or below the bid when the inside bid is lower than the previous inside bid. However, short sales may occur if they are priced at least 1/16th above the bid.
      Question #5: Does the daily calculation of up and down bids start with the opening bid (i.e., can you always sell short on the opening bid)?
      Answer: The calculation of "up bids" and "down bids" at the opening incorporates bids from the previous close. Thus, if the opening inside bid is the same as the previous day's closing inside bid, and the closing bid was a down bid, then the opening bid would be a down bid. Similarly, if the opening inside bid is below the previous day's closing inside bid, the opening inside bid is a down bid.
      Question #6: How will Nasdaq trading services such as SelectNetSM and the Advanced Computerized Execution System (ACES®) operate under the short-sale rule?
      Answer: Members will have to mark SelectNet orders as short sales when entering them. The short-sale information will be retained by the NASD for surveillance purposes and will not be revealed to market makers receiving the orders. SelectNet will not inhibit the execution of short sales. Rather, the order-entry firm has to monitor the bid condition and assure compliance with the rule. The NASD Market Surveillance Department will monitor questionable short-sale activity in SelectNet and will investigate suspected rule violations. ACES is available for short sales, however, ACES has been programmed so that it will not automatically execute a short sale on a down bid. In addition, order-entry firms are reminded that they are prohibited from entering short sales into the Small Order Execution System (SOESSM).
      Question #7: Are members responsible for monitoring their open SelectNet short-sale orders to comply with the short-sale rule? For example, what if a member is long and then puts a sell order into SelectNet but later in the day the member discovers it is short and the bid is down. In this case, must that order be canceled because an execution would result in a violation of the short-sale rule?
      Answer: Yes. Members are required to comply with the short-sale rule at all times. The status of an open order in SelectNet or any other execution system must be monitored to assure compliance with the rule.
      Question #8: If a Nasdaq market maker executes a short sale for a qualified options market maker on a down bid and it is subsequently determined that the options market maker was not entitled to the exemption, did the Nasdaq market maker violate the short-sale rule?
      Answer: No. Section 48(h)(2)(f) of the Nasdaq short-sale rule provides that a member will not be in violation of the short-sale rule if it executes a short sale for the account of a qualified options market maker that is in violation of the options market maker exemption, provided that the member did not know or have reason to know that the options market maker's short sale violated the exemption.
      Question #9: Can a firm "journal" short positions established pursuant to the market-maker exemption from its market-making department to other departments within the firm?
      Answer: Nasdaq's short-sale rule does not constrain the ability of firms to "journal" positions between departments within the firm. However, if a firm establishes a short position in reliance on the market-maker exemption just to transfer this position to another department in circumvention of the rule, the NASD would view this as a violation. As noted in Interpretation C to the rule, the NASD believes member attempts to circumvent the rule through indirect actions are antithetical to the purposes of the rule.
      Question #10: Does a member's obligation to comply with the NASD's Limit Order Protection Interpretation supersede the member's obligation to comply with Nasdaq's short-sale rule?
      Answer: Once a limit order to buy is activated, the member must fill the order, regardless of whether the member is long or short the stock. For example, if a market maker with a short position of 1,500 shares in XYZ fills a market order to sell for 500 shares at the inside bid on a down bid while holding a customer's limit order to buy priced at the bid, it must execute the limit order to buy it by effecting a short sale at the down bid. The NASD would view the execution of the short sale as effectively achieving a cross between the limit order to buy and the market order to sell.
      Question #11: How will the NASD treat new Nasdaq National Market securities that come from The Nasdaq SmallCap Market™ or that transfer from another marketplace? Will all new market makers in these securities be automatically qualified without the 20-business-day test?
      Answer: Yes. All market makers in a new Nasdaq National Market issue will be qualified if they register and begin quoting in the security within the first 48 hours. If, however, a market maker registers and begins quoting after this time period, it must wait the 20-business-day period to qualify.
      Question #12: If a security migrates to the Nasdaq National Market from the Nasdaq SmallCap Market, the OTC Bulletin Board®, or another exchange, will an up bid or down bid be calculated for these securities at the opening of trading on Nasdaq?
      Answer: Yes. Nasdaq will compare the opening inside bid on Nasdaq with the closing inside bid on the market where the security last traded to determine whether the inside bid at the opening is up or down.
      Question #13: In the case of an ADR traded on the Nasdaq National Market, if the price of the underlying foreign security were to go down overnight, causing the inside bid on Nasdaq to decline, can any person sell short at the lower inside bid? In other words, is there an "international equalizing exemption" comparable to the one in place for exchange-listed ADRs?
      Answer: Yes. Consistent with a no-action position issued by the staff of the SEC for applying SEC Rule 10a-1 to exchange-listed ADRs, the NASD has interpreted its short-sale rule to provide that any person can sell a foreign security, or a depositary share or a depositary receipt relating to such a security, on a down bid at the opening, provided that the inside bid is equal to or above the last reported sale price (adjusted for current exchange rates and ADR multiples) of that security in the principal foreign market for the security.
      Question #14: Will a cash dividend and any resulting reduction in bid price be considered a down bid for purposes of the short-sale rule?
      Answer: No. A cash dividend adjustment will not create a down bid for purposes of the short-sale rule. In these situations the NASD will manually adjust the bid indicator.

      Determining Net Long Or Short Positions

      Question #15: How will a firm know when it is "long" or "short" in a stock?
      Answer: SEC rules (now part of Nasdaq's short-sale rule) require members to aggregate and net all firm positions in each stock to determine if the member is long or short in each issue.
      Question #16: Can NASD members rely on their established procedures for determining intraday whether they have a net long or short position in an exchange-listed security to also determine intraday whether they have a net long or short position in a Nasdaq National Market security?
      Answer: Yes.
      Question #17: Does a firm violate the rule if it effects a sale for its own account under the mistaken but good faith belief that it was long in the security and subsequently determines that the sale was in fact a short sale?
      Answer: If a firm adheres to its established procedures for determining intraday whether it has a net long or short position in a particular security, and, as a result, believes in good faith that it is long the stock when it effects the sale, the NASD would not consider the sale a violation of the short-sale rule if it were later determined that the firm's good faith belief was wrong and the firm was short when it sold the stock. Nevertheless, a pattern of such transactions would militate against the presumption that the firm was acting in good faith when it effected the sale and may subject the firm to disciplinary action for violation of the short-sale rule.
      Question #18: How should firms calculate their overall long or short positions when there is a qualified market maker in-house?
      Answer: In each Nasdaq National Market security, all firm positions must be aggregated to determine whether the firm is long or short, regardless of the presence of a qualified market maker. For example, if a qualified market maker is short 5,000 shares and another firm position is long 1,000 shares, the firm would be considered short 4,000 shares, regardless of the fact that the qualified market maker may sell short out of its market-making position.
      Question #19: If a firm owns shares of an ADR listed on Nasdaq as well as shares of the underlying security registered in another marketplace, may the firm aggregate its underlying shares with the ADRs to calculate a net position?
      Answer: Yes, aggregation of ADRs and underlying securities on a share-for-share basis is appropriate.
      Question #20: In a merger or acquisition situation, may the broker/dealer aggregate or net its positions in both the target company and the acquirer to determine its overall long or short position?
      Answer: No. This type of aggregation is not permitted.
      Question #21: If a member is long 500 shares and wants to sell 600 shares, the firm may treat this either as a long sale for 500 and a short sale for 100 (two reports), or it may mark the entire order as a short sale. But if a member is long 500 shares and sells 535, what do you do?
      Answer: The short-sale rule does not apply to odd lots, therefore the order may be marked and executed as a long sale.

      Qualified Market-Maker Exemption

      Question #22: When does the 20-business-day "time in grade" qualification standard for market makers come into effect?
      Answer: On the first day of the short-sale rule's implementation, all market makers will be "grandfathered" and considered qualified market makers. Thereafter, market makers that register and begin quoting a Nasdaq National Market issue must wait 20 business days before becoming a qualified market maker. Each market maker is then qualified on the 21st day.
      Question #23: With IPOs, the rule affords market makers that pick up the security an exemption if they stay in it for 20 days. In what time period must they register and begin quoting in the IPO?
      Answer: Same day, on-line registration is possible using Nasdaq Market Operations personnel. However, to be qualified, all market makers must register and begin quoting in the IPO before 9:30 a.m., Eastern Time, the business day after the offering.
      Question #24: If a firm is a qualified market maker in a security that is the subject of an announced merger or acquisition, may the firm retain its qualified status if the market-making activity passes to the risk-arbitrage trading desk?
      Answer: Yes. The firm may retain its status provided that the risk-arbitrage trader complies with the qualification standards. If the firm subsequently engages in speculative selling activity disproportionate to the usual market-making patterns or practices of the member in that security, then those transactions are not covered by the exemption. These conditions are covered in Interpretation A to the rule.
      Question #25: If a firm engages in block positioning in a stock in which it is not a qualified market maker, can the firm avail itself of the market-maker exemption when effecting block transactions in that security?
      Answer: No. The market-maker exemption is only available to qualified market makers.
      Question #26: When Nasdaq is available for the permanent "primary" market-maker qualification calculations (time at the inside, dealer spread in relation to average spread, quote changes in relation to transactions, and proportionate volume), will firms be able to see the actual numbers on their performance in each category in each stock?
      Answer: Yes. The calculations will be available to the market makers through the Nasdaq Workstation® terminals.
      Question #27: Will Nasdaq Workstations indicate whether a particular market maker is a qualified market maker and, therefore, entitled to an exemption?
      Answer: For the first year that the rule is in effect, there will be no qualified market-maker indicator. During the first year, absent an IPO, secondary offering, or merger or acquisition situation, market makers will have to know whether they have been registered in and quoting a stock for more than 20 business-days to determine whether they are eligible for an exemption from the rule. After September 6, 1995, there will be a "P" indicator next to every Primary Nasdaq market maker (i.e., qualified Nasdaq market maker). In addition, market makers will be able to review their status as Primary Nasdaq market makers through Nasdaq.

      Identifying Short Sales

      Question #28: Will members have to indicate on their ACT reports whether a sale is short?
      Answer: Members must append a designator to their ACT reports indicating whether certain sales are short sales or short sales exempt from the rule. Specifically, a "sell short" designator is required for all proprietary short sales by members who are not qualified market makers and short sales by customers, even when a qualified market maker facilitates a short sale for a customer (i.e., buys as principal from a customer selling short). In addition, if a short sale by a customer or a non-qualified market maker is exempt from the rule, a "sell short exempt" designator must be appended to the ACT report. Qualified market makers must indicate short sales as "sell" transactions on their ACT reports. If a report of a sale transaction is transmitted to the ACT Service desk for input into ACT, the report must indicate if the sale is long or short. The NASD will not disseminate this information to the public. However, the NASD will continue to disseminate aggregated monthly short-interest data on Nasdaq securities.
      Question #29: If an order-entry firm calls a market maker to execute a short-sale order from a customer, does the order-entry firm have to identify the order as a short sale?
      Answer: Both the order-entry firm and the market maker must comply with the short-sale rule. In this instance, the order-entry firm should inform the market maker that the sale is short. If, however, the market maker does not know or has no reason to know that the sale is a short sale, it would not violate the short-sale rule if it were to execute the order at the inside bid on a down bid. The exception to this policy is that market-making firms operating automated systems must have incoming orders marked long or short by the order-entry firm so that the market maker does not violate the short-sale rule by executing a short sale on a down bid. In addition, order-entry firms and market makers that operate automated execution systems must mark their ACT reports using the new short-sale indicator. Members also should remind correspondent brokers of their obligations to mark order tickets short so that the executing member will not violate the short-sale rule.
      Question #30: If a firm has entered into a Qualified Service Representative (QSR) arrangement with another firm, must the firm functioning as the QSR indicate if sales by the order-entry firm are short or short-sale exempt?
      Answer: Yes.
      Question #31: If a non-market maker effects a short-sale transaction with a market maker, is the market maker (who is obligated to report the trade under NASD rules) required to indicate in its ACT report whether the contra-side was a short sale?
      Answer: No. However, the member selling short must submit an ACT report indicating that the sale was a short sale. Accordingly, members effecting short sales with market makers will be unable to use the ACT "browse/accept" feature to compare trades in ACT for clearance and settlement purposes.
      Question #32: If member firm A sends a short-sale order to member firm B (not a market maker in the stock) and B sends the order to member firm C (a market maker in the stock) to execute the order, which member is responsible for complying with the rule?
      Answer: All members must comply with the rule, but in this case the compliance obligation is linked to the amount of information known. For example, if firm A is aware the order is a short sale but does not inform firm B, and the order is executed on a down bid, firm A violates the rule. If firm A knows that the order is a short sale and notifies firm B, then it is firm B's obligation to either relay this information to the executing market maker (firm C) or take responsibility itself for complying with the short-sale rule.

      Risk Arbitrage Questions

      Interpretation A to the rule clarifies that certain types of trading activity, such as index arbitrage or index arbitrage that is independent from a member's market-making functions, will not be considered bona fide market-making activity. However, Interpretation A does provide that short sales of a security of a company involved in a merger or acquisition will be deemed bona fide market-making activity if made to hedge the purchase or prospective purchase (based on communicated indications of interest) of another security of a company involved in the merger or acquisition, which purchase was made, or is to be made, in the course of bona fide market-making activity. In addition, Interpretation A also provides that the purchase of a security of a company involved in a merger or acquisition made to hedge a short sale of another security involved in the merger or acquisition, which sale was made in the course of bona fide market-making activity, will not cause the sale to be deemed unrelated to normal market-making activity. Interpretation A also provides that short sales made to hedge any such purchases or prospective purchases must be reasonably consistent with the exchange ratio (or exchange-ratio formula) specified by the terms of the merger or acquisition.

      The following questions provide more specificity to the principles contained in Interpretation A for risk-arbitrage activity. In each question, a merger or acquisition involving an exchange of stock has been announced wherein stock A is seeking to acquire stock T (the M&A transaction). RMM is a "Risk Arbitrage Market Maker"—a broker/dealer that is a qualified market maker and is also engaged in risk arbitrage with regard to the M&A transaction. Consequently, in each question, RMM has a short position in stock A and a corresponding long position in stock T. Each question assumes that the short sale described therein is executed at or below the inside bid when the inside bid, displayed in Nasdaq, is below the preceding inside bid (i.e., a minus bid). Each question further assumes that all other conditions of the proposed short-sale rule have been met.

      Question #33: RMM, a qualified market maker in both stocks A and T, receives a sell order at the bid for stock T. RMM, acting as a market maker in stock T, purchases the position from the customer at the bid and sells short stock A to hedge its position in stock T. Does the short sale of stock A fall within the qualified market-maker exemption?
      Answer: Yes. RMM initiated the trading activity with a purchase on the bid. The original purchase was a bona fide market-making transaction that added liquidity to the market in stock T. In addition, if RMM indicated its interest in purchasing stock T in AUTEX or placed an order to buy in Instinet or SelectNet priced below the inside offer, the NASD also would deem the short sale in stock A to hedge the purchase of stock T to be bona fide market-making activity. In sum, as long as RMM is purchasing stock T on the bid or purchasing stock T in response to its indication of interest to buy stock T at a price better than the inside bid but below the inside offer, short sales in stock A to hedge such purchases are within the qualified market-maker exemption.
      Question #34: RMM is registered as a qualified market maker in both stocks A and T. The offer price of stock T is attractive versus the bid price of stock A. RMM buys stock T at the offer and sells short stock A at the bid. Does the short sale of stock A fall within the qualified market-maker exemption?
      Answer: No. The qualified market-maker exemption would not be available to RMM. RMM's interest in selling stock A is driven solely by its own interest in the M&A transaction and the attractive pricing, not as a response to customer interest in the security or in the interest of providing market liquidity in stock A or T. Therefore, the market-maker exemption would not be available. In sum, if RMM purchases stock T at the offer or purchases stock T below the offer by entering an order to buy that is not publicly advertised (for example, a preferenced order in SelectNet) and then immediately sells stock A short, the short sale of stock A does not fall within the qualified market-maker exemption.
      Question #35: RMM is registered as a market maker in both stocks A and T. ABC, a large, well known investment adviser, has placed orders with RMM to sell stock A for three consecutive days, which RMM has executed as principal. On day four, in reasonable anticipation of continued sell interest from ABC, RMM sells short stock A. ABC does not place an order that day. Immediately after selling stock A short, RMM acquires an appropriate amount of stock T to hedge the short sale in stock A by improving the bid price for stock T or initially entering a publicly advertised order to buy stock T (for example, through an unpreferenced order in SelectNet or the use of AUTEX or Instinet). RMM has no other transactions in stock A or T that day. Does the short sale of stock A fall within the qualified market-maker exemption?
      Answer: Yes. RMM's immediate purchase of stock T at a price below the offer due to RMM's improving its bid for stock T or initially entering a publicly advertised order to buy stock T at a price above the inside bid in stock T provides liquidity to the market in stock T and affords sellers of stock T a superior sale price. Therefore, the qualified market-maker exemption would be available. In sum, if RMM sells stock short at the bid and immediately thereafter purchases stock T at a price below the offer by improving its bid or initially publicly advertising an order to buy stock T at a price above the inside bid for stock T, the short sale in stock A will be deemed bona fide market-making activity.
      Question #36: Immediately after selling stock A short, RMM purchases stock T in response to a market order to sell stock T. Does the short sale of stock A fall within the qualified market-maker exemption?
      Answer: Yes. RMM's purchase of stock T during the normal course of market-making activity would never cause a short sale in stock A to not be deemed bona fide market-making activity.
      Question #37: Immediately after selling stock A short, RMM actively seeks out by telephone or by a preferenced order through an electronic or other automated system another market maker or customer and purchases an appropriate amount of stock T to hedge the short sale in stock A. Does the short sale of stock A fall within the qualified market-maker exemption?
      Answer: No. RMM's efforts to actively seek out by telephone or by a preferenced order through an electronic or other automated system another market maker or customer to sell stock T to RMM immediately after RMM executes the short sale of stock A indicates that RMM's interest in selling stock A was driven solely by its own interest in the M&A transaction, and not as a response to customer interest in the security or in the interest of providing market liquidity in stock A or T. Therefore, the qualified market-maker exemption would not be available.
      Question #38: RMM is registered as a qualified Nasdaq market maker in both stocks A and T. Market activity in stocks A and T suggests imminent selling pressure in both. In response to this anticipated selling pressure, RMM sells short stock A. After a reasonable period of ordinary market-making activity in stock T (or just before the close), RMM purchases an appropriate amount of stock T at the offer. Does the short sale of stock A fall within the qualified market-maker exemption?
      Answer: Yes. If RMM sells short stock A on the bid in anticipation of selling pressure in stock A that does not materialize, the short sale of stock A would be deemed to be bona fide market-making activity if RMM hedged the short sale in stock A by purchasing stock T at the offer after a reasonable period of ordinary market making. In sum, if after selling stock A short RMM purchases stock T at the offer after a reasonable period of ordinary market-making activity, such subsequent purchases of stock T to hedge the short sale in stock A will not cause the short sale in stock A to not be deemed bona fide market-making activity. In addition, if RMM sells stock A short at the bid and immediately thereafter (or after a reasonable period of ordinary market making) purchases stock T at a price below the offer by improving its bid or initally publicly advertising an order to buy stock T at a price above the inside bid for stock T, the short sale in stock A will be deemed bona fide market-making activity.
      Question #39: Stock T is exchange-listed while stock A is on Nasdaq. RMM is registered as a qualified market maker in stock A and generally acts as a block positioner in listed stocks such as stock T. In response to customer selling interest, RMM purchases stock T on the bid or in between the bid and ask. To hedge this purchase, RMM sells short stock A. Does the short sale of stock A fall within the qualified market-maker exemption?
      Answer: Yes. The principles expressed in the answers to questions 33-38 are equally applicable to situations where one of the stocks involved in a M&A transaction is exchange listed. Accordingly, because RMM is adding liquidity to the market for stock T as a block positioner, the related short sale of stock A would be consistent with bona fide market-making activity.
      Question #40: If a qualified options market maker makes a market in a security (stock T) that becomes the target of a merger or acquisition by another company (stock A), do short sales in stock A by the options market maker to hedge options positions in stock T qualify as "exempt hedge transactions"?
      Answer: Yes. Such short sales are exempt assuming the short sale in stock A hedges an existing or prospective position (based on communicated, specified indications of interest) in options on stock T. It will be primarily up to the qualified options exchange to determine if such short sales are in fact "exempt hedge transactions." In addition, with respect only to merger or acquisition situations, the NASD has taken the position that short sales in the "other" security involved in the merger or acquisition (i.e., the security for which the options market maker does not make an options market, if there are options on that security at all) need not qualify for good faith margin treatment under Regulation T under the Securities Exchange Act of 1934.

      Questions regarding this Notice should be directed to James M. Cangiano, Senior Vice President, Market Surveillance, at (301) 590-6424; Glen Shipway, Senior Vice President, Nasdaq Market Operations, at (203) 385-6250; or Thomas R. Gira, Assistant General Counsel, at (202) 728-8957.

      Text Of Section 48 Of The NASD Rules Of Fair Practice

      (Note: New text is underlined.)

      Nasdaq Short-Sale Rule: Effective September 6, 1994

      (a) No member shall effect a short sale for the account of a customer or for its own account in a Nasdaq National Market security at or below the current best (inside) bid when the current best (inside) bid as displayed by the Nasdaq system is below the preceding best (inside) bid in the security.
      (b) In determining the price at which a short sale may be effected after a security goes ex-dividend, ex-right, or ex-any other distribution, all quotation prices prior to the "ex" date may be reduced by the value of such distribution.
      (c) The provisions of subsection (a) shall not apply to:
      (1) Sales by a qualified market maker registered in the security in the Nasdaq system in connection with bona fide market-making activity. For purposes of this subsection, transactions unrelated to normal market-making activity, such as index arbitrage and risk arbitrage that is independent from a member's market-making functions, will not be considered bona fide market-making activity.
      (2) Any sale by any person, for an account in which he has an interest, if such person owns the security sold and intends to deliver such security as soon as possible without undue inconvenience or expense:
      (3) Sales by a member, for an account in which the member has no interest, pursuant to an order to sell which is marked "long" in which the member does not know, or have reason to know, that the beneficial owners of the account have, or would as a result of such sales have, a short position in the security.
      (4) Sales by a member to offset odd-lot orders of customers.
      (5) Sales by a member to liquidate a long position which is less than a round lot, provided that such sale does not change the position of the member by more than one unit of trading.
      (6) Sales by a person of a security for a special arbitrage account if the person then owns another security by virtue of which the person is, or presently will be. entitled to acquire an equivalent number of securities of the same class of securities sold; provided such a sale, or the purchase which such sale offsets, is effected for the bona fide purpose of profiting from a current difference between the price of the security sold and the security owned and that such right of acquisition was originally attached to or represented by another security or was issued to all the holders of any such class of securities of the issuer.
      (7) Sales by a person of a security effected for a special international arbitrage account for the bona fide purpose of profiting from a current difference between the price of such security on a securities market not within or subject to the jurisdiction of the United States and on such a securities market subject to the jurisdiction of the United States: provided the person at the time of such sale knows or. by virtue of information currently received, has reasonable grounds to believe that an offer enabling the person to cover such sale is then available to the person in such foreign securities market and intends to accept such offer immediately.
      (8) Sales by an underwriter, or any member of a syndicate or group participating in the distribution of a security, in connection with an over-allotment of securities, or any layoff sale by such a person in connection with a distribution of securities through rights pursuant to SEC Rule 10b-8 or a standby underwriting commitment.
      (d) No member shall effect a short sale for the account of a customer or for its own account indirectly or through the offices of a third party to avoid the application of this section.
      (e) No member shall knowingly, or with reason to know, effect sales for the account of a customer or for its own account to avoid the application of this section.
      (f) A member that is not currently registered as a Nasdaq market maker in a security and that has acquired a security while acting in the capacity of a block positioner shall be deemed to own such security for the purposes of this rule notwithstanding that such member may not have a net long position in such security if and to the extent that such member's short position in such security is the subject of one or more offsetting positions created in the course of bona fide arbitrage, risk arbitrage, or bona fide hedge activities.
      (g) For purposes of this section, a depositary receipt of a security shall be deemed to be the same security as the security represented by such receipt.
      (h)
      (1) A member shall be permitted, consistent with its quotation obligations, to execute a short sale for the account of an options market maker that would otherwise be in contravention of this section, if:
      (a) the options market maker is registered with a qualified options exchange as a qualified options market maker in a stock options class on a Nasdaq National Market security or an options class on a qualified stock index; and
      (b) the short sale is an exempt hedge transaction.
      (2) For purposes of this subsection:
      (a)
      (i) An "exempt hedge transaction." in the context of qualified options market makers in stock options classes, shall mean a short sale in a Nasdaq National Market security that was effected to hedge, and in fact serves to hedge, an existing offsetting options position or an offsetting options position that was created in a transaction(s) contemporaneous with the short sale.1 provided that when establishing the short position the options market maker is eligible to receive(s) good faith margin pursuant to Section 220.12 of Regulation T under the Securities Exchange Act of 1934 for that transaction.
      (ii) An "exempt hedge transaction." in the context of qualified options market makers in stock index options classes, shall mean a short sale in a Nasdaq National Market security that was effected to hedge, and in fact serves to hedge, an existing offsetting stock index options position or an offsetting stock index options position that was created in a transaction(s) contemporaneous with the short sale, provided that: (a) the security sold short is a component security of the index underlying such offsetting index options position: (b) the index underlying such offsetting index options position is a "qualified stock index": and (c) the dollar value of all exempt short sales effected to hedge the offsetting stock index options position does not exceed the aggregate current index value of the offsetting options position.
      (iii) Notwithstanding any other provision of this subsection, any transaction unrelated to normal options market making activity, such as index arbitrage or risk arbitrage that in either case is independent of an options market maker's market making functions, will not be considered an "exempt hedge transaction."
      (b) A "qualified options market maker" shall mean an options market maker who has received an appointment as a "qualified options market maker" for certain classes of stock options on Nasdaq National Market securities and/or index options on qualified stock indexes pursuant to the rules of a qualified options exchange.
      (c) A "qualified options exchange" shall mean a national securities exchange that has approved rules and procedures providing for:
      (i) designating market makers as qualified options market makers, which standards shall be designed to identify options market makers who regularly engage in market making activities in the particular options classes):
      (ii) the surveillance of its market maker's utilization of the exemption set forth in Section 48(h)(D to assure that short sales effected by qualified options market makers are exempt hedge transactions and that other nonqualified market makers are not utilizing the exemption: and
      (iii) authorization of the NASD to withdraw, suspend, or modify the designation of a qualified options market maker but only if a qualified options exchange has determined that the qualified options market maker has failed to comply with the terms of the exemption, and that such a withdrawal, suspension, or modification of the market maker's exemption is warranted in light of the substantial, willful, or continuing nature of the violation.
      (d) A "qualified stock index" shall mean any stock index that includes one or more Nasdaq National Market securities, provided that more than 10 percent of the weight of the index is accounted for by Nasdaq National Market securities and provided further that the qualification of an index as a qualified stock index shall be reviewed as of the end of each calendar quarter, and the index shall cease to qualify if the value of the index represented by one or more Nasdaq National Market securities is less than 8 percent at the end of any subsequent calendar quarter.
      (e) "Aggregate current index value" shall mean the current index value times the index multiplier.
      (f) A member will not be in violation of Section 48(a) above if the member executes a short sale for the account of an options market maker that is in contravention of this subsection (It), provided that the member did not know or have reason to know that the options market maker's short sale was in contravention of this subsection (h),
      (i)
      (1) A member shall be permitted. consistent with its quotation obligations, to execute a short sale for the account of a warrant market maker that would otherwise be in contravention of this section, if:
      (a) the warrant market maker is a registered Nasdaq market maker for the warrant; and
      (b) the short sale is an exempt hedge transaction that results in a fully hedged position.
      (2) For purposes of this subsection, an "exempt hedge transaction" shall mean a short sale in a Nasdaq National Market security that was effected to hedge, and in fact serves to hedge, an existing offsetting warrant position or an offsetting warrant position that was created in a transaction(s) contemporaneous with the short sale.2 Notwithstanding any other provision of this subsection, any transaction unrelated to normal warrant market making activity, such as index arbitrage or risk arbitrage that in either case is independent of a warrant market maker's market making functions, will not be considered an "exempt hedge transaction."
      (3) The NASD may withdraw, suspend, or modify the exemption for a warrant market maker upon determination that the market maker has failed to comply with the terms of the exemption, and that such a withdrawal, suspension, or modification of the market maker's exemption is warranted in light of the substantial, willful, or continuing nature of the violation.
      (4) A member will not be in violation of Section 48(a) above if the member executes a short sale for the account of a warrant market maker that is in contravention of this subsection (i). provided that the member did not know or have reason to know that the warrant market maker's short sale was in contravention of this subsection (i).
      (j) Upon application or on its own motion, the Association may exempt either unconditionally, or on specified terms and conditions, any transaction or class of transactions from the provisions of this section.
      (k) From time to time, the Securities and Exchange Commission may amend Rule 10a-1. Rule 3b-3. or Rule 3b-8 under the Securities Exchange Act of 1934. As a result, the Board of Governors may alter, amend, modify, or supplement this section in accordance with amendments to Rule 10a-1. Rule 3b-3. or Rule 3b-8. or as otherwise deemed appropriate or necessary for Nasdaq National Market securities.
      (l) Definitions:
      (1) The term "short sale" shall have the same meaning as contained in SEC Rule 3b-3. adopted pursuant to the Securities Exchange Act of 1934. reprinted as follows: The term "short sale" means any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by. or for the account of, the seller. A person shall be deemed to own a security if: (1) he or his agent has title to it: or (2) he has purchased, or has entered into an unconditional contract, binding on both parties thereto, to purchase it but has not yet received it: or (3) he owns a security convertible into or exchangeable for it and has tendered such security for conversion or exchange: or (4) he has an option to purchase or acquire it and has exercised such option: or (5) he has rights or warrants to subscribe to it and has exercised such rights or warrants: provided, however, that a person shall be deemed to own securities only to the extent that he has a net long position in such securities.
      (2) The term "block positioner" shall have the same meaning as contained in SEC Rule 3b-8 for "Qualified Block Positioner" adopted pursuant to the Securities Exchange Act of 1934. reprinted as follows: (c) The term "Qualified Block Positioner" means a dealer who: (1) is a broker or dealer registered pursuant to Section 15 of the Act. (2) is subject to and in compliance with Rule 15c3-1. (3) has and maintains minimum net capital, as defined in Rule 15c3-1. of $1.000.000 and (4) except when such activity is unlawful, meets all of the following conditions: (i) he engages in the activity of purchasing long or selling short, from time to time, from or to a customer (other than a partner or a joint venture or other entity in which a partner, the dealer, or a person associated with such a dealer, as defined in Section 3(a)(18) of the Act, participates) a block of stock with a current market value of $200.000 or more in a single transaction, or in several transactions at approximately the same time from a single source to facilitate a sale or purchase by such customer, (ii) he has determined in the exercise of reasonable diligence that the block could not be sold to or purchased from others on equivalent or better terms, and (iii) he sells the shares comprising the block as rapidly as possible commensurate with the circumstances.
      (3) The term "qualified market maker," for a period of one year after the effective date of this section, shall mean a registered Nasdaq market maker that has maintained, without interruption, quotations in the subject security for the preceding 20 business days. Notwithstanding the 20-day period specified in this subsection, after an offering in a stock has been publicly announced, a registration statement has been filed, or a merger or acquisition involving two issues has been announced, no market maker may register in the stock as a qualified market maker unless it meets the requirements set forth below:
      (i) For secondary offerings, the offering has become effective and the market maker has been registered in and maintained quotations without interruption in the subject security for 40 calendar days:
      (ii) For initial public offerings, the market maker may register in the offering and immediately become a qualified market maker: provided however, that if the market maker withdraws on an unexcused basis from the security within the first 20 days of the offering, it shall not be designated as a qualified market maker on any subsequent initial public offerings for the next 10 business days;
      (iii) After a merger or acquisition involving an exchange of stock has been publicly announced and not yet consummated or terminated, a market maker may immediately register in either or both of the two affected securities as a qualified market maker pursuant to the same-day registration procedures in Part VI. Schedule D to the By-Laws: provided, however, that if the market maker withdraws on an unexcused basis from any stock in which it has registered pursuant to this subsection within 20 days of so registering, it shall not be designated as a qualified market maker pursuant to this subsection for any subsequent merger or acquisition announced within three months subsequent to such unexcused withdrawal.
      For purposes of this subsection, a market maker will be deemed to have maintained quotations without interruption if the market maker is registered in the security and has continued publication of quotations in the security through the Nasdaq system on a continuous basis: provided however, that if a market maker is granted an excused withdrawal pursuant to the requirements of Part VI. Schedule D to the By-Laws, the 20-business-day standard will be considered uninterrupted and will be calculated without regard to the period of the excused withdrawal. One year after effectiveness of this section, the term "qualified market maker" shall mean a registered Nasdaq market maker that meets the criteria for a Primary Nasdaq market maker as set forth in Article III. Section 49 of the Rules of Fair Practice.
      (m) This section shall be in effect until March 6, 1996.

      Interpretation A

      In developing a short-sale rule for Nasdaq National Market securities, the Association adopted an exemption to the rule for certain market making activity. This exemption was deemed an essential component of the rule because bona fide market making activity is necessary and appropriate to maintain continuous, liquid markets in Nasdaq National Market securities. Subsection (c)(1) of this section states that short selling prohibitions shall not apply to sales by qualified Nasdaq market makers in connection with bona fide market making activity and specifies that transactions unrelated to normal market making activity, such as index arbitrage and risk arbitrage that is independent from a member's market making functions, will not be considered as bona fide market making. Thus two standards are to be applied: one must be a "qualified" Nasdaq market maker and one must engage in "bona fide" market making activity to take advantage of this exemption. With this Interpretation, the Association wishes to clarify for members some of the factors that will be taken into consideration when reviewing market making activity that may not be deemed to be bona fide market making activity and therefore would not be exempted from the rule's application-First, as the rule indicates, bona fide market making activity does not include activity that is unrelated to market making functions, such as index arbitrage and risk arbitrage that is independent from a member's market making functions. While these types of arbitrage activity appear to be suitable for the firm's overall hedging or risk management concerns, they do not warrant an exemption from the rule. However, short sales of a security of a company involved in a merger or acquisition will be deemed bona fide market-making activity if made to hedge the purchase or prospective purchase (based on communicated indications of interest) of another security of a company involved in the merger or acquisition, which purchase was made, or is to be made, in the course of bona fide market making activity. The purchase of a security of a company involved on a merger or acquisition made to hedge a short sale of another security involved in the merger or acquisition, which sale was made in the course of bona fide market making activity, will not cause the sale to be deemed unrelated to normal market-making activity. Short sales made to hedge any such purchases or prospective purchases must be reasonably consistent with the exchange ratio (or exchange ratio formula) specified by the terms of the merger or acquisition.

      Similarly, bona fide market making would exclude activity that is related to speculative selling strategies of the member or investment decisions of the firm and is disproportionate to the usual market making patterns or practices of the member in that security. The NASD does not anticipate that a firm could properly take advantage of its market maker exemption to effectuate such speculative or investment short selling decisions. Disproportionate short selling in a market making account to effectuate such strategies will be viewed by the NASD as inappropriate activity that does not represent bona fide market making and would therefore be in violation of the rule.

      Interpretation B

      Section 48 requires that no member shall effect a short sale for the account of a customer or for its own account in a Nasdaq National Market security at or below the current best (inside) bid when the current best (inside) bid as displayed by the Nasdaq system is below the preceding best (inside) bid in the security. The Association has determined that in order to effect a "legal" short sale when the current best bid is lower than the preceding best bid the short sale must be executed at a price of at least 1/16th point above the current inside bid. The last sale report for such a trade would, therefore, be above the inside bid by at least 1/16th of a point.

      Moreover, the Association believes that requiring short sales to be a minimum increment of 1/16th point above the bid ensures that transactions are not effected at prices inconsistent with the underlying purpose of the rule.

      Interpretation C

      Section 48 prohibits a member from effecting a short sale for the account of a customer or for its own account directly or through the offices of a third party for the purpose of avoiding the application of the short-sale rule-Further, the section prohibits a member from knowingly, or with reason to know, effecting sales for the account of a customer or for its own account for the purpose of avoiding the rule. With this Interpretation, the Association wishes to clarify some of the circumstances under which a member would be deemed to be in violation of this section.

      For example, in instances where the current best bid is below the preceding best bid, if a market maker alone at the inside best bid were to lower its bid and then raise it to create an "up bid" for the purpose of facilitating a short sale, the NASD would consider such activity to be a manipulative act and a violation of the NASD's short-sale rule. The NASD also would consider it a manipulative act and a violation of the rule if a market maker with a long stock position were to raise its bid above the inside bid and then lower it to create a "down bid" for the purpose of precluding market participants from selling short. In addition, if a market maker agrees to an arrangement proposed by a member or a customer whereby the market maker raises its bid in the Nasdaq system in order to effect a short sale for the other party and is protected against any loss on the trade or on any other executions effected at its new bid price, the market maker would be deemed to be in violation of this section. Similarly, a market maker would be deemed in violation of the rule if it entered into-an arrangement with a member or a customer whereby it used its exemption from the rule to sell short at the bid at successively lower prices, accumulating a short position, and subsequently offsetting those sales through a transaction at a prearranged price, for the purpose of avoiding compliance with this section, and with the understanding that the market maker would be guaranteed by the member or customer against losses on the trades.

      The NASD believes that members' activities to circumvent the rule through indirect actions such as executions with other members or through facilitation of customer orders while being protected from loss are antithetical to the purposes of the rule-Accordingly, the Association will consider any such activity as a violation of this section.

      Primary Nasdaq Market Maker Standards: Effective September 6, 1995

      Section 49 of the NASD Rules of Fair Practice

      (a) A member registered as a Nasdaq Market Maker pursuant to Part VI. Schedule D of the NASD By-Laws may be deemed to be a Primary Nasdaq Market Maker in Nasdaq National Market securities if the market maker complies with threshold standards (as established and published by the Association from time to time) in the following qualification criteria:
      (1) amount of time a dealer maintains a quotation that represents the best bid or best offer as shown in the Nasdaq
      (2) relation of individual dealer spread to average dealer spread; and
      (3) frequency of dealer quotation updates without a corresponding execution in the security occurring within three minutes before or after a quotation update.3
      (b) A market maker for a Nasdaq National Market security must satisfy the threshold standards in at least two of the criteria in section (a) in order to be designated a Primary Nasdaq Market Maker in that security: provided, however, that if a market maker satisfies only one of the criteria, it may qualify as a Primary Nasdaq Market Maker if it also accounts for a threshold level of proportionate volume in the security (as established and published by the Association from time to time).4
      (c) The review period for review of market maker performance in each of the qualification criteria in section (a), section (g)(1)(b), and section (g)(2)(b)(ii) shall be one calendar month.
      (d) If, after the review period, a market maker does not satisfy the threshold standards for the criteria in section (a), the Primary Nasdaq Market Maker designation shall be withheld commencing on the next business day following notice of failure to comply with the standards.
      (e) Market makers may requalify for designation as a Primary Nasdaq Market Maker by satisfying the threshold standards for the next review period.
      (f) A market maker may request reconsideration of the notice to with hold the Primary Nasdaq Market Maker designation.
      (1) Grounds for requests for reconsideration shall be limited to:
      (a) system failure;
      (b) excused market maker withdrawal status: or
      (c) where a market maker failed to qualify under the criteria set forth in subsection (a)(3) because of activity in a related derivative or convertible security, or activity in a security subject to derivative pricing mechanisms, such as currency differentials with foreign stocks.
      (2) Requests for reconsideration must be sent in writing to Nasdaq Operations within 24 hours of the determination to withhold the Primary Nasdaq Market Maker designation.
      (3) Requests for reconsideration will be reviewed by the Market Operations Review Committee, whose decisions are final and binding on the members.
      (g) In registration situations:
      (1) To register and immediately become a Primary Nasdaq Market Maker in a Nasdaq National Market security, a member must be a Primary Nasdaq Market Maker in 80 percent of the securities in which it has registered. If the market maker is not a Primary Nasdaq Market Maker in 80 percent of its stocks, it may qualify as a Primary Nasdaq Market Maker in that stock if:
      (a) the market maker registers in the stock but does not enter quotes for five days; or
      (b) the market maker registers in the stock as a regular Nasdaq market maker and satisfies the qualification criteria for the next review period.
      (2) Notwithstanding subsection (g)(1) above, after an offering in a stock has been publicly announced or a registration statement has been filed, no market maker may register in the stock as a Primary Nasdaq Market Maker unless it meets the requirements set forth below:
      (a) For secondary offerings:
      (i) the secondary offering has become effective and the market maker has satisfied the qualification criteria in the time period between registering in the security and the offering becoming effective; or
      (ii) the market maker has satisfied the qualification criteria for 40 calendar days.
      (b) For initial public offerings:
      (i) the market maker may register in the offering and immediately become a Primary Nasdaq Market Maker if it is a Primary Nasdaq Market Maker in 80 percent of the securities in which it has registered; provided however, that if, at the end of the first review period, the Primary Nasdaq Market Maker has withdrawn on an unexcused basis from the security or has not satisfied the qualification criteria, it shall not be afforded a Primary Nasdaq Market Maker designation on any subsequent initial public offerings for the next 10 business days; or
      (ii) the market maker registers in the stock as a regular Nasdaq market maker and satisfies the qualification criteria for the next review period.
      (3) Notwithstanding subsection (g)(1) or (g)(2) above, after a merger or acquisition has been publicly announced, a Primary Nasdaq Market Maker in one of the two affected securities may immediately register as a Primary Nasdaq Market Maker in the other merger or acquisition security pursuant to the same-day registration procedures in Part VI. Schedule D to the By-Laws.
      (h) The Board of Governors may modify the threshold standards set forth in sections (a) and (b) above if it finds that maintenance of such standards would result in an adverse impact on a class of investors or on the Nasdaq marketplace.
      (i) The Board of Governors may alter, amend, modify, or supplement this section as deemed appropriate or necessary for Nasdaq National Market securities without recourse to membership for approval as required by Article XII to the By-Laws.

      ACT Rules

      d) Trade Report Input

      1.-3. Unchanged.
      4. Trade information to be input

      Each ACT report shall contain the following information:
      (A)–(E) Unchanged.
      (F) A symbol indicating whether the transaction is a buy, sell, sell short, sell short exempt.* or cross;
      (G)–(L) Unchanged.

      * * *


      1 The phrase contemporaneously established includes transactions occurring simultaneously as well as transactions occurring within the same brief period of time.

      2 The phrase contemporaneously established includes transactions occurring simultaneously as well as transactions occurring within the same brief period of time.

      3 The threshold standards initially shall be established as:

      (a) a market maker must maintain the best bid or best offer as shown in the Nasdaq system no less than 35 percent of the time:

      (b) a market maker must maintain a spread no greater than 102 percent of the average dealer spread:

      (c) no more than 50 percent of a market maker's quotation updates may occur without being accompanied by a trade execution of at least one unit of trading.

      The NASD Board of Governors reserves the authority to rescind or modify one or more of the threshold standards immediately upon a finding that the standard is operating in a manner that is unfair to a class of investors or members, or that continued imposition of the standard results in a substantial adverse impact on the liquidity or market quality of the Nasdaq market.

      4 The threshold proportionate volume standard initially shall require a market maker to account for volume of at least one and a half times its proportionate share of overall volume in the stock for the review period.

      * The "sell short" and "sell short exempt" indicators must be entered for all customer short sales, including cross transactions, and for short sales effected by members that are not qualified market makers pursuant to Section 48 of Article III of the Rules of Fair Practice.

    • 94-67 NASD Solicits Member Comment On Cash And Non-Cash Compensation For Selling Investment Company And Variable Contract Securities;

      Comment Period Expires October 3, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Institutional
      Legal & Compliance
      Mutual Fund

      Executive Summary

      The NASD requests member comment on proposed amendments to Article III, Sections 26 and 29 of the Rules of Fair Practice that would revise existing rules applicable to the sale of investment company securities and establish new rules applicable to the sale of variable contract securities. In connection with the sale of investment company and variable contract securities, the proposed amendments would: (1) prohibit, with certain exceptions, members and associated persons from accepting any non-cash compensation from an investment or insurance company or another member; (2) prohibit associated persons from receiving any compensation from anyone other than the member with which the person is associated, unless permitted by the rule; (3) prohibit receipt by a member of cash compensation from the offerer unless such arrangement is described in the current prospectus; and (4) require that members maintain records of compensation received from offerers. The amendments also would retain the prohibition, in connection with the sale of investment company securities, against a member receiving compensation in the form of securities from an offerer.

      The exceptions from the non-cash compensation prohibition would permit: (1) in-house sales incentive programs for a broker/dealer's associated persons; (2) sales incentive programs of mutual funds and insurance companies for the associated persons of a broker/dealer subsidiary; (3) payment or reimbursement for training and education meetings held by a broker/dealer or a mutual fund or insurance company for associated persons of broker/dealers; (4) gifts of up to $ 100 per associated person annually; and (5) an occasional meal, ticket to a sporting event or theater, or entertainment for associated persons and their guests. The text of the proposed amendments and an addendum containing background information on the proposals follows this Notice.

      Background

      The NASD is requesting comment on proposed amendments to Article III, Sections 26 and 29 of the Rules of Fair Practice that would, among other things, prohibit the receipt of non-cash items of compensation (with certain exceptions) in connection with the sale of investment company and variable contract securities. The current requirements of Subsection 26(1) regulate the disclosure and form of dealer concessions between underwriters and retail dealers of investment company securities (Investment Company Rule). These provisions prohibit dealer concessions in the form of securities, and the payment of concessions directly to associated persons of a member. The provisions also set forth requirements regarding the disclosure of compensation arrangements between underwriters and dealers in the investment company's prospectus.1 In comparison, Article III, Section 29 currently does not contain similar regulations for sales of variable contract securities (Variable Contracts Rule). Thus, the proposed amendments to the Investment Company Rule would modify current requirements and the amendments to the Variable Contracts Rule would establish new requirements that address compensation arrangements between an investment or insurance company and any member participating in the distribution of the company's securities.

      The Investment Companies and Insurance Affiliated Member Committees of the NASD have each considered the current environment in which investment company and variable contract securities are sold. The Committees did not find that the manner in which non-cash compensation is offered and paid to members and their associated persons indicates a level of supervisory and compliance problems similar to those present in the sale of direct participation program securities (DPPs) which led the NASD to prohibit non-cash compensation in the sale of such securities in 1988.2 The Committees believe, however, that the increased use of non-cash compensation for the sale of investment company securities heightens the potential for loss of supervisory control over sales practices and increases the possibility for the perception of impropriety, which may result in a loss of investor confidence. The Committees determined, therefore, that limiting non-cash compensation for the sale of investment company securities is appropriate at this time.

      Description Of Proposed Amendments

      DEFINITIONS

      Associated Person of an Underwriter—The definition of the term "associated person of an underwriter" is proposed to be deleted from Subsection (b)(7) to the Investment Company Rule and is incorporated in the proposed new term "offeror," as discussed more fully below. The term encompasses the issuer, the underwriter, the investment adviser to the issuer, and any affiliated person of such entities.

      Offeror—The NASD is proposing to define the term "offeror" in the Investment Company Rule to include an investment company, an adviser to an investment company, an underwriter, and any affiliated person of such entities. The term would be defined in the Variable Contracts Rule to include a separate account of an insurance company, an adviser to a separate account of an insurance company, an underwriter, and any affiliated person of such entities. The enumerated entities included in the definition of "offeror" were previously included in the definition of "associated person of an underwriter." The term "affiliated person" is defined in accordance with Section 2(a)(3) of the Investment Company Act of 1940 (1940 Act). The term "underwriter" is defined in Section 2(a)(40) of the 1940 Act and is intended to reference the principal underwriter through which the investment company and insurance company distribute securities to participating dealers for sale to the investor.

      Cash Compensation—This term encompasses cash compensation arrangements covered under the current provisions of the Investment Company Rule. The proposed amendments to the Investment Company Rule are intended to be applicable only to those compensation arrangements for the sale of investment company securities that are covered under the current provisions of the Investment Company Rule. The Variable Contracts Rule amendments are proposed to have a similar scope for the sale of variable contract securities.

      Non-Cash Compensation—This term encompasses any form of non-cash compensation received by a member or persons associated with a member in connection with the sale and distribution of investment company and variable contract securities, including, but not limited to, merchandise, gifts and prizes, and payment of travel expenses, meals, and lodging. Thus, the definition of "non-cash compensation" encompasses payments of cash to reimburse costs for travel, meals, and lodging incurred by a member or an associated person.

      REGULATING CASH AND NON-CASH COMPENSATION

      The NASD is proposing to adopt as Section (1) of the Investment Company Rule and Section (h) of the Variable Contracts Rule new provisions governing the receipt of cash and non-cash compensation by members and associated persons. The proposed amendments would apply to both variable annuity and variable life products under the Variable Contracts Rule. As to the Investment Company Rule, the proposed amendments would apply to securities sales of an investment company registered under the 1940 Act. Thus, the proposed rules would apply to securities sales by a face-amount certificate company, a unit investment trust, and open- and closed-end management companies. Closed-end management companies are also regulated under Article III, Section 44 of the Rules of Fair Practice, and the receipt of non-cash compensation is prohibited under Subsection (c)(6)(ix) of that rule.3

      The preamble to the new provisions provides that such compensation must be received "in connection with the sale and distribution" of investment company or variable contract securities, as applicable. The NASD is aware that members and their associated persons receive compensation for the sale of non-securities products from insurance companies and receive other forms of payments from investment and insurance companies that are not for sales and distribution activities. The preamble is intended to clarify that the provisions only relate to cash and non-cash compensation received in connection with the sale and distribution of the security covered by the rule.

      Limitation on Receipt of Compensation by Associated Persons—The NASD is proposing in new Subsection (1)(1) of the Investment Company Rule and new Subsection (h)(1) of the Variable Contracts Rule to prohibit an associated person from accepting any compensation from any person other than the member with which the person is associated, except as permitted elsewhere in the proposed rule.

      Ministerial Exception to Limitation on Receipt of Compensation by Associated Persons—The second proposed sentence of new Subsection (1)(1) of the Investment Company Rule and new Subsection (h)(1) of the Variable Contracts Rule clarifies that the prohibition on receipt of compensation by an associated person from any person other than the member with which the person is associated does not prohibit arrangements, agreed to by a member, where an investment or insurance company maintains a commission account as a ministerial service for a member and pays commission checks from the account directly to the member's associated persons. This exception is intended to recognize current practice in the insurance industry, and reflects the view of the Securities and Exchange Commission (SEC) in Securities Exchange Act Rel. No. 34-8389 (August 29, 1968) (Release 8389) that under certain circumstances such commission payments to associated persons may be made by a life insurance company acting for a subsidiary broker/dealer.4 The NASD is proposing that the same exception recognize other SEC no-action letters that permit an insurance company to establish a commission account as a ministerial service to make payments of commission overrides for sales of insurance and investment company securities products.5

      NASD staff also recognizes that the SEC has issued a number of no-action letters permitting, inter alia, associated persons to receive compensation for the sale of variable contract products from a licensed corporate insurance agent acting for one or more insurance companies.6 The NASD believes it would be appropriate to permit reliance on the NASD's ministerial exception, so long as there is a legitimate state law impediment that prevents an insurance company or its licensed corporate insurance agent from making payments of compensation for the sale of variable contract products directly to the broker/dealer entity and the arrangement otherwise complies with the terms of an appropriate SEC no-action letter.7 To the extent that an arrangement proposed by a member to rely on the ministerial exception does not appear to come within the parameters of Release 8389 or an applicable no-action letter previously issued by the SEC, the NASD recommends that members request a no-action position from the staff of the Division of Market Regulation of the SEC.

      The NASD requests comment on whether (1) there are other situations, not discussed above, where the SEC has issued interpretive or no-action positions on payments of commissions directly to associated persons, and (2) the language of the ministerial exception appropriately encompasses the situations discussed above and any other situations where commissions may be paid directly to associated persons pursuant to SEC interpretive or non-action positions.

      Securities As Compensation—The NASD will retain the provision currently in Subsection (1)(1)(A) that prohibits members and their associated persons from receiving compensation in the form of securities of any kind. The NASD proposes that this provision be renumbered as new Subsection (1) (2) of the Investment Company Rule.

      Recordkeeping Requirement—The NASD is proposing to adopt as new Subsection (1)(3) of the Investment Company Rule and Subsection (h)(2) of the Variable Contracts Rule the general requirement that members must maintain records of all compensation, cash and non-cash, received from offerers. The records are required to include the names of the offerers, the names of the associated persons, and the amount of cash and/or the nature of non-cash compensation received. Two exceptions are provided to the recordkeeping requirement, as described in Subsection (1)(5)(a) and (b) of the Investment Company Rule and Subsection (h)(5)(a) and (b) of the Variable Contracts Rule. These arrangements are discussed below as they are also exceptions to the prohibition on non-cash compensation.

      Prospectus Disclosure of Cash Compensation—Newly numbered Subsection (1)(4) in the Investment Company Rule preserves the requirement currently in Subsection (1)(1)(C) prohibiting acceptance of compensation by a member from an offerer unless such compensation is disclosed in the prospectus. In the case where special cash compensation arrangements are made available by an offerer to a member, but are not available on the same terms to all members to distribute the securities, the disclosure shall include the name of the recipient member and the details of the special arrangements. The provision has been modified to reference only "cash compensation" because non-cash compensation is proposed to be prohibited in a manner that would not require disclosure of any such non-cash compensation.

      Exceptions From Prospectus Disclosure Requirement—The NASD is proposing an additional exception from the prospectus disclosure requirement in proposed Subsection (1)(4) in the Investment Company Rule and proposed Subsection (h)(3) in the Variable Contracts Rule. The first two exceptions in paragraphs (a) and (b) incorporate current Subsections (1)(4)(A) and (B) of the Investment Company Rule, with minor language changes for clarification. These two provisions provide an exception from disclosure for compensation arrangements between: (1) principal underwriters of the same security; and (2) the principal underwriter of a security and the sponsor of a unit investment trust that utilizes such security as its underlying investment. By their terms, these provisions describe arrangements that would not trigger the proposed recordkeeping requirements.

      The additional exception being proposed is contained in paragraph (c), and excepts from the prospectus disclosure requirement compensation arrangements between a non-member company and its sales personnel who are registered representatives of an NASD member that directly or indirectly controls, is controlled by, or is under common control with, the non-member company. The purpose of this exception is to permit an investment or insurance company to provide cash compensation to the employees of an NASD member firm with which it has a control relationship without the need to disclose such arrangements. Regardless of the exception, however, the member is required to comply with the record-keeping requirements of the proposed rule for compensation received from a non-member company. As the prospectus disclosure provision is only related to compensation received by a member from an offeror, it is not necessary to provide an exception for the in-house compensation paid by a member to its own associated persons.

      Prohibition on Non-Cash Compensation—The NASD is proposing to adopt as new Subsection (1)(5) to the Investment Company Rule and Subsection (h)(4) to the Variable Contracts Rule a prohibition on non-cash compensation. The new provision prohibits a member or an associated person from directly or indirectly accepting any non-cash compensation offered or provided to such member or its associated persons unless such non-cash compensation is permitted under another provision.

      Exceptions From Non-Cash Compensation, Recordkeeping, and Direct Payment Prohibitions for Gifts and Entertainment—Proposed Subsection (1)(5) to the Investment Company Rule and Subsection (h)(4) to the Variable Contracts Rule include two exceptions for gifts and entertainment, which may be paid directly to an associated person and, as non-cash items, do not have to be disclosed in the prospectus. Additionally, these two forms of non-cash compensation are specifically excepted from the recordkeeping requirement of the proposed rule.

      Proposed Subsections (1)(5)(a) and (b) to the Investment Company Rule and Subsections (h)(4)(a) and (b) of the Variable Contracts Rule provide that, so long as such compensation is not provided as a precondition or an incentive to sell, the following items are excepted from the prospectus disclosure requirement and an associated person may accept them from a person other than the member-employer: (1) gifts that do not exceed an annual amount per person fixed periodically by the Board of Governors, which is currently $100 per person; and (2) an occasional meal, a ticket to a sporting event or the theater, or comparable entertainment for persons associated with a member and, if appropriate, their guests, which is neither so frequent nor so extensive as to raise any question of impropriety. The latter exception has been revised from the current language to reflect that entertainment for associated persons will usually include a spouse or guest of the person and that payment for a guest is permissible.

      The current requirement that such entertainment "not be conditioned on sales of shares of investment companies" and that gifts of up to $ 100 be "unconditional" was replaced by the requirement that the entertainment or gift "not be provided or offered as an incentive to sell." The revised language is intended to clarify that such gifts and entertainment are permitted to be provided as rewards, for example, for past sales, but shall not be part of an incentive program or plan which requires that the recipient reach a specific sales goal to receive the entertainment or gift. It is believed that the revised language permits the continuation of normal business practices, while preventing an investment or insurance company from providing the gift or entertainment as part of a non-cash sales incentive program.

      Exception From Non-Cash Compensation Prohibition For Training And Education Meetings— The NASD is proposing an exception for training and education meetings to the prohibition on non-cash compensation as Subsection (1)(5)(c) of the Investment Company Rule and Subsection (h)(4)(c) of the Variable Contracts Rule. The proposed exception would, under certain circumstances, permit payment or reimbursement by offerers for meetings held by the offeror or by a member for the purpose of training or educating associated persons. This provision is intended to continue to permit members and offerers to hold training and education meetings for associated persons. In the case of a meeting held by a member, it is not unusual for offerers to reimburse certain of the member's expenses related to the meeting in exchange for the opportunity to discuss with the member's associated persons a particular training or education topic. In the case of a meeting held by an offeror, the offeror provides an opportunity for associated persons of many members to attend a training and education meeting, so long as attendance is determined by the member firm.

      Since the proposed prospectus disclosure provision only requires disclosure of cash compensation, the proposed exception would not trigger the disclosure requirements as payment or reimbursement of expenses by an offeror for a member's training and education meeting is considered to be non-cash compensation. The proposed exception would, however, be subject to the prohibition on an associated person accepting any compensation from anyone other than his or her member-employer.

      The limitations imposed on the exception are intended to ensure that the meeting is for the purpose of training and education and is not, in fact, a prohibited non-cash sales incentive trip or entertainment. The payment or reimbursement by offer-ors for such meetings would be subject to the recordkeeping requirement in order that information on such payments and reimbursements is in the records of the member and, therefore, subject to examination by the NASD. To avoid supervisory problems, associated persons would also be required to obtain the member's prior approval to attend the meeting.

      Such prior approval would satisfy the prohibition on associated persons accepting any compensation from anyone other than their member-employer. Members should establish a procedure so that their records reflect that appropriate approval has been provided to associated persons in connection with such meetings for review by the NASD.

      The location of the meeting must be appropriate to its purpose. A showing of appropriate purpose is demonstrated where the location is the office of the offeror or the member, or a facility located in the vicinity of such office. To address meetings where the attendees are from a number of offices in a region of the country, the meeting location may be in a regional location. The NASD will periodically review the proposed meeting location and agenda to determine whether the meeting is for the purpose of training or education.

      The payment or reimbursement by an offeror may also only be applied to the expenses of the member and its associated persons in attending the meeting and shall not be used to defray the expenses of guests of the associated person. Thus, either the member-employer of the associated person or the associated person must pay the expenses of a guest of an associated person attending a training or education meeting. The non-cash sales incentive prohibitions in connection with DPPs in Article III, Section 34 and in connection with REITs and corporate equity and debt in Article III, Section 44 of the Rules of Fair Practice do not include rule language providing a similar exception for training and education meetings. However, the NASD has interpreted those rules to provide a similar exception.8

      Finally, the exception permitting training and education meetings is only available if the payment or reimbursement by the offeror is not conditioned on sales or the promise of sales by the member or its associated persons. This requirement is intended to ensure that the offeror making the payment or reimbursement does not participate in any manner in a member's decision as to which associated persons will attend a member's or offerer's meeting. The provision is not, however, intended to prevent a member from designating persons to attend a meeting held by the member or by an offeror based on sales or any other criteria as deemed appropriate by the member-employer, so long as attendance at the meeting is not earned through a member's in-house sales incentive program. The requirement prohibiting offerers from conditioning payment on sales or the promise of sales should be compared to that applicable to gifts and entertainment which prohibits the offeror from requiring that the recipient meet a specific sales goal.

      Exception From Non-Cash Compensation and Direct Payment Prohibitions for In-House Arrangements—The NASD is proposing to adopt as Subsection (1)(6) to the Investment Company Rule and Subsection (h)(5) of the Variable Contracts Rule an exception from the prohibitions on non-cash compensation and direct payments to associated persons for non-cash compensation arrangements between a member and its associated persons and between an investment or insurance company and the sales personnel of a member with which it has a control relationship. This provision is not subject to the proposed disclosure requirements.

      In-house payment arrangements, however, are subject to three conditions. They must conform to the recordkeeping requirement, must be multi-product type oriented, and may not involve, directly or indirectly, an unaffiliated investment or insurance company or other member participating in or contributing to such non-cash compensation arrangements.

      The phrase "multi-product type" is intended to ensure that in-house non-cash compensation arrangements are not based on the sale of a specifically designated mutual fund or variable contract. That is, for multi-product type firms (e.g., firms selling mutual funds, equity securities, DPPs, variable contracts, corporate bonds, etc.), the non-cash arrangement must be based on the sales of more than one product type. For single-product type firms (e.g., a firm selling only mutual funds or only variable contracts), the rule permits one product type to be the basis for the sales incentive. However, the incentive must be based on the associated person's gross production of all securities within that product type, not on the sales of a specifically designated mutual fund or variable contract.

      The prohibition against the involvement of unaffiliated investment or insurance companies or other members is intended to ensure that, except in the narrow areas where non-cash compensation arrangements are permitted, investment and insurance companies and other members do not, by payments of cash to a member or by some other means, participate in or contribute to a permitted non-cash compensation arrangement.

      Both the Investment Companies and Insurance Affiliated Members Committees believe that the exception for non-cash compensation arrangements between a member and its associated persons should be equally available in the context of non-cash compensation arrangements between a non-member company and the associated persons of the company's affiliated NASD member firm. This practice, which is codified in Subsection (1)(4)(C) of the Investment Company Rule, has long been permitted in the sale of investment company and variable contract securities products. In both cases, the non-cash compensation arrangement is internal to the employer-employee relationship and, therefore, should not raise the supervisory concerns that are present in the compensation arrangements between a non-member and the unaffiliated broker/dealers selling its product. Moreover, the Committees note that it has generally not been the practice for the NASD to regulate the internal compensation arrangements between a member and its associated persons.

      Operation Of Proposed New Rules

      To facilitate understanding of the proposed new rules, the NASD is providing examples of different compensation arrangements with an analysis of the applicability of the different provisions of the proposed new rules. References to the provisions of the proposed rules will only be to the amendments proposed to the Investment Company Rule to simplify the discussion.

      Examples

      Example 1: An offeror holds an overnight educational meeting for associated persons of broker/dealer firms at a location that requires transportation by airplane and includes meals.

      Analysis: This arrangement would be permitted if it complies with the requirements of proposed Section (1)(5)(c) of the Investment Company Rule that permits training and education meetings, so long as the member controls the determination of which associated persons will attend the meeting, the associated persons obtain the member's prior approval to attend the meeting, the location is appropriate to the purpose of the meeting, the payments by the offerer are only for expenses of the associated persons, and the member satisfies the recordkeeping requirements set forth in Subsection (1)(3) of the Investment Company Rule and Subsection (h)(2) of the Variable Contracts Rule.
      Example 2: An offeror holds a training or educational meeting for associated persons not affiliated with the offeror. The meeting is more social than business; for example, it is comprised of two to three hours per day of training/educational sessions and the remainder of the day consists of social activities.

      Analysis: This arrangement would be prohibited by proposed Section 5 of the Investment Company Rule as non-cash compensation. For an offeror or a member (for persons associated with other members) to provide a training and educational meeting, the arrangements must comply with the exception in proposed Section (1)(5)(c). An offeror is, however, allowed to entertain associated persons of a member, so long as the arrangement complies with proposed Section (1)(5)(b) that assumes there is a meal or entertainment that is not a "meeting," and does not raise any question of impropriety.
      Example 3: A broker/dealer holds its annual meeting for its associated persons and their guests, paying all expenses without reimbursement from any offeror not affiliated with the broker/dealer.

      Analysis: This arrangement would be permitted by proposed Section (1)(6) of the Investment Company Rule and can be at any location which the member-employer deems appropriate. If attendance at the event is conditioned on the achievement of specified sales goals under an incentive program, the incentive program must meet the requirements of Section (1)(6)(a) that the program must be multi-product type oriented or, if the member is a single-product type firm, must be based on the gross production of associated persons.
      Example 4: Same arrangement as Example 3, except that one or more non-member companies not affiliated with the broker/dealer pays for certain of the meeting arrangements or reimburses certain of the broker/dealer's expenses.

      Analysis: This arrangement would be permitted under proposed Section (1)(5)(c) of the Investment Company Rule only if the member controls the determination of which associated persons will attend the meeting, the associated persons obtain the member's approval to attend the meeting, the location is appropriate to the purpose of the meeting, the payments by the offeror are only for expenses of the associated persons, and the member satisfies the recordkeeping requirements. While it is the decision of the member to choose who attends the meeting, it may not use an incentive program to determine who attends.
      Example 5: Same arrangement as Example 3, except that an affiliated non-member company pays for or reimburses the member's expenses.

      Analysis: This arrangement would be permitted under proposed Section (1)(6) of the Investment Company Rule, under the same conditions as set forth in Example 3.
      Example 6: An investment or insurance company establishes a program for the payment of a special cash incentive bonus for broker/dealers that meet certain specific sales targets.

      Analysis: This arrangement would be permitted because the incentive is in the form of cash, subject to the requirements of proposed Sections (1)(1), (3), and (4) of the Investment Company Rule which prohibit payment of the incentive directly to an associated person, require that the member maintain a record of the cash bonus, and require that the special compensation arrangement be described in the current prospectus.
      Example 7: An investment or insurance company pays a percentage commission to a broker/dealer for the sale of its securities products. The broker/dealer uses the commission to pay for the expenses of a training or educational meeting for its associated persons.

      Analysis: This arrangement would be permitted, subject to compliance with proposed Sections (1)(1), (3), and (4) of the Investment Company Rule. The meeting is not specifically subject to the requirements of proposed Subsection (1)(5)(c) of the Investment Company Rule because (absent a more direct relationship between the payment and the meeting) the commission payment would not be viewed as intended as a payment or reimbursement for the member's in-house educational meeting.

      Proposed Implementation Of New Rules

      The NASD is proposing that the amendments to the Investment Company and Variable Contracts Rules be implemented to prohibit the initiation of a new non-cash incentive program after the approval of the amendments by the SEC. Thus, if the proposed amendments were approved, for example, on July 1, 1995, no new program could begin from that effective date forward. However, sales that occurred after the July 1 approval date could be applied to a non-cash incentive program that was already in progress. Therefore, after the July 1, 1995, effective date, members and their associated persons would be permitted to receive non-cash sales incentives earned before that effective date.

      The NASD requests comment on the proposed structure of implementation to assist it in developing an appropriate transition methodology that takes into account the structure of non-cash sales incentive programs that are used in the sale of investment company and variable contract securities products.

      Request For Comment

      The NASD encourages all members and other interested parties to comment on the proposed amendments to Article III, Sections 26 and 29 of the Rules of Fair Practice. Comments should be forwarded to:

      Joan C. Conley
      Office of the Secretary
      NASD
      1735 K Street, N.W.
      Washington, D.C. 20006-1506

      Comments should be received by October 3, 1994.

      Questions concerning this Notice should be directed to Clark Hooper, Vice President, Advertising/ Investment Companies Regulation Department, at (202) 728-8325; Suzanne E. Rothwell, Associate General Counsel, Office of General Counsel, at (202) 728-8247; and Robert J. Smith, Attorney, Office of General Counsel, at (202) 728-8176.


      1 In Notice to Members 94-14 (March 1994), the NASD clarified the obligations of members in complying with the compensation disclosure requirements for mutual funds in Subsection 26(1)(1)(C) to Article III of the Rules of Fair Practice. See, also, Notice to Members 94-41 (May 1994).

      2 For a detailed discussion of the background of the proposed amendments, please call Carolyn Thrower, Advertising/Investment Companies Regulation, at (202) 728-6977.

      3 See, Sections 3, 4, and 5 of the 1940 Act. Section (b)(8)(C) to Article III, Section 44 of the Rules of Fair Practice provides an exemption from compliance with Section 44 for securities of investment companies registered under the Investment Company Act of 1940, except for securities of a closed-end management company as defined in Section 5(a)(2)of the 1940 Act.

      4 Release 8389 states that the SEC would not recommend enforcement action where the insurance company makes payments directly to its life insurance agents who are also persons associated with the insurance company's subsidiary broker/dealer, so long as: (1) such payments are made as a purely ministerial service and are properly reflected on the books and records of the broker/dealer; (2) a binding agreement exists between the insurance company and the broker/dealer that all books and records are maintained by the insurance company as agent for the broker/dealer and are preserved in conformity with the requirements of Rules 17a-3 and l7a-4 under the Securities Exchange Act of 1934; (4) all such books and records are subject to inspection by the SEC in accordance with Section 17(a) of the Exchange Act; and (5) the subsidiary broker/dealer has assumed full responsibility for the securities activities of all persons engaged directly or indirectly in the variable annuity operation.

      5 See, e.g., SEC No-Action Letter to The Mutual Benefit Life Insurance Company (publicly available January 21, 1985) and other SEC no-action letters cited therein.

      6 See, Traditional Equinet, publicly available January 8, 1992; and Mariner Financial Services, publicly available December 16, 1988, which include references to other SEC no-action letters in the incoming letters requesting the SEC no-action position.

      7 Thus, to rely on an SEC no-action letter, there must be state law impediments that satisfy either category (1) or (2) and also satisfy category (3). Regardless of whether a state law impediment exists, an insurance company may rely on Release 8389 to establish a ministerial account where an insurance company makes commission payments directly to associated persons of its subsidiary broker/dealer makes commission payments.

      8 See, Securities Exchange Act Rel. No. 26185 (October 14, 1988); 53 FR 41262 (October 20, 1988), footnote 4, at 41263.


      Proposed Amendments To Sections 26 And 29 To Article III Of The Rules Of Fair Practice

      (Note: New text is underlined; deleted text is in brackets.)

      Investment Companies

      Section 26

      Application

      (a) (Unchanged)

      Definitions

      (b)
      (1)–(6) (Unchanged.)
      (7) ["Associated person of an underwriter" as used in subsection (1) of this section, shall include an issuer for which an underwriter is the sponsor or a principal underwriter, any investment adviser to such issuer, or any affiliated person (as defined in Section 2(a)(3) of the 1940 Act) of such underwriter, issuer or investment advisor.] The terms "offerer," "cash compensation" and "non-cash compensation" as used in Subsection (1) shall have the following meanings:

      "Offerer" shall mean an investment company, an adviser to an investment company, an underwriter and any affiliated person (as defined in Section 2(aV3) of the Investment Company Act of 1940) of such entities.

      "Cash compensation" shall mean any discount, concession, fee, commission, asset-based sales charge, loan, or override received in connection with the sale and distribution of investment company securities.

      "Non-cash compensation" shall mean any non-cash form of compensation received in connection with the sale and distribution of investment company securities, including but not limited to merchandise, gifts and prizes, and payment of travel expenses, meals and lodging.
      (c) – (k) (Unchanged.) [Dealer concessions]
      [(1)(1) No underwriter or associated person of an underwriter shall offer, pay, or arrange for the offer or payment to any other member, in connection with retail sales or distribution of investment company securities, any discount, concession, fee or commission (hereinafter referred to as "concession") which:]
      [(A) is in the form of securities of any kind, including stock, warrants or options;]
      [(B) is in a form other than cash (e.g., merchandise or trips), unless the member earning the concession may elect to receive cash at the equivalent of no less than the underwriter's cost of providing the non-cash concession; or]
      [(C) is not disclosed in the prospectus of the investment company. If the concessions are not uniformly paid to all dealers purchasing the same dollar amounts of securities from the underwriter, the disclosure shall include a description of the circumstances of any general variations from the standard schedule of concessions. If special compensation arrangements have been made with individual dealers, which arrangements are not generally available to all dealers, the details of the arrangements, and the identities of the dealers, shall also be disclosed.]
      [(2) No underwriter or associated person of an underwriter shall offer or pay any concession to an associated person of another member, but shall make such payment only to the member.]
      [(3)
      (A) In connection with retail sales or distribution of investment company shares, no underwriter or associated person of an underwriter shall offer or pay to any member or associated person, anything of material value, and no member or associated person shall solicit or accept anything of material value, in addition to the concessions disclosed in the prospectus.]
      [(B) For purposes of this paragraph (1)(3), items of material value shall include but not be limited to:]
      [(i) gifts amounting in value to more than $50 per person per year.]
      [(ii) gifts or payments of any kind which are conditioned on the sale of investment company securities.]
      [(iii) loans made or guaranteed to a non-controlled member or person associated with a member.]
      [(iv) wholesale overrides (commissions) granted to a member on its own retail sales unless the arrangement, as well as the identify of the member, is set forth in the prospectus of the investment company.]
      [(v) payment or reimbursement of travel expenses, including overnight lodging, in excess of $50 per person per year unless such payment or reimbursement is in connection with a business meeting, conference or seminar held by an underwriter for informational purposes relative to the fund or funds of its sponsorship and is not conditioned on sales of shares of an investment company. A meeting, conference or seminar shall not be deemed to be of a business nature unless: the person to whom payment or reimbursement is made is personally present at, or is en route to or from, such meeting in each of the days for which payment or reimbursement is made; the person on whose behalf payment or reimbursement is made is engaged in the securities business; and the location and facilities provided are appropriate to the purpose, which would ordinarily mean the sponsor's office.]
      [(C) For purposes of this paragraph (1)(3), items of material value shall not include:]
      [(i) an occasional dinner, a ticket to a sporting event or the theater, or comparable entertainment of one or more registered representatives which is not conditioned on sales of shares of an investment company and is neither so frequent nor so extensive as to raise any question of propriety.]
      [(ii) a breakfast, luncheon, dinner, reception or cocktail party given for a group of registered representatives in conjunction with a bona fide business or sales meeting, whether at the headquarters of a fund or its underwriter or in some other city.]
      [(iii) an unconditional gift of a typical item of reminder advertising such as a ballpoint pen with the name of the advertiser inscribed, a calendar pad, or other gifts amounting in value to not more than $50 per person per year.]
      [(4) The provisions of this subsection (1) shall not apply to:]
      [(A) Contracts between principal underwriters of the same security.]
      [(B) Contracts between principal underwriter of a security and the sponsor of a unit investment trust which utilizes such security as its underlying investment.]
      [(C) Compensation arrangements of an underwriter or sponsor with its own sales personnel.]

      Member Compensation

      (l) In connection with the sale and distribution of investment company
      (1) Except as described below, no associated person of a member shall accept any compensation, cash or non-cash, from anyone other than the member with which the person is associated. This requirement will not prohibit arrangements, agreed to by a member, where an insurance company maintains a commission account as a ministerial service for a member and, on behalf of the member, pays commission checks from such an account directly to associated persons of the member.
      (2) No member or person associated with a member shall accept any compensation from an offeror which is in the form of securities of any kind.
      (3) Except for items described in Subsection (1)(5)(a) and (b). a member shall maintain records of all compensation, cash and non-cash, received from offerers. The records shall include the names of the offerors, the names of the associated persons and the amount of cash and/or the nature of non-cash compensation received.
      (4) No member shall accept any cash compensation from an offeror unless such compensation is described in the current prospectus of the investment company. When special cash compensation arrangements are made available by an offeror to a member, which arrangements are not made available on the same terms to all members who distribute the investment company securities of the offeror. a member shall not enter into such arrangements unless the name of the member and the details of the arrangements are disclosed in the prospectus. Prospectus disclosure requirements shall not apply to cash compensation arrangements between:
      (a) principal underwriters of the same
      (b) the principal underwriter of a security and the sponsor of a unit investment trust which utilizes such security as its underlying investment: and
      (c) a non-member company and its sales personnel who are associated persons of an NASD member which, directly or indirectly controls, is controlled by. or is under common control with that non-member company provided that the recordkeeping requirement in Subsection (1)(3) is
      (5) No member or person associated with a member shall directly or indirectly accept any non-cash compensation offered or provided to such member or its associated persons. Notwithstanding the foregoing prohibition and the provisions of Subsection (1)(1), the following items of non-cash compensation may be accepted:
      (a) Gifts to associated persons of members that do not exceed an annual amount per person fixed periodically by the Board of Governors1 and are not preconditioned on achievement of a specified sales target.
      (b) An occasional meal, a ticket to a sporting event or the theater, or comparable entertainment for persons associated with a member and, if appropriate, their guests, which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a specified sales target.
      (c) Payment or reimbursement by offerers in connection with meetings held by an offeror or by a member for the purpose of training or education of associated persons of a member, provided that:
      (i) the recordkeeping requirement in Subsection (1)(3) is satisfied:
      (ii) associated persons obtain the member's prior approval to attend the meeting: (iii) the location is appropriate to the purpose of the meeting, which shall mean an office of the offeror or the member, or a facility located in the vicinity of such office. or a regional location with respect to regional meetings:
      (iv) the payment or reimbursement is only applied to the expenses of the member and persons associated with the member in attending the meeting, which shall not include guests of the associated person; and
      (v) the payment or reimbursement by the offeror is not conditioned on sales or the promise of sales by the member or persons associated with the member.
      (6) Notwithstanding the prohibition in Section (5). non-cash compensation arrangements are permissible between a member and its associated persons or a non-member company and its sales personnel who are associated persons of a member which, directly or indirectly controls, is controlled by. or is under common control with that non-member company, provided that:
      (a) the member's or non-member's non-cash compensation arrangement is multi-product type oriented, or. for single-product type firms, based on the gross production of the associated person:
      (b) no unaffiliated non-member company or other member directly or indirectly participates in or contributes to such non-cash compensation arrangements: and
      (c) the recordkeeping requirement in Subsection (1)(3) is satisfied.
      * * * Variable Contracts Of An Insurance Company Section 29
      (a) (Unchanged.)

      Definitions

      (b)
      (1)–(2) (Unchanged.)
      (3) The terms "offeror." "cash compensation" and "non-cash compensation" as used in Subsection (h) shall have the following meanings:

      "Offeror" shall mean a separate account of an insurance company, an adviser to a separate account of an insurance company, an underwriter and any affiliated person (as defined in Section 2(a)(3) of the Investment Company Act of 1940) of such entities.

      "Cash compensation" shall mean any discount, concession, fee, commission, asset-based sales charge, loan or override received in connection with the sale and distribution of variable contracts.

      "Non-cash compensation" shall mean any form of non-cash compensation received in connection with the sale and distribution of variable contracts, including but not limited to merchandise, gifts and prizes, and payment of travel expenses, meals and lodging.
      (c) – (g) (Unchanged.)

      Member Compensation

      (h) In connection with the sale and distribution of variable contracts:
      (1) Except as described below, no associated person of a member shall accept any compensation, cash or non-cash, from anyone other than the member with which the person is associated. This requirement will not prohibit arrangements, agreed to by a member, where an insurance company maintains a commission account as a ministerial service for a member and, on behalf of the member, pays commission checks from such an account directly to associated persons of the member.
      (2) Except for items as described in Subsection (h)(4)(a) and (b). a member shall maintain records of all compensation, cash and non-cash, received from offerers. The records shall include the names of the offerors, the names of the associated persons and the amount of cash and/or the nature of non-cash compensation received.
      (3) No member shall accept any cash compensation from an offeror unless such compensation is described in the current prospectus of the investment company. When special cash compensation arrangements are made available by an offeror to a member, which arrangements are not made available on the same terms to all members who distribute the investment company securities of the offeror. a member shall not enter into such arrangements unless the name of the member and the details of the arrangements are disclosed in the prospectus. Prospectus disclosure requirements shall not apply to cash compensation arrangements between:
      (a) principal underwriters of the same security;
      (b) the principal underwriter of a security and the sponsor of a unit investment trust which utilizes such security as its underlying investment: and
      (c) a non-member company and its sales personnel who are associated persons of an NASD member which. directly or indirectly controls, is controlled by. or is under common control with that non-member company provided that the recordkeeping requirement in Subsection (h)(3) is
      (4) No member or person associated with a member shall directly or indirectly accept any non-cash compensation offered or provided to such member or its associated persons. Notwithstanding the foregoing prohibition and the provisions of Subsection (h)(1), the following items of non-cash compensation may be accepted:
      (a) Gifts to associated persons of members that do not exceed an annual amount per person fixed periodically by the Board of Governors2 and are not preconditioned on achievement of a specified sales target.
      (b) An occasional meal, a ticket to a sporting event or the theater, or comparable entertainment for persons associated with a member and, if appropriate, their guests, which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a specified sales target.
      (c) Payment or reimbursement by offerers in connection with meetings held by an offeror or by a member for the purpose of training or education of associated persons of a member, provided that:
      (i) the recordkeeping requirement in Subsection (h)(2) is satisfied:
      (ii) associated persons obtain the member's prior approval to attend the meeting:
      (iii) the location is appropriate to the purpose of the meeting, which shall mean an office of the offeror or the member, or a facility located in the vicinity of such office, or a regional location with respect to regional meetings:
      (iv) the payment or reimbursement is only applied to the expenses of the member and persons associated with the member in attending the meeting, which shall not include guests of the associated person: and
      (v) the payment or reimbursement by the offeror is not conditioned on sales or the promise of sales by the member or persons associated with the
      (5) Notwithstanding the prohibition in Section (4), non-cash compensation arrangements are permissible between a member and its associated persons or a non-member company and its sales personnel who are associated persons of a member which, directly or indirectly controls, is controlled by. or is under common control with that non-member company, provided that:
      (a) the member's or non-member's non-cash compensation arrangement is multi-product type oriented, or, for single-product type firms, based on the gross production of the associated person:
      (b) no unaffiliated non-member company or other member directly or indirectly participates in or contributes to such non-cash compensation arrangements; and
      (c) the recordkeeping requirement in Subsection (h)(2) is satisfied.

      1 The current annual amount fixed by the Board of Governors is $100.

      2 The current annual amount fixed by the Board of Governors is $100.

    • 94-66 Fixed Income Pricing System Additions, Changes, And Deletions As Of July 29, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Institutional
      Legal & Compliance
      Municipal
      Operations
      Systems
      Trading

      As of July 29, 1994, the following bonds were added to the Fixed Income Pricing System (FIPSSM). These bonds are not subject to mandatory quotation:

      Symbol

      Name

      Coupon

      Maturity

      FERL.GB

      Ferrellgas, L.P.

      7.875

      8/1/01

      BYD.GA

      Boyd Gaming

      10.750

      9/1/03

      TROC.GA

      Trans Ocean Container

      12.250

      7/1/04

      ACF.GB

      ACF

      14.500

      12/1/96

      As of July 29, 1994, the following changes to the list of FTPS symbols occurred:

      New/Old Symbol

      Name

      Coupon

      Maturity

      ISCM.GA/TNCM.GA

      Insight Communication

      8.250

      3/1/20

      HCNA.GA/HARC.GA

      Harris Chem. No. Amer.

      10.250

      7/15/01

      HCNA.GB/HARC.GB

      Harris Chem. No. Amer.

      10.750

      10/15/03

      HYSY.GA/HYAL.GA

      Hyster-Yal

      12.375

      8/1/99

      ISHC.GA/ISPC.GA

      ISP Chem/ISP Tech

      9.000

      3/1/99

      All bonds listed above are subject to trade-reporting requirements. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-65 Nasdaq National Market Additions, Changes, And Deletions As Of July 28, 1994

      As of July 28, 1994, the following 45 issues joined the Nasdaq National Market®, bringing the total number of issues to 3,679:

      Symbol

      Company

      Entry Date

      SOES Execution Level

      DSGT

      Designatronics Incorporated

      6/29/94

      200

      WCBO

      West Coast Bancorp

      6/29/94

      200

      BELW

      Bellwether Exploration Company

      6/30/94

      200

      HMNF

      HMN Financial Resources

      6/30/94

      500

      MSNS

      MediSense, Inc.

      6/30/94

      200

      RAWL

      Rawlings Sporting Goods Company,

      6/30/94

      500

      BCBF

      Inc. BCB Financial Services Corporation

      7/1/94

      200

      TREE

      Doubletree Corporation

      7/1/94

      500

      ITGR

      Integrity Music, Inc. (Cl A)

      7/1/94

      500

      SMFC

      Sho-Me Financial Corp.

      7/1/94

      500

      CINRF

      Cinar Films, Inc.

      7/6/94

      200

      XNVAZ

      Xenova Group plc (Uts exp 7/8/95) ADR

      7/8/94

      500

      HSTR

      American Homestar Corporation

      7/12/94

      500

      FLROW

      FluoroScan Imaging Systems, Inc. (Wts exp 7/11/99)

      7/12/94

      200

      FLRO

      FluoroScan Imaging Systems, Inc.

      7/12/94

      200

      AGNU

      PM Agri-Nutrition Group Limited

      7/12/94

      500

      BPOPP

      BanPonce Corporation (Ser A Pfd)

      7/13/94

      500

      GMED

      GeneMedicine, Inc.

      7/13/94

      200

      GLFE

      Golf Enterprises, Inc.

      7/13/94

      500

      THRD

      TF Financial Corporation

      7/13/94

      500

      FBARP

      Family Bargain Corporation (Ser A Pfd)

      7/14/94

      200

      HUBCP

      HUBCO,Inc. (SerAPfd)

      7/14/94

      500

      BCMPY

      Bell Cablemedia pic (ADR)

      7/15/94

      500

      JANNF

      Jannock Limited

      7/15/94

      500

      PFSB

      PennFed Financial Services, Inc.

      7/15/94

      1000

      CHERA

      The Cherry Corporation (Cl A)

      7/15/94

      500

      DWYR

      The Dwyer Group Inc.

      7/19/94

      200

      CLCI

      Cadiz Land Company, Inc.

      7/20/94

      200

      CCCI

      Continental Choice Care, Inc.

      7/20/94

      200

      CCCIU

      Continental Choice Care, Inc. (Uts exp 4/29/99)

      7/20/94

      200

      CCCIW

      Continental Choice Care, Inc. (Wts exp 4/29/99)

      7/20/94

      200

      MATW

      Matthews International Corporation (CIA)

      7/20/94

      200

      STON

      GreenStone Industries, Inc.

      7/21/94

      200

      STONW

      GreenStone Industries, Inc. (Wts exp 7/20/99)

      7/21/94

      200

      EFCW

      Eagle Finance Corp.

      7/22/94

      200

      FLCO

      FelCor Suite Hotels, Inc.

      7/22/94

      200

      BREW

      Rock Bottom Restaurants, Inc.

      7/22/94

      500

      ASTI

      Astram International Corp.

      7/25/94

      200

      BEST

      Best Products Co., Inc.

      7/25/94

      200

      MIDI

      Midisoft Corporation

      7/25/94

      200

      HAPY

      Happiness Express, Inc.

      7/26/94

      200

      NORL

      Norrell Corporation

      7/26/94

      200

      TPIFY

      P.T. Tri Polyta Indonesia (ADR)

      7/26/94

      200

      HBCCA

      Heftel Broadcasting Corporation (Cl A)

      7/27/94

      500

      WCCX

      Wackenhut Corrections Corporation

      7/27/94

      500

      Nasdaq National Market Symbol And/Or Name Changes

      The following changes to the list of Nasdaq National Market securities occurred since June 27, 1994:

      New/Old Symbol

      New/Old Security

      Date of Change

      CMSB/CMSB

      Commonwealth Savings Bank/Commonwealth Federal Savings Bank

      7/1/94

      QVCN/QVCN

      QVC, Inc./QVC Network Inc.

      7/1/94

      DOCSF/QTXXF

      PC DOCS Group International/Quartex Corp.

      7/5/94

      UNNB/UNNB

      University Bank & Trust Company/University Natl. Bk & Tr Co.

      7/8/94

      CHERB/CHER

      The Cherry Corporation (Cl B)/The Cherry Corporation

      7/12/94

      NPCIA/PIZA

      NPC International Inc. (Cl A)/National Pizza Company (Cl A)

      7/13/94

      NPCDB/PIZB

      NPC International Inc. (Cl B)/National Pizza Company (Cl B)

      7/13/94

      BANC/ASAL

      BankAtlantic Bancorp Inc/BankAtlantic A Federal Savings Bank

      7/14/94

      EFMC/EITI

      E for M Corp./Enhanced Imaging Technologies Inc.

      7/18/94

      SIHLF/SIHFV

      Sun International Hotels Limited (S/D 7/28/94)/Sun International Hotels Limited (W/D

      7/21/94

      CCSC/CCSCV

      Coherent Communications Systems Corporation (S/D 8/2/94)/Coherent Communications Systems Corp. (WI)

      7/26/94

      Nasdaq National Market Deletions

      Symbol

      Security

      Date

      FPUB

      Franklin Electronic Publishers, Incorporated

      6/29/94

      BGENW

      Biogen Inc. (Wts exp 6/30/94)

      7/1/94

      FAHS

      Farm & Home Financial Corporation

      7/1/94

      GVGC

      Grand Valley Gas Company

      7/1/94

      SSVB

      Security Savings Bank, F.S.B.

      7/1/94

      VSBC

      VSB Bancorp, Inc.

      7/5/94

      WBNC

      Washington Bancorp, Inc.

      7/5/94

      SHOP

      Shopsmith, Inc.

      7/6/94

      CFLX

      Curaflex Health Services, Inc.

      7/11/94

      HINF

      Healthlnfusion, Inc.

      7/11/94

      JSBK

      Johnstown Savings Bank

      7/11/94

      LSNB

      Lake Shore Bancorp, Inc.

      7/11/94

      MEDS

      Medisys, Inc.

      7/11/94

      CCSCR

      Coherent Communications System Corporation (Rights 7/21/94)

      7/22/94

      CICIQ

      Communication Intelligence Corporation

      7/22/94

      IASG

      International Airline Support Group, Inc.

      7/22/94

      ODDEQ

      Odd's-N-End's Inc.

      7/22/94

      CYCLR

      Centennial Cellular Corp. (Rights 7/22/94)

      7/25/94

      WELS

      Wellstead Industries, Inc.

      7/25/94

      Questions regarding this Notice should be directed to Mark A. Esposito, Supervisor, Market Listing Qualifications, at (202) 728-8002. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-64 Labor Day: Trade Date-Settlement Date Schedule

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      The Nasdaq Stock Market™ and the securities exchanges will be closed on Monday, September 5, 1994, in observance of Labor Day. "Regular way" transactions made on the preceding business days will be subject to the settlement date schedule listed below.

      Trade Date

      Settlement Date

      Reg. T Date*

      Aug. 26

      Sept. 2

      Sept. 7

      29

      6

      8

      30

      7

      9

      31

      8

      12

      Sept. 1

      9

      13

      2

      12

      14

      5

      Markets Closed

      -

      6

      13

      15

      * Pursuant to Sections 220.8(b)(1) and (4) of Regulation T of the Federal Reserve Board, a broker/dealers must promptly cancel or otherwise liquidate a customer purchase transaction in a cash account if full payment is not received within seven (7) business days of the date of purchase or, pursuant to Section 220.8(d)(1), make application to extend the time period specified. The date by which members must take such action is shown in the column entitled "Reg. T Date."

      Brokers, dealers, and municipal securities dealers should use these settlement dates to clear and settle transactions pursuant to the NASD Uniform Practice Code and Municipal Securities Rulemaking Board Rule G-12 on Uniform Practice.

      Questions regarding the application of these settlement dates to a particular situation may be directed to the NASD Uniform Practice Department at (203) 375-9609.

    • 94-63 New Section 46 Of Article III Of The Rules Of Fair Practice Governing The Repricing Of Open Orders Takes Effect September 15, 1994

      SUGGESTED ROUTING

      Senior Management
      Institutional
      Internal Audit
      Legal & Compliance
      Operations
      Systems
      Trading

      Executive Summary

      The NASD is publishing this Notice to remind members that new Section 46 of Article III of the Rules of Fair Practice requiring members holding open orders to adjust the price and size of such orders by the amount of any dividend, payment, or distribution on the day that the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-interest will be effective on September 15, 1994. Members will be required to comply with the new rule on that date regardless of whether automated repricing systems are available internally on proprietary systems or from outside vendors. The NASD is also announcing resolutions of certain issues raised by member firms with respect to the availability of dividend or distribution information and the obligations of member firms.

      Background

      In Notice to Members 94-09, published in February 1994, the NASD announced the Securities and Exchange Commission's (SEC) approval of new Section 46 of Article in of the Rules of Fair Practice requiring members holding open orders to adjust the price and size of such orders by the amount of any dividend, payment, or distribution on the day that the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-interest and announced that the new rule would be effective May 15, 1994. In Notice to Members 94-22, the NASD announced that the effective date of new Section 46 would be delayed until September 15, 1994.

      Compliance

      To comply with the requirements of the rule, members may choose to handle open orders in one or more of the following ways:

      1. Manually reprice such orders according to the requirements of the rule;
      2. Automatically reprice such orders according to the requirements of the rule by using an in-house proprietary order-handling system;
      3. Automatically reprice such orders according to the requirements of the rule by using a Nasdaq® system; (See below for information on the availability of such systems.)
      4. Route such orders to an order execution firm for handling pursuant to 1,2, or 3, above;
      5. Accept open orders only on a "do not reduce" (DNR) or "do not increase" (DM) basis; or
      6. Not accept open orders.

      Currently, the NASD's Small Order Execution System (SOESSM) limit order file will "pend" an order (take it out of the automatic execution mode) when the security trades ex-dividend. When SOES pends an order, it is returned to the member that entered the order for reconfirmation. If the order is not reconfirmed by the member, it is canceled. When Section 46 takes effect, members will be required to reprice such returned orders according to the requirements of the rule. The member will not be required to return the order to SOES after repricing; however, Section 46 does not permit a member to ignore or refuse to reprice a returned order, unless the order was originally accepted with a DNR/DNI instruction.

      Regardless of the method chosen for handling open orders, the member accepting an order from a customer or another member is responsible for ensuring compliance with Section 46. Thus, if a member accepts an open order from a customer and routes it to another member for execution, the member accepting the order must ensure that the order-executing firm has agreed to and can, in fact, comply with Section 46, and the order-executing firm must, in fact, comply with Section 46. Failure to comply with Section 46 in such a situation may subject both firms to disciplinary action.

      Information On Securities Traded Ex

      Members have expressed concern about obtaining timely information on securities traded ex to permit them to comply with the requirements of the rule. Currently, issuers are required by SEC Rule 10b-17, adopted under the Securities Exchange Act of 1934, to report dividends or other distributions to the NASD or to the exchange (pursuant to the exchange's rules) on which its securities are listed, unless the SEC has exempted the issuer from complying with the rule. When an issuer reports a dividend to the NASD, for instance, an ex-date is set by the NASD Operations Department and reported to an information vendor. Subscribers to such vendors are, therefore, advised of the dividend and in a position to reprice open orders.

      To comply with new Section 46, members accepting open orders must ensure that they have access to, whether by subscription, on-line, or some other method, the ex-date information for the securities for which they are accepting orders. The NASD is exploring methods for supplying all ex-date information directly or through a third party and, if created, will announce such a program at a later date.

      Finally, members have expressed concern about their liability under Section 46 where the issuer has not reported a dividend or distribution pursuant to SEC Rule 10b-17. The NASD has determined that members should not be liable for failing to reprice orders in such situations and has submitted a proposed rule change to the SEC for approval that would amend Section 46 to exempt open orders where the issuer has not reported the dividend or distribution pursuant to SEC Rule 10b-17. This would mean that orders for the securities of an issuer that was not required to submit 10b-17 reports, or was exempted from reporting under 10b-17 by the SEC, or where the issuer failed to report as required, would not be subject to the repricing requirements of Section 46.

      Fractional Pricing

      Several member firms have asked whether the 1/8 minimum increment in Section 46 specified for calculating prices is consistent with the possibility that there may be smaller minimum increments for quotations and transaction reports. Further, members have asked whether, for securities quoted or traded in smaller fractions, rounding prices to the nearest 1/8 would create problems for such repriced orders. The NASD recognizes that occasional problems as described might arise; however, because the NYSE relies on l/8s in pricing and in the interests of having Section 46 function in a manner substantially the same as the NYSE's rule, the NASD does not believe that reducing the repricing increment is advisable at this time. The NASD suggests that if members wish to avoid problems in such situations that they consider accepting open orders for securities that trade in less than 1/8 increments only on a DNR/DNI basis. The NASD will continue to keep abreast of developments in this area.

      Nasdaq Systems

      The NASD is planning updates of The Nasdaq Stock Market's operating systems by, among other things, improving the features of SOES1 and implementing the Advanced Computerized Execution System (ACESSM). These updates will include automatic repricing of open orders and will permit a member to comply with new Section 46 by placing such orders in the system. It is unlikely, however, that these changes will receive SEC approval before the September 15, 1994, effective date of Section 46. Therefore, the NASD will not be able to provide automated repricing capability for member firms subscribing to our systems on the effective date of the rule. Nevertheless, members will be expected to comply with the requirements of the rule when it becomes effective.

      Repricing Calculation Methodology In Notice to Members 94-09 announcing the approval of new Section 46, the NASD discussed the calculation methodology to be used to reprice orders in accordance with the rule. The NASD is aware that the discussion appearing on page 44 of that Notice may mislead people into believing that there is a particular dollar value that may be ascribed to a share of stock in a dividend. This is not the case; the value of a stock dividend is a ratio of old stock to new stock that has a dollar value only in the context of a particular open order at a particular price. Thus, when Subsection 46(a)(ii) speaks of the "dollar value" of the stock dividend, it is referring to the dollar value as it relates to the particular order being repriced. As the NASD stated in Notice to Members 93-61 published in September 1993, the dollar value of a dividend with respect to particular order is discovered by applying the ratio of old shares to new shares to the price of the particular order.

      This is accomplished by multiplying the current order price by the number of old shares being exchanged and dividing the product by the number of new shares to be issued. For example, in a 3 for 2 distribution, multiply the per share price of the original order by 2 and divide the result by 3. Finally, round the resulting price up to the nearest 1/8. This method eliminates the need to find a dollar value for the split, round it up 1/8, and then subtract it from the current price of the order. Expressing this as a formula:

      Where

      P = the price per share of the original order,

      C = number of shares being exchanged for new shares,

      D = number of new shares being distributed, and

      n = the resulting new price of the order

      Then,

      n = (P x C)/D

      The resulting new price must then be rounded up to the nearest 1/8.2

      Combined Cash/Stock Dividends Finally, the NASD wishes to advise members that for dividends in both cash and stock, do the cash dividend calculation first and the stock calculation second. If the putative dollar value of the combined dividend is less than 25 percent and the NASD sets the ex-date for both on the same date pursuant to current practice, repricing an open order involves calculating the cash dividend adjustment first and then calculating the stock dividend adjustment based on the new price. Thus, if an open order at $10 per share were the subject of a $1.00 cash dividend and a 5 percent stock dividend, the price would first be reduced by $1.00 to $9.00 and then would be reduced by applying the preceding formula, thus: (9 x 20)/21 = $8.57 = 8 S8. If the putative dollar value of the combined dividend is greater than 25 percent, pursuant to current practice, the NASD sets an ex-date for the cash dividend and then the stock dividend. In such cases, open orders are repriced once on the cash dividend ex-date and once on the stock dividend ex-date.

      Treatment Of DNR/DNI Instructions While Subsection 46(e) states that the provisions of the rule will not apply to orders marked DNR or DNI, several members have inquired whether the provision means, for instance, that an order marked DNI will not be adjusted either for size or price, or just for size. Because the NASD's intent in adopting this rule was for it to function in the same manner as the NYSE's Rule 118, and under Rule 118 a DNI instruction only applies to size adjustments, the NASD has determined that Section 46 should be read in the same manner. Therefore, a DNI instruction in a stock dividend situation will require the member to adjust the price of the order pursuant to Subsection 46(a)(ii), but not the size of the order. Similarly, a DNR instruction in a stock dividend situation will require the member to adjust the size of the order, but not the price. If a customer does not want the order adjusted as to size or price, both DNR and DNI instructions should be included. The NASD will announce at a later date whether its automated systems will be able to distinguish between orders carrying one instruction and orders carrying both.

      Questions regarding this Notice may be directed to Dorothy L. Kennedy, Assistant Director, Nasdaq Operations, at (203) 385-6246, or Elliott R. Curzon, Assistant General Counsel, Office of General Counsel, (202) 728-8451.


      1 The NASD recently filed proposed rule change SR-NASD-94-13 to adopt a Nasdaq Primary Retail Order View and Execution System (N'PROVE). N'PROVE will replace SOES and will include an automatic repricing feature that will comply with the new Section 46.

      2 Members may apply any formula or method of calculation that yields the same result.

    • 94-62 NASD Solicits Member Comments On The Application Of The NASD Mark-Up Policy To Transactions In Government And Other Debt Securities, And Suitability Obligations To Institutional Customers In Debt And Equity Transactions;

      Comment Period Expires September 30, 1994

      SUGGESTED ROUTING

      Senior Management
      Government Securities
      Institutional
      Legal & Compliance
      Trading

      Executive Summary

      With the enactment of the Government Securities Act Amendments of 1993, the NASD's regulatory jurisdiction was intended to encompass, among other things, sales practices relating to government securities. In conjunction with this authorization to adopt rules and regulations relating to government securities, the NASD requests member comment on proposed Interpretations of the Board of Governors to Article III, Sections 2 and 4 of the Rules of Fair Practice (RFP). The first Interpretation would provide further guidance to members on their suitability obligations under Article III, Section 2(a) of the RFP when making recommendations in equity or debt transactions, except municipals, to customers that are institutional accounts as defined under Article III, Section 21(c)(4) of the RFP. The second Interpretation would provide guidance to members regarding the application of the NASD Mark-Up Policy under Article III, Section 4 of the RFP to transactions in government and other debt securities, except municipals.

      Background

      In December 1993, Congress enacted the Government Securities Act Amendments of 1993 which, in part, authorizes the NASD to apply its sales practice rules to government securities, except municipal securities. To address this issue in the most effective and efficient manner and incorporate the views and ideas of those industry officials actually involved in the government securities markets, the NASD's Fixed Income Committee (Committee) appointed a Subcommittee on Government Securities (Subcommittee) to review the NASD's sales practice rules and draft proposed amendments to address the NASD's expanded authority to government securities.

      On June 27, 1994, the Committee reviewed recommendations and draft amendments from its Subcommittee and approved a Resolution to the Board of Governors to merge the NASD Government Securities Rules into the RFP and to issue two Board Interpretations to the RFP.

      On My 15, 1994, the NASD Board of Governors (Board) reviewed the Committee's Resolution and concurred with the Committee's recommendation that, consistent with the manner in which other securities products are handled, a single set of NASD sales practice rules is also appropriate for NASD membership in connection with government securities, and clarifications regarding the application of the RFP to government securities and other debt markets should be provided through Board Interpretations under the RFP.

      The NASD Government Securities Rules, therefore, will be deleted and merged into the RFP, which will be expanded to cover government securities, except municipals, by replacing the phrase "exempted securities" with the phrase "municipal securities" in Article I, Section 4 of the RFP, "Effect on Transactions in Exempted Securities." In addition, the Rules of Fair Practice would be expanded to NASD members who do business solely in government securities, by amending Article I, Section 5(a) of the RFP, "Applicability," by deleting the phrase "other than those members registered with the Securities and Exchange Commission solely under the provisions of Section 15C of the Act and persons associated with such members."

      In addition, the Board specifically requested member comment on two proposed Board Interpretations that address the application of the NASD's Mark-Up policy to government securities and other debt securities (except municipals), and member suitability obligations to institutional customers in debt and equity transactions (except municipals). The Board's action to approve the merger of the Government Securities Rules into the NASD's RFP will be filed with the SEC for approval as part of an overall filing that includes these proposed Interpretations once member comments have been received, analyzed, and acted upon by the Board.

      Discussion And Summary Of Proposed Board Interpretations

      I. Proposed Interpretation Of The Board Of GovernorsSuitability Obligations To Institutional Customers

      The Committee affirmed Article III, Section 2(a) of the NASD Rules of Fair Practice (Section 2(a)) as an important investor-protection provision that should be applied to all transactions in the government securities market as well. However, the Committee also determined that the expansion of NASD rules to the government securities market, a market with a broad institutional component, requires that the Association provide further guidance to members on their suitability obligations under Section 2(a) of the RFP when making recommendations to certain institutional customers. Article III, Section 2(a) of the RFP states,
      "In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of facts, if any, disclosed by such customer as to his security holdings and as to his financial situation and needs."
      The Committee believes that a principal assumption underlying Section 2(a) is that the member's relationship with the customer gives rise to a duty to help the customer determine reasonable investment parameters. The Committee expressed concerns that, in the case of certain institutional customers, this principal assumption underlying Section 2(a) does not reflect the reality of the member/customer relationship leading to the execution of a transaction. The Committee, therefore, believes it is necessary to further clarify and give guidance as to a member's suitability obligations under Article III, Section 2(a) of the RFP with regard to certain institutional investors through the issuance of a new Interpretation of the Board. The Committee notes that many institutions develop resources and procedures that provide them with the sophistication to make independent investment decisions and, in certain cases, the institution develops more sophistication than that maintained by the NASD member. The Committee also believes that many such institutional customers do not rely on a particular member's recommendations, but only use the member as one source of market and/or product information and ideas for transactions.

      The Committee, therefore, proposed a new Interpretation of the Board of Governors—Suitability Obligations to Institutional Customers (Suitability Interpretation). The purpose of the proposed Suitability Interpretation would be to explain how the suitability obligations contained under Article III, Section 2(a) of the RFP should operate in the context of certain institutional client relationships consistent with generally accepted business practices that have resulted from such clients' needs and demands. Because the Committee believes the nature of the relationship between the firm and customer is the same regardless of the product involved, the Committee recommends that the proposed Suitability Interpretation apply not only in government and other debt securities (except municipals) but to equity securities as well. The Committee referred the issue of applying the Suitability Interpretation to equity securities to the NASD National Business Conduct Committee (NBCC). The NBCC reviewed the request before the July 1994 Board meeting and supported the application of the proposed Suitability Interpretation to equity securities.

      The proposed Suitability Interpretation would be applicable only to customers of institutional accounts, as defined in Article III, Section 21(c)(4) of the Rules of Fair Practice (institutional customer). Section 21(c)(4) defines the term "institutional account" for purposes of Article III, Section 2 of the RFP as the account of (i) a bank, savings and loan association, insurance company, or registered investment company; (ii) an investment adviser registered under Section 203 of the Investment Advisers Act of 1940; or (iii) any other entity (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million. The proposed Suitability Interpretation would be applicable to transactions in debt and equity markets, except municipal securities.

      The proposed Suitability Interpretation states that underlying Article in, Section 2(a) is the assumption that a member's relationship with the customer gives rise to a duty to help the customer determine reasonable investment parameters. It then provides that, in the case of certain institutional customers, this assumption may not reflect the reality of the member/customer relationship. The proposed Suitability Interpretation specifically recognizes that the reality of the member/customer relationship can be significantly altered when institutional customers develop resources and procedures to make their own independent investment decisions. A non-exclusive list of examples is provided as guidance to members in determining when the resources and procedures for independent investment decisions may exist.

      The proposed Suitability Interpretation further provides that even if the institutional customer has developed resources and procedures to make independent decisions, factors should also be present that provide reasonable grounds for the belief that the institutional customer is not relying on the member's recommendations in connection with a particular transaction or market product. In other words, there is no safe harbor presumption created for any institutional accounts, but rather the proposed Suitability Interpretation provides that in dealing with institutional customers, this method of compliance with its suitability obligations under Article III, Section 2(a) would continue to be determined on a transaction-by-transaction basis. The existence of such factors is key to members fulfilling their suitability obligations for each such institutional customer. The proposed Suitability Interpretation discusses a number of examples that help the member determine that it is fulfilling its suitability obligations under Article III, Section 2(a) of the RFP for a particular transaction with an institutional customer.

      The proposed Suitability Interpretation also highlights that in the case of a new product, or a security with significantly different risk or volatility characteristics than other investments generally made by the institution, the member should ascertain whether the institutional customer is relying on the member to explain the new product and its risk(s) or is relying on other sources.

      The proposed Suitability Interpretation clarifies that a member would not be considered to be fulfilling its suitability obligations under this Interpretation if, before the transaction, the member knows or can reasonably conclude, based on information available to it, that the institutional customer is not capable of understanding the product or its risks, or of making an independent investment decision.

      The Committee believes that the proposed Suitability Interpretation will clarify the applicability of Article III, Section 2(a) of the RFP to certain member/customer relationships where such Section is currently difficult to apply. In doing so, the proposed Suitability Interpretation will promote just and equitable principles of trade, eliminate confusion that may currently impede the markets, and further protect investors and the public interest in the debt and equity markets.
      II. Proposed Interpretation Of The Board Of GovernorsApplication Of The NASD Mark-Up Policy To Transactions In Government And Other Debt Securities

      The Committee believes the nature of the debt market often requires reconsideration or reexamination of the traditional equity analysis for calculating markups and mark-downs. For instance, unlike the equities market, inter-dealer transactions in certain debt securities are rare, and this difference can, at times or often, make applying the traditional method of determining the prevailing market price for purposes of calculating markups difficult. For example, government securities broker/dealers, unlike their equity counterparts, usually do not continuously trade or make markets in just one government security, but instead may make continuous markets in similar types of debt securities. Unlike the equity markets, where the concept of similar securities is not applicable because each issuer is a unique entity, in the government securities markets such a concept can be very relevant. Such similarity can reflect the financial nature of the instruments in the debt market and may exist because the price/yield of a particular debt security is more dependent on objective external market factors, such as interest rates, and comparable to alternative debt securities, the prices of which are based on the same or similar external market factors.

      Based on its discussions, the Committee concluded that notwithstanding that inter-dealer transactions in certain debt securities are rare, the fact that broker/dealers often make continuous markets in similar types of debt securities provides the debt market with additional factors in determining the prevailing market price.

      The Committee, therefore, recommends the addition of an Interpretation of the Board of Governors (Mark-Up Interpretation) regarding the application of the NASD Mark-Up Policy under Article III, Section 4 of the Rules of Fair Practice to transactions in debt securities, excluding municipal securities, which remain subject to MSRB Rule G-30. The proposed Mark-Up Interpretation recognizes that inter-dealer transactions ordinarily are the best evidence of the prevailing market price. The proposed Mark-Up Interpretation notes that inter-dealer transactions in the debt market may be rare or nonexistent and states that imposing a contemporaneous cost standard would not be appropriate without first considering other relevant factors.

      In the absence of inter-dealer transactions, the proposed Mark-Up Interpretation lists five other contemporaneous factors for members to consider before contemporaneous cost is used for determining the prevailing market price. The first factor would allow the member to consider the prices of recent dealer transactions in the security in question with institutional accounts, as defined above under Article III, Section 21(c)(4) of the Rules of Fair Practice. The Committee believes that referencing the prices of such transactions is a fair and reasonable alternative to inter-dealer transactions, given the significant institutional participation in the debt market.

      The second factor would allow the member to consider validated inter-dealer quotations in the security in question through a quotation mechanism, for example, inter-dealer brokers, through which transactions do occur from time to time at prices that are equal to or close to the displayed quotations.

      The third, forth, and fifth factors would allow a member to consider (i) yields calculated from prices of inter-dealer transactions in similar securities; (ii) yields calculated from prices of transactions with sophisticated institutional customers in similar securities; and (iii) yields calculated from prices of validated inter-dealer quotations in similar securities. The Committee believes that allowing a member to reference prices in transactions of such similar securities reflects the important distinction from equities in the debt markets whereby prices of similar securities can be reasonably compared. When inter-dealer transactions in the same debt security are absent, the reference to contemporaneous transactions in such similar securities is often more fair and reasonable for determining prevailing market price than referencing contemporaneous cost.

      The proposed Mark-Up Interpretation, in addition to listing the preceding five factors for determining prevailing market price, states that consideration may also be given to a value constructed by aggregating the values of components of the security where those values can be derived from the prices and yields of similar securities as reflected in transactions or validated quotations in the market between dealers or with sophisticated institutional customers. The proposed Mark-Up Interpretation provides a nonexclusive list of examples of such components, such as embedded call options, detachable call options, bond insurance, guarantees, and pools of collateral.

      The Committee recommends that because the concept of similarity between securities in the debt market plays a significant role in the determination of prevailing market price, it would be appropriate for the Interpretation to provide guidance through a nonexclusive list of factors for members to reference in determining the similarity of debt securities. The proposed Mark-Up Interpretation, therefore, provides the following nonexclusive list of factors on the subject of similarity:
      1. Credit quality considerations, such as whether the security is issued by the same or similar entity, bears the same or similar credit rating, is supported by a similarly strong guarantee or collateral;
      2. The extent to which the security trades at a comparable spread over Treasuries of similar duration;
      3. General structural characteristics of the issue, such as coupon, maturity, duration, complexity or uniqueness of the structure, callability (and likelihood of being called, tendered, or exchanged) and other embedded options;
      4. Technical factors, such as the size of the issue, the size of the transactions or quotations being compared, the float and recent turnover of the issue, legal restrictions on transfer-ability, extent of institutional participation in the market for the security, and/or the disclosure regime governing transactions in the security; and
      5. The cost and availability of financing, and the cost, availability and effectiveness of hedging for the issue when held by dealers in inventory as well as the volatility of the spread of the issue to Treasuries or to alternative hedging vehicles available to dealers.
      The Committee also recommends that a definition of markup and mark-down be provided in the Interpretation for transactions in debt securities. As in footnote 2 to the proposed Mark-Up Interpretation, the term "markup for sales to customers" is defined as the difference between the sales price to the customer and the prevailing price on the sell side of the market. The term "mark-down for purchases of customers" is defined as the difference between the purchase price to the customer and the prevailing market price on the buy side of the market.

      The Board of Governors asks all members and interested persons to comment on these proposed amendments. Comments should be directed to:

      Ms. Joan C. Conley
      Corporate Secretary
      National Association of Securities Dealers, Inc.
      1735 K Street, NW
      Washington, DC 20006-1506

      Questions concerning this Notice may be directed to Walter J. Robertson, NASD Compliance, (202) 728-8236; or John H. Pilcher, NASD Office of General Counsel, (202) 728-8287.

      Comments must be received no later than September 30, 1994. Changes to the NASD Rules of Fair Practice must be approved by the Board of Governors and filed with and approved by the SEC before becoming effective.

      Text Of Proposed Interpretation

      (Note: New text is underlined.)

      Interpretation Of The Board Of Governors—Suitability Obligations To Institutional Customers

      As a result of broadened authority provided by amendments to the Government Securities Act adopted in 1993, the Association is extending its sales practice rules to the government securities market, a market with a particularly broad institutional component. Accordingly the Board believes it is appropriate to provide further guidance to members on their suitability obligations when making recommendations to customers who are institutional accounts as defined in Article III. Section 21(c)(4) of the NASD Rules of Fair Practice. The Board believes this Interpretation is applicable not only to government securities but to all debt securities.1 Furthermore, because of the nature and characteristics of the institutional customer/member relationship, the Board is intending this Interpretation to apply equally to the equity securities markets as well.

      Members have requested, in particular, further guidance regarding their suitability obligations under Article III. Section 2(a) of the NASD Rules of Fair Practice when dealing with institutional customers who have developed resources and procedures for the purpose of making their own independent investment decisions-Article III. Section 2Ca1 requires that.

      In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.

      The Board believes that underlying Article III, Section 2(a) is the assumption that the member's relationship with the customer gives rise to a duty to help the customer determine reasonable investment parameters. In the case of certain institutional customers, the Board believes that this assumption may not reflect the reality of the member/customer relationship.

      For example, institutional customers may have developed resources and procedures in order to make their own independent investment decisions. Many institutional customers have at least one or more experienced professionals charged with the specific responsibility for making or recommending investment decisions on behalf of the institution. Institutional customers may also invest through one or more registered investment advisors or a bank trust department, and these intermediary entities have a fiduciary responsibility for determining an appropriate investment strategy for the institutional customer. Many institutional customers have developed a pattern of utilizing the resources of more than one dealer to transact business. and taking into consideration numerous alternative investment recommendations prior to making an investment decision. The extent to which the institutional customer utilizes resources for alternative market information, including quotation services and research materials from independent sources, may also be relevant.

      However, even if the institutional customer has developed resources and procedures to make independent investment decisions, factors should also be present that provide reasonable grounds for the belief that the institutional customer is not relying on the member's recommendations in connection with a particular transaction or market product.

      A primary consideration is the extent to which the institutional customer appears to be relying on the member's recommendations. The element of reliance may be established to exist in the member/customer relationship through affirmative statements made at the time of the transaction that the institutional customer is relying on the member's recommendations, or by a pattern of acceptance of the member's advice through the execution of all or nearly all of the recommended transactions. On the other hand, an institutional customer that initiates transactions on an unsolicited basis or who maintains substantive relationships with a number of members may be demonstrating by such actions that it is not relying on a particular member's recommendations, but only using the member as one source of market and/or product information and ideas for transactions.

      Many institutional customers independently determine their investment strategy and provide the member with explicit investment guidelines. If explicit guidelines are made available to the member, then it is reasonable to believe that the institutional customer is assuming responsibility for the suitability obligation traditionally held by the member. If the member's investment recommendations are consistent with such guidelines, then the member generally should be regarded as having fulfilled its suitability obligations to the institutional customer. Consistency with guidelines may be evident from the document or may be derived from a reasonable interpretation by responsible officers or agents of the institutional customer at or before the time of the transaction.

      Sometimes the institutional customer's investment guidelines set forth percentage limitations for categories of investments. If the institutional customer does business with a number of dealers, and does not provide a particular member with current information on its portfolio holdings, then that member should generally not be responsible for investments that exceed the guideline limitations unless, the Registered Representative executing the transaction on behalf of the member or other persons with member supervisory responsibilities has actual knowledge that the transaction will result in a position that exceeds the guideline limitation.

      If based on the consideration set forth above, the member has concluded that the institutional customer is not relying on the member for recommendations in connection with a particular transaction, then the member generally should be viewed as having fulfilled its suitability obligations regarding the institutional customer with respect to that particular transaction. In dealing with such institutional customers, this method of member compliance with its suitability obligations under Article III. Section 2(a) would continue to be determined on a transaction-by-transaction basis.

      In the case of a new product, or a security with significantly different risk or volatility characteristics than other investments generally made by the institution, the member should ascertain whether the institutional customer is relying on the member to explain the new product and its risk(s) or is relying on other sources. A member would not be considered to be fulfilling its suitability obligations under this Interpretation if. prior to the transaction, the member knows or can reasonably conclude. based on information available to it, that the customer is not capable of understanding the product or its risks, or of making an independent investment decision

      * * *

      Interpretation Of The Board Of Governors—Application Of The NASD Mark-Up Policy To Transactions In Government And Other Debt Securities

      As a result of the amendments to the Government Securities Act adopted in 1993. expanding the NASD's sales practices authority to encompass government securities, the Board believes it is appropriate to provide guidance to the membership on markup and markdown practices for such securities, and at the same time, for other debt securities as well.2

      Ordinarily, the best evidence of the prevailing market price for a security against which a markup or mark down should be measured, is inter-dealer transaction prices. In the market for government or other debt securities, however, inter-dealer transactions may be rare or non-existent for certain securities. Therefore, establishing inter-dealer transaction prices in a particular bond, note or other debt obligation may be difficult. In the equity securities market, if evidence does not exist of inter-dealer transaction prices, the contemporaneous cost to the dealer has traditionally been used as the basis for determining the appropriate markup and markdown.3 On the other hand, in the debt securities market, the Board believes that imposing such a contemporaneous cost standard would not be appropriate without first considering other relevant factors. The Board believes, specifically, that the use of the contemporaneous cost standard as the primary determinative factor in assessing the prevailing market price against which the fairness and reasonableness of a markup or markdown should be judged, is unnecessary because there are other sources of pricing information which more accurately reflect the prevailing market price of debt securities.

      Factors which the Board believes may be taken into consideration in determining the prevailing market price of debt securities in the absence of inter-dealer transactions, include but are not limited to:

      1. Prices of any dealer transactions in the security in question with institutional accounts as defined in Article III. Section 21(c)(4) of the NASD Rules of Fair Practice:
      2. Inter-dealer quotations in the security in question made through a quotation mechanism (such as inter-dealer brokers) through which transactions do in fact occur from time to time at prices which are at or about the displayed quotations ("validated inter-dealer quotations"):
      3. Yields calculated from prices of inter-dealer transactions in "similar" securities, as defined below:
      4. Yields calculated from prices of transactions with sophisticated institutional customers in "similar" securities; and
      5. Yields calculated from validated inter-dealer quotations in "similar" securities. In considering yields of "similar" securities, member firms may not rely on a limited number of transactions that are not fairly representative of the yields of transactions of "similar" securities taken as a whole-Consideration may also be given to a value constructed by aggregating the values of components of the security where those values can be derived from the prices or yields of similar securities as reflected in transactions or quotations in the market between dealers or with sophisticated institutional customers. Some examples of such components are, embedded call options, detachable call options. bond insurance, guarantees and pools of collateral.

      If the application of the foregoing factors does not assist in the analysis of the prevailing market price, the use of contemporaneous cost may be appropriate.

      The degree to which a security is "similar" as that term is used in Items 3.4. and 5 above may be determined by factors which include but are not limited to:

      1. Credit quality considerations such as whether the security is issued by the same or similar entity, bears the same or similar credit rating, is supported by a similarly-strong guarantee or collateral:
      2. The extent to which the security trades at a comparable spread over Treasuries of similar duration:
      3. General structural characteristics of the issue such as coupon, maturity, duration, complexity or uniqueness of the structure, callability (and likelihood of being called, tendered or exchanged) and other embedded options.
      4. Technical factors such as the size of the issue, the size of the transactions or quotations being compared, the float and recent turnover of the issue, legal restrictions on transfer-ability, extent of institutional participation in the market for the security, and/or the disclosure regime governing transactions in the security: and
      5. The cost and availability of financing, and the cost, availability and effectiveness of hedging for the issue when held by dealers in inventory as well as the volatility of the spread of the issue to Treasuries or to alternative hedging vehicles available to dealers. Consideration should also be given to general market conditions and any likely or threatened changes in those conditions.

      1 Except for municipal securities, the rules for which are written by the Municipal Securities Rulemaking Board.

      2 Except for municipal securities, the rules for which are written by the Municipal Securities Rulemaking Board.

      3 The markup for sales to customers is the difference between the price to the customer and the prevailing market price on the sell side of the market. The markdown for purchases from customers is the difference between the price to the customer and the prevailing market price on the buy side of the market.

    • 94-61 SEC Approves Amendment To Code Of Arbitration Procedure Permitting Arbitrator Disciplinary Referrals

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance

      Executive Summary

      On July 11, 1994, the Securities and Exchange Commission (SEC) approved an amendment to Section 5 of the Code of Arbitration Procedure (Code) to specify that arbitrators, at the conclusion of a proceeding, may refer matters arising or discovered during the course of a proceeding for disciplinary investigation. The text of the amendment, which takes effect on August 15, 1994, follows the discussion below.

      Background

      On July 11, 1994, the SEC approved an amendment to Section 5 of the Code to specify that arbitrators, at the conclusion of a proceeding, may refer for disciplinary investigation matters that come to their attention during the course of an arbitration proceeding.

      The amendment was adopted because the NASD believes that potential violations uncovered during arbitration hearings should be investigated by the NASD as part of its comprehensive regulatory program. The NASD is aware that while customers who suffer a financial loss as a result of misconduct by their registered representative may bring arbitration actions, they often do not pursue formal complaints with a self-regulatory organization (SRO) necessary to trigger an investigation of the potential violation. Further, while the filing of an arbitration complaint will alert an SRO to the existence of a potential violation,1 because customer complaints in arbitration often do not allege or disclose sufficient information to indicate obvious misconduct on the part of a respondent, they may not trigger a disciplinary investigation. Indeed, in such cases, violations of the securities laws or the NASD's rules are not apparent until an arbitration hearing occurs and the parties testify and introduce evidence about the relevant events. Thus, in some cases, the NASD is never made aware of securities law violations or violations of the NASD's rules, notwithstanding the fact that the financial injury to the customer resulting from the violation is the subject of an arbitration proceeding.

      The NASD has also observed that arbitrators seldom refer matters that come to their attention during the course of an arbitration proceeding for disciplinary investigation. Because the NASD believes that arbitration matters, and the evidentiary material related to or produced in such matters, constitutes a valuable source of information concerning potential violations of the NASD's rules and the federal securities laws, bringing such information to the attention of the NASD's regulatory staff should improve the efficacy of the NASD's regulatory function. Accordingly, the NASD believes that this amendment provides a mechanism in the Code for arbitrators to bring such information to the attention of the NASD's regulatory staff for investigation that will serve the public interest by ensuring that potential violations of the NASD's rules and the federal securities laws are not overlooked.

      In addition, the NASD believes that it is important for arbitrators to understand that the arbitration process is for the resolution of civil disputes between the securities industry and others, and that the securities industry maintains a regulatory apparatus separate from the arbitration process that is designed to address misconduct that affects the public interest and the integrity of the financial markets. Thus, to the extent arbitrators are aware that they may refer matters rather than engage in ad hoc disciplinary sanctions as part of awards, the fairness of the arbitration process will be enhanced and challenges to arbitration awards may be reduced, an occurrence that would redound to the benefit of successful claimants.

      The amendment to Section 5 specifies that if any matter comes to the attention of an arbitrator during the course of a proceeding, the arbitrator may initiate a referral of the matter to the NASD for disciplinary investigation. The amendment also specifies, however, that any such referral should only be initiated by an arbitrator after final disposition of the matter through settlement or award. Although the NASD is not setting forth a specific procedure for such referrals, the NASD contemplates that arbitrators will direct referrals to the Association through the Arbitration Department staff and the Director of Arbitration.

      Questions regarding this Notice may be directed to the NASD Arbitration Department at (212) 858-4400.


      1 The filing of a customer-initiated arbitration complaint against an associated person alleging damages of $10,000 or more triggers a requirement of the member or associated person to amend the associated person's Form U-4 or U-5, as appropriate. Information supplied pursuant to such an amendment will be entered into the Central Registration Depository and will also be forwarded to the appropriate NASD District Office for preliminary investigation.


      Text Of Amendment To Section 5 Of The Code Of Arbitration Procedure

      (Note: New text is underlined.)

      Code of Arbitration Procedure

      Non-Waiver of Association Objects and Purposes

      Sec. 5. The submission of any matter to arbitration under this Code shall in no way limit or preclude any right, action or determination by the Association which it would otherwise be authorized to adopt, administer or enforce. If any matter comes to the attention of an arbitrator during and in connection with the arbitrator's participation in a proceeding, either from the record of the proceeding or from material or communications related to the proceeding, that the arbitrator has reason to believe may constitute a violation of the Association's rules or the federal securities laws, the arbitrator may initiate a referral of the matter to the Association for disciplinary investigation: provided, however, that any such referral should only be initiated by an arbitrator after the matter before him has been settled or otherwise disposed of. or after an award finally disposing of the matter has been rendered pursuant to Section 41 of the Code.

    • 94-60 SEC Approves Guidelines Relating To The Use Of Rankings In Investment Company Advertisements And Sales Literature

      SUGGESTED ROUTING

      Senior Management
      Advertising
      Internal Audit
      Legal & Compliance
      Mutual Fund

      Executive Summary

      On July 12, 1994, the Securities and Exchange Commission (SEC) approved amendments adopting Guidelines to Article III, Section 35 of the NASD Rules of Fair Practice that prohibit members from using investment company rankings in advertisements and sales literature unless certain requirements are met. The requirements include, among other things, that the ranking is accurate, is accompanied by certain minimum informational disclosures, includes certain minimum time frames, and is based on a category or subcategory that provides a sound basis for evaluating investment company performance. The text of the amendments, which took effect July 12, 1994, follows the discussion below.

      Background

      On July 12, 1994, the SEC approved amendments adopting Guidelines to Article III, Section 35 of the NASD Rules of Fair Practice (Guidelines) that prohibit members from using investment company rankings in advertisements and sales literature unless certain requirements are met.

      Article III, Section 35(d)(2)(M) of the NASD Rules of Fair Practice requires that a member that makes investment comparisons, directly or indirectly, must ensure that the purpose of the comparison is clear. The comparison must be fair, balanced, and disclose any material differences between the subjects of the comparison. The use of investment company rankings to demonstrate performance qualifies as such a comparison.

      As the number of investment companies has increased substantially in recent years, so has the number of investment company ranking entities. The NASD has observed increased references to rankings in investment company advertisements and sales literature. In response to the increased use of investment company rankings, the Investment Company Institute, the national association of the American mutual fund industry, submitted to the NASD suggested standards for the use of rankings in sales materials that served as the foundation for the NASD proposal. The NASD proposed, and the SEC approved, comprehensive Guidelines to be used when investment company advertisements and sales literature include references to investment company rankings.

      Description Of The Amendments

      The Guidelines apply to all registered investment companies, including open-end and closed-end management companies as defined in Sections 3,4, and 5 of the Investment Company Act of 1940.

      Definition Of Ranking Entity The term "ranking entity," refers to an entity that provides general investment company information to the public, is independent of the investment company and its affiliates, and whose services are not procured by the investment company or its affiliates to assign a ranking. The definition encompasses entities formed specifically to provide such information as well as financial publications and periodicals that include such a service in their publications.

      General Prohibition Members are prohibited from using investment company rankings in advertising and sales literature unless the rankings were developed by entities that meet the definition of ranking entity. When members use rankings developed by ranking entities, the rankings must conform to the requirements of the Guidelines.

      Required Disclosures All advertisements and sales literature containing a ranking must disclose the name of the investment company category, the number of investment companies in the category, the name of the ranking entity, the period on which the ranking is based, the criteria on which the investment company is ranked, and, for investment companies with front-end sales loads, whether the ranking takes into account sales charges. Also, for advertisements and sales literature containing rankings based on total return or the SEC standardized yield, the advertisements and sales literature must contain a statement as to the material effect on total return or yield, if any, of fees waived or expenses advanced during the period on which the ranking is based. The amendments also require disclosure of the publisher of the ranking data.

      Prominent statements and headlines that include or refer to rankings must disclose the name of the investment company category, the total number of investment companies in the category, and the period on which the ranking is based, in close proximity to the headline or prominent statement. Such statement or headline may not state or imply that an investment company is ranked first in a category when it is not.

      All advertising or sales literature using a ranking system consisting of a symbol must disclose the meaning of the symbol. All advertising and sales literature containing a ranking must disclose that past performance is no guarantee of future results.

      Time Periods

      To ensure that rankings are based on meaningful, not misleading, information, the Guidelines require that the information be current and provide a minimum standard of what is current. Rankings should be at least current to the most recent calendar quarter, though use of more current ranking data is permissible.

      For all investment companies except money market mutual funds, rankings based on a period of less than one year can be misleading and, therefore, are prohibited. Additionally, for all investment companies except money market mutual funds, rankings based on total return or the SEC standardized yield must be accompanied by rankings based on total return for the one-year period for investment companies in existence for one year; the one- and five-year periods for investment companies in existence for at least five years; and the one-, five-, and 10-year periods for investment companies in existence for at least 10 years. The ranking information for the periods must be supplied by the same ranking entity and the periods must end on the same date.

      The NASD believes that a meaningful comparison of rankings in excess of one year should include multiple time periods for comparison to avoid the possibility of selecting only those time periods in which an investment company was highly ranked. Also, the required use of the one-year period prohibits a member from using a ranking that ranks investment companies over, for example, a three-year period only.

      Categories

      The NASD believes it is important to set standards for methods of investment company categorization that provide a sound basis for evaluating investment company performance. Generally, advertisements and sales literature must use only categories or subcategories created by a ranking entity. Advertisements or sales literature using rankings based on a sub-category must disclose the name of the full category, the investment company's ranking and the number of investment companies in the full category, unless the subcategory is based solely on the investment objectives of the investment company and is created by a ranking entity.

      Categories or subcategories created by an investment company or its affiliate may be used as long as performance is measured by the same performance measurements as those used by a ranking entity. However, categories or subcategories created by an investment company or its affiliate must also prominently disclose the fact that the investment company or its affiliate has created the ranking category, the number of investment companies in the category, the basis for selecting the category, and the identity of the ranking entity that developed the performance measurements and data on which the ranking is based. Headlines and prominent statements using a ranking created by an investment company or its affiliate must indicate in close proximity to the headline or statement that the ranking is based on a category created by the investment company or its affiliate.

      Advertisements or sales literature must not use any ranking category based on the investment company's asset size because such information does not provide a meaningful basis on which the investment company's performance can be evaluated.

      Multiple Class/Two-Tier Investment Companies Advertisements or sales literature containing rankings for more than one class or investment company with the same portfolio must disclose the fact that the investment companies or classes have a common portfolio.

      * * *

      The NASD believes that by establishing a baseline of standards for the use of investment company rankings in advertising and sales literature, the amendments will prevent the misleading use of such rankings and will help investment company investors make informed investment decisions based on information set forth in a clear and uniform manner.

      Questions regarding this Notice may be directed to R. Clark Hooper, Vice President, Advertising/Investment Companies Regulation Department, at (202) 728-8325; Thomas A. Pappas, Assistant Director, Advertisement/Investment Companies Regulation Department, at (202) 728-8330; or Robert J. Smith, Attorney, Office of General Counsel, at (202) 728-8176.

      Approved Amendments To Article III, Section 35 Of The NASD Rules Of Fair Practice.

      (Note: New text is underlined.)

      * * *

      Guidelines For The Use Of Rankings In Investment Company Advertisements And Sales Literature

      I. Definition of "Ranking Entity"

      For purposes of these guidelines, the term "Ranking Entity" refers to any entity that provides general information about investment companies to the public, that is independent of the investment company and its affiliates, and whose services are not procured by the investment company or any of its affiliates to assign the investment company a ranking.
      II. General Prohibition

      Members shall not use in investment company advertisements, sales literature or general promotional material any investment company rankings other than those developed and produced by entities that meet the definition of "Ranking Entity." and which conform to the requirements of the Guidelines herein.
      III. Required Disclosures
      A. Headlines/Prominent Statements
      1. A headline or other prominent statement must not state or imply that an investment company is the best performer in a category unless it is actually ranked first in the category.
      2. Prominent disclosure of the investment company's ranking, the total number of investment companies in the category, the name of the category, and the period on which the ranking is based (i.e., the length of the period and the ending date; or, the first day of the period and the ending date! must appear in close proximity to any headline or other prominent statement that refers to a ranking.
      B. All advertisements and sales literature containing an investment company ranking must disclose, with respect to the ranking:
      1. the name of the category (e.g., growth):
      2. the number of investment companies in the category:
      3. the name of the Ranking Entity:
      4. the length of the period and the ending date, or, the first day of the period and the ending date:
      5. criteria on which the ranking is
      6. for investment companies which assess front-end sales loads, whether the ranking takes into account sales charges:
      7. if the ranking is based on total return or the current SEC standardized yield, fees have been waived or expenses advanced during the period on which the ranking is based, and the waiver or advancement had a material effect on the total return or yield for that period, a statement to that effect: and
      8. the publisher of the ranking data (e.g., "ABC Magazine. June 1993"). The disclosure required by B1. B2. B3 and B4 must be set forth prominently in the body of the advertisement or sales literature.
      C. If the investment company ranking consists of a symbol (e.g., a star system) rather than a number, the advertisement or sales literature also must disclose the meaning of the symbol (e.g., a four-star ranking indicates that the investment company is in the top 30% of all investment companies).
      D. All advertisements and sales literature containing an investment company ranking must disclose that past performance is no guarantee of future results.
      IV. Time Periods
      A. Any investment company ranking set forth in an advertisement or sales literature must be, at a minimum. current to the most recent calendar quarter ended, in the case of advertising, prior to the submission for publication, or. in the case of sales literature, prior to use.
      B. Except for money market investment companies:
      1. advertisements and sales literature must not use any ranking based on a period of less than one year:
      2. an investment company ranking based on total return must be accompanied by rankings based on total return for the one-year period for investment companies in existence for at least one year: the one-and five-year periods for investment companies in existence for at least five years, and the one-, five-, and ten-year periods for investment companies in existence for at least ten years supplied by the same Ranking Entity in the category and based on the same time period; and.
      3. an investment company ranking based on yield may be based only on the current SEC standardized yield. An investment company ranking based on the current SEC standardized yield must be accompanied by rankings based on total return for the one-year period for investment companies in existence for at least one year; the one- and five-year periods for investment companies in existence for at least five years, and the one-, five-, and ten-year periods for investment companies in existence for at least ten years supplied by the same Ranking Entity in the category and based on the same time period.
      V. Categories
      A. The choice of category (including a subcategory of a broader category) on which the investment company ranking is based must be one that provides a sound basis for evaluating the performance of the investment company.
      B. Subject to the standards below, an investment company ranking must be based only on (1") a published category or subcategory created by a Ranking Entity or (2) a category or subcategory created by an investment company or an investment company affiliate, but based on the performance measurements of a Ranking
      C. When the investment company ranking is based on a subcategory, the advertisement or sales literature must disclose the name of the full category and the investment company's ranking and the number of investment companies in the full category. This requirement does not apply if the subcategory is (1) based solely on the investment objectives of the investment companies included and (2) created by a Ranking Entity. This disclosure could be included in a footnote.
      D. The advertisement or sales literature must not use any category or subcategory that is based upon the investment company's asset size (whether or not it has been created by a Ranking Entity).
      E. If an advertisement uses a category created by the investment company or an investment company affiliate, including a "subcategory" of a category established by a Ranking Entity, the advertisement must prominently disclose:
      1. the fact that the investment company or its affiliate has created the ranking category:
      2. the number of investment companies in the category:
      3. the basis for selecting the category: and
      4. the Ranking Entity that developed the research on which the ranking is based.
      F. An advertisement or sales literature containing a headline or other prominent statement that proclaims an investment company ranking created by an investment company or its affiliate must indicate, in close proximity to the headline or statement, that the investment company ranking is based upon a category created by the investment company or its affiliate.
      VI. Multiple Class/Two-Tier Investment Companies

      Investment company rankings for more than one class or investment company with the same portfolio must be accompanied by prominent disclosure of the fact that the investment companies or classes have a common portfolio.

    • 94-59 Rule Proposals Of The Industry/Regulatory Council On Continuing Education

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance
      Registration
      Training

      Executive Summary

      The NASD Board of Governors requests member comment on rule proposals developed by the Industry/Regulatory Council on Continuing Education (the Council). These proposals codify and expand the conceptual recommendations made by a special task force comprised entirely of industry representatives and published by six serf-regulatory organizations (SROs)1 in September 1993. The proposed rules would establish a formal, two-part continuing education program for securities industry professionals that would require uniform training on regulatory matters and ongoing programs by firms to keep their registered persons up to date on job-specific subjects.

      * * *

      The text of the proposed rules of the Council, which are amendments to Schedule C to the NASD By-Laws, follow this introduction. Background information and an explanation of these proposals are in the Status Report on the Continuing Education Program, which is reprinted in this Notice. A special section of the report, entitled "Questions and Answers Regarding The Securities Industry Continuing Education Proposal," helps further understanding of the proposed continuing education program in member firms.

      The NASD Board of Governors urges members to comment on this important new regulatory initiative. Member comments will be considered by the Council, the NASD Membership Committee, and the NASD Board of Governors and will have an important impact on the final structure of the continuing education program.

      Comments should be submitted no later than October 15, 1994, and be addressed to Joan C. Conley, Corporate Secretary, National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006. If you have questions about this Notice or want additional copies of the report, contact Frank J. McAuliffe, Vice President, Membership & Qualifications, at (301) 590-6694, or Mark R Costley, Senior Qualifications Analyst, at (301) 590-6697.


      1 The six SROs include the American Stock Exchange (AMEX), the Chicago Board Options Exchange (CBOE), the Municipal Securities Rulemaking Board (MSRB), the National Association of Securities Dealers, Inc. (NASD), the New York Stock Exchange (NYSE), and the Philadelphia Stock Exchange (PHLX).


      Text Of Proposed Amendment To Schedule C Of The NASD By-Laws

      (Note: New language is underlined.)

      Part XII

      Continuing

      Education Requirements

      This Part prescribes requirements regarding the continuing education of certain registered persons subsequent to their initial qualification and registration with the NASD. The requirements shall consist of a Regulatory Element and a Firm Element as set forth below.

      (1) Regulatory Element
      (a) Requirements — No member shall permit any registered person to continue to. and no registered person shall continue to, perform duties as a registered person, unless such person has complied with the requirements of Section (1) hereof.
      (i) Each registered person shall complete the Regulatory Element on three occasions, at intervals of two, five and 10 years after the effective date of their registration, or as otherwise prescribed by the NASD. On each of the three occasions, the Regulatory Element must be completed within one hundred twenty days after the person's registration anniversary date. The content of the Regulatory Element shall be prescribed by the NASD.
      (ii) Registered persons who have been continuously registered for more than 10 years as of the effective date of this Part shall be exempt from participation in the Regulatory Element provided such persons have not been subject to any disciplinary action within the last 10 years as enumerated in subsection (1)(c)(i)(ii) of this Part. In the event of such disciplinary action, a person will be required to satisfy the requirements of the Regulatory Element by participation for the period from the effective date of this Part to 10 years after the occurrence of the disciplinary action.
      (iii) Persons who have been currently registered for 10 years or less as of the effective date of this Part shall initially participate in the Regulatory Element within 120 days after the occurrence of the second, fifth or tenth registration anniversary date. whichever anniversary date first applies, and on the applicable registration anniversary date(s) thereafter. Such persons will have satisfied the requirements of the Regulatory Element after participation on the tenth registration anniversary.
      (iv) All registered persons who have satisfied the requirements of the Regulatory Element shall be exempt from further participation in the Regulatory Element, subject to reentry into the program as set forth in subsection d)(c) of this Part.
      (b) Failure to Complete — Unless otherwise determined by the NASD, any registered persons who have not completed the Regulatory Element within the prescribed time frames will have their registrations deemed inactive until such time as the requirements of the program have been satisfied. Any person whose registration has been deemed inactive under this Part shall cease all activities as a registered person and is prohibited from performing any duties and functioning in any capacity requiring registration. The NASD may, upon application and a showing of good cause, allow for additional time for a registered person to satisfy the program requirements.
      (c) Re-entry into Program — Unless otherwise determined by the NASD, a registered person will be required to re-enter the Regulatory Element and satisfy the program's requirements in their entirety commencing with initial participation within 120 days of a disciplinary action becoming final, and on three additional occasions thereafter, at intervals of two, five and 10 years after re-entry, notwithstanding that such person has completed all or part of the program requirements based on length of time as a registered person or completion of ten years of participation in the program, whenever the registered person has been:
      (i) subject to any statutory disqualification as defined in Section 3(a)(39) of the Securities Exchange Act of 1934 (See also Rule 346(f));
      (ii) subject to suspension or to the imposition of a fine of $5.000 or more for violation of any provision of any securities law or regulation, or any agreement with or rule or standard of conduct of any securities governmental agency, securities serf-regulatory organization, or as imposed by any such regulatory or self-regulatory organization in connection with a disciplinary proceeding; or
      (iii) ordered to re-enter the continuing education program by the Securities and Exchange Commission, any securities self-regulatory organization or any state securities agency.
      (d) Any registered person who has terminated association with a member and who has, within two years of the date of termination, become reassociated in a registered capacity with a member shall participate in the Regulatory Element at such intervals (two, five and 10 years') that may apply based on the initial registration anniversary date rather than based on the date of reassociation in a registered capacity.
      (e) Definition of registered person — For purposes of this Part, the term "registered person" means any person registered with the NASD as a representative, principal or assistant representative pursuant to Parts II, III or IV respectively of Schedule C to the By-Laws.
      (2) Firm Element
      (a) Persons Subject to the Firm Element — The requirements of this section shall apply to any person registered with a member who has direct contact with customers in the conduct of the member's securities sales, trading and investment banking activities, and to the immediate supervisors of such persons (collectively, "covered registered persons"). "Customer" shall mean any natural person and any organization, other than another broker or dealer, executing securities transactions with or through or receiving investment banking services from a member.
      (b) Standards for the Firm Element
      (i) Each member must maintain a continuing and current education program for its covered registered persons to enhance their securities knowledge, skill, and professionalism. At a minimum, each member shall at least annually evaluate and prioritize its training needs and develop a written training plan. The plan must take into consideration the member's size, organizational structure, and scope of business activities, as well as regulatory developments and the performance of covered registered persons in the Regulatory Element.
      (ii) Minimum Standards for Training Programs — Programs used to implement a member's training plan must be appropriate for the business of the member and, at a minimum must cover the following matters concerning securities products, services and strategies offered by the member:
      a. General investment features and associated risk factors;
      b. Suitability and sales practice considerations:
      c. Applicable regulatory requirements.
      (iii) Administration of Continuing Education Program — A member must administer its continuing education programs in accordance with its annual evaluation and written plan and must maintain records documenting the content of the programs and completion of the programs by covered registered persons.
      (c) Participation in the Firm Element

      — Covered registered persons included in a member's plan must take all appropriate and reasonable steps to participate in continuing education programs as required by the member.
      (d) Specific Training Requirements

      — The NASD may require a member, individually or as part of a larger group, to provide specific training to its covered registered persons in such areas the NASD deems appropriate. Such a requirement may stipulate the class of covered registered persons for which it is applicable, the time period in which the requirement must be satisfied and, where appropriate, the actual training content.

      STATUS REPORT

      On The Continuing EDUCATION Program

      THE INDUSTRY/REGULATORY COUNCIL ON CONTINUING EDUCATION

      AUGUST 1994

      BACKGROUND

      In March 1993, six self-regulatory organizations (SROs)1 announced the formation of an industry task force to consider whether the industry should develop a uniform continuing education program for registered persons. The task force was composed of experienced individuals with diverse backgrounds from a broad range of firms, thus ensuring consideration of the interests and needs of a wide cross section of the industry. The SROs noted that the increasing complexity of the securities industry demands that professionals who deal with the public or are in supervisory positions maintain minimum standards of competence and professionalism. The SROs also said that a formal industry-wide continuing education program to keep professionals up to date on products, markets, and rules might be needed. By initiating a broad-based industry effort, the SROs hoped to provide a unified industry-wide approach acceptable to all segments of the industry.

      In September 1993, the industry task force issued a report calling for a formal two-part continuing education program for securities industry professionals that would require uniform periodic training in regulatory matters (Regulatory Element) and ongoing programs by firms to keep employees up-to-date on job and product-related subjects (Firm Element). The report also recommended the creation of a permanent Industry/Regulatory Council on Continuing Education (the Council)2 to recommend to the SROs the specific content of the uniform Regulatory Element and the minimum core curricula for ongoing firm training programs undertaken to satisfy the requirements of the Firm Element. The task force recommended further that computer-based training be used as a primary delivery vehicle for the uniform Regulatory Element of the program. In November 1993, the SROs endorsed in concept the recommendations of the industry task force.

      Since November 1993, the Council has met monthly and has formed separate committees to work on the Regulatory and Firm Elements. The Regulatory and Firm Element Committees have prepared proposed draft rules that would implement the program when approved by the SROs. The Regulatory Element Committee has also developed an initial listing of standardized subject matter for the computer-based training program. The Firm Element Committee has developed standards that firms must adhere to in developing and implementing their training programs.

      The Council has now submitted these proposed rules to the various SROs for review with an aggressive schedule to develop and implement the continuing education program. The current target is to have the final rules adopted by the SROs by November 1994 and for the SROs to immediately thereafter file the rules for approval with the SEC. It is anticipated that the rules will be formally approved by the SEC in January 1995. The continuing education program would then be implemented on July 1, 1995.

      PROPOSED PROGRAM HIGHLIGHTS

      The Regulatory Element proposal requires all registered persons to participate in a prescribed computer-based training session on their second, fifth, and tenth registration anniversary dates. Persons who have been registered for more then 10 years and have not been the subject of a serious disciplinary action (as more fully described below) during the most recent 10 years are exempt from the Regulatory Element.

      Failure to complete the required Regulatory Element computer-based training session during the prescribed period would result in a person's registration becoming inactive. A person whose registration becomes inactive cannot conduct a securities business or perform any of the functions of a registered person until such person meets the requirement.

      Any person who would otherwise be exempt from the Regulatory Element would be required to re-enter the program for another 10 years upon becoming subject to certain disciplinary actions or as otherwise required by a securities regulatory or self-regulatory organization. Such re-entry would be occasioned by a person becoming subject to a statutory disqualification pursuant to the Securities Exchange Act of 1934; if an individual's registration is suspended by a securities regulatory or self-regulatory organization; or if a securities regulatory or self-regulatory authority imposes a fine of $5,000 or more for a violation of any securities law, rule, or regulation, which is the threshold level for determining a serious disciplinary action.

      The Regulatory Element computer-based training program will be designed to transmit information broadly applicable to all registered persons. The content will be recommended by a group of industry representatives, subject to Council review and SRO approval. The content will focus on compliance, regulatory, ethical, and sales-practice standards. Because of the general and broadly applicable nature of this material, the Council determined to recommend that the Regulatory Element should be initiated with a "one size fits all" approach to the material to be transmitted in the computer-based training program, regardless of the job functions or registration status, such as Series 6 or Series 7.

      While there will be no grading of individual performance on the Regulatory Element, information feedback will be provided to individuals and their firms regarding areas of apparent strength or weakness as indicated by the individual's interaction with the computer-based training program. In addition, aggregated information will be provided to firms on all their covered registered persons who take the computer-based training program in a given period. Firms will be expected to consider this information when formulating their training plans for the Firm Element, as more fully described below.

      Unlike the Regulatory Element, where only those persons registered for 10 years or less are covered, the Firm Element has no time limitations. It is applicable to all persons who conduct business with retail, institutional, or investment banking customers of the firm. The immediate supervisors of such persons are also covered by the Firm Element.

      The Firm Element requires each member to establish a training process and identifies certain minimum requirements associated with that process. The firm must prepare a training plan after an analysis of its training needs. Firms must consider certain factors when conducting their analyses and in developing their training plans, such as the firm's size, organizational structure, and scope of business activities, as well as regulatory developments and the performance of covered registered persons in the Regulatory Element. The program requires a training plan to be implemented by a member and requires the member to maintain records that clearly demonstrate the content of its training programs and the completion of the programs by the persons identified in the firm's training plan. Persons who are subject to the training plan would have an affirmative obligation to participate in the programs identified by the member.

      The Firm Element also establishes certain minimum standards for the training programs that are used in a member's plan. For example, such programs, when dealing with investment products and services, must identify their investment features and associated risk factors, their suitability in various investment situations and applicable regulatory requirements that affect the products or services. The SROs would have the ability to require members, individually or as part of a group, to provide specific training to covered registered persons in any area the SROs deem necessary. Depending on the issue of concern, these requirements could be directed at specific individuals or portions of a firm, a specific firm or group of firms, or across the entire industry.

      IMPLEMENTATION

      The SROs propose to fully implement the Regulatory Element on July 1, 1995. The Central Registration Depository (CRD) system will track persons subject to the requirement and notify members in advance of those individuals approaching their second, fifth, and tenth year anniversary dates who are required to participate in a computer-based training session. Follow-up notices will also be sent as persons subject to the Regulatory Element requirement approach the end of the 120 days during which the requirement must be satisfied. In addition, the CRD system will generate monthly reports to members identifying those persons approaching or subject to the Regulatory Element requirement as well as those persons whose registrations have become inactive due to failure to complete the requirement within the specified time.

      The Regulatory Element requirements will apply to all registered persons whose second, fifth, and tenth registration anniversary dates occur on or after July 1, 1995. Persons who have completed 10 years of registration before July 1, 1995, will be exempt. A person's registration anniversary dates will be measured from his or her first registration in the CRD, regardless of any subsequent firm changes or changes in registration category. Persons who have incurred a disciplinary event during the 10-year period before July 1, 1995, that would require them to re-enter the program will have an initial registration date that coincides with the effective date of the final decision in a disciplinary action.

      The NASD PROCTOR® system will be modified to handle the delivery of the computer-based training program in the 55-center PROCTOR network. Future expansion of the network is also being investigated, including the use of temporary centers that would operate periodically in areas located at a considerable distance from a full-time network center. In addition, the Council and the SROs will in the future consider the feasibility of permitting members to deliver the computer-based training on their internal computer systems if certain technical, administrative and regulatory concerns can be adequately resolved.

      The Firm Element of the continuing education program will be implemented in two stages. By July 1, 1995, members would be required to complete their training needs analyses and to develop written training plans that would be available for review upon request by the SROs, the SEC, and state regulators. Members would be expected to begin implementing their plans as soon as practicable but, in any event, no later than January 1, 1996. The SROs are committed to developing a consistent approach to examination and enforcment of the Firm Element requirements. Additionally, the SROs will coordinate their field inspection efforts to avoid any unnecessary regulatory overlap in the inspection process for firms that are joint members of two or more SROs.

      The Firm Element provides great flexibility to firms in designing training programs appropriate to their needs and consistent with their resources, subject to broad standards defined in the Firm Element. The Firm Element framework is intended to be flexible enough to accommodate differences in the size, scope, and complexity of firm operations. Therefore, the Council and the SROs believe that the training needs analysis and training plan requirements of the proposal are within the capabilities of all organizations, regardless of size.

      The Firm Element also proposes that a member would be responsible for assuring that training programs for investment products and services used in its training plan appropriately cover the investment characteristics and associated risk factors of the product or service, their suitability for different investment situations and any regulatory requirements that affect the product or service. The Council and the SROs realize that a great deal of the training material and programs will be provided by a variety of training and education providers. Nevertheless, the proposed rules place the responsibility on each member to assure that such training meets the broad content standards included in the rule as they relate to that particular firm. The SROs do not intend to pre-approve training materials and programs developed by members or providers. They will, however, communicate regularly with members regarding the expectations for the content of training programs. As the program evolves, it is expected some curricula content standards will be defined by the SROs for products and services where heightened regulatory concerns exist.

      The Council intends to develop more extensive guidelines to assist firms in carrying out their responsibilities under the Firm Element and will recommend to the SROs that these guidelines be provided to firms when the final continuing education rules are adopted by the SROs and approved by the SEC.


      1 The SROs include the American Stock Exchange (AMEX), the Chicago Board Options Exchange (CBOE), the Municipal Securities Rulemaking Board (MSRB), the National Association of Securities Dealers, Inc. (NASD), the New York Stock Exchange (NYSE), and the Philadelphia Stock Exchange (PHLX).

      2 The Council includes representatives from 13 broker/dealers and the six SROs. In addition, the Securities and Exchange Commission (SEC) and the North American Securities Administrators Association (NASAA) have each assigned a liaison to the Council. Members of the Council are listed at the end of this report.

      INDUSTRY/ REGULATORY COUNCIL ON CONTINUING EDUCATION

      William R. Simmons
      Council Chairman
      Executive Vice President & Director
      Dean Witter Reynolds, Inc.
      New York, NY

      INDUSTRY REPRESENTATIVES

      Judith Belash
      Vice President & Associate General Counsel
      Goldman Sachs
      New York, NY

      Mary Alice Brophy
      First Vice President & Director of Compliance
      Dam Bosworth Inc.
      Minneapolis, MN

      Ronald E. Buesinger
      Corporate Secretary & Senior Vice President
      A.G. Edwards & Sons, Inc.
      St. Louis, MO

      Elena Dasaro
      Compliance Official
      H.C. Wainright & Co., Inc.
      Boston, MA

      David A. DeMuro
      Senior Vice President
      Associate General Counsel
      Lehman Brothers Inc.
      New York, NY

      John P. Gualtieri
      Vice President & Insurance Counsel
      Prudential Insurance Co. of America
      Newark, NJ

      Therese M. Haberle
      Associate General Counsel
      Charles Schwab & Co., Inc.
      San Francisco, CA

      James Harrod
      General Principal, Investment Representative
      Edward D. Jones & Co.
      Maryland Heights, MO

      Todd A. Robinson
      Chairman & CEO
      Linsco/Private Ledger Corp.
      Boston, MA

      Richard C. Romano
      President
      Romano Brothers & Co.
      Evanston, IL

      Lois Towers
      Director Institutional Compliance
      Fidelity Securities
      Boston, MA

      O. Ray Vass
      First Vice President
      Merrill Lynch, Pierce, Fenner & Smith, Inc.
      New York, NY

      SRO REPRESENTATIVES

      Diane Anderson
      Vice President of Examinations
      Philadelphia Stock Exchange
      Philadelphia, PA

      Howard Baker Senior
      Vice President American Stock Exchange
      New York, NY

      Darrell Dragoo
      Vice President of Compliance
      Chicago Board Options Exchange
      Chicago, IL

      Frank J. McAuliffe
      Vice President
      NASD Rockville, MD

      Loretta Rollins
      Professional Qualifications
      Administrator
      MSRB
      Alexandria, VA

      Donald van Weezel
      Managing Director
      NYSE
      New York, NY

      Questions & Answers Regarding

      THE SECURITIES INDUSTRY

      Continuing Education Proposals

      1.
      Q. What is the Industry/Regulatory Council on Continuing Education (the Council) and what role does it play?
      A. The Council is comprised of 13 representatives of the securities industry (primarily the former members of the Securities Industry Task Force on Continuing Education) and representatives of six self-regulatory organizations (SROs). In addition, liaison personnel from the SEC and NASAA participate in Council meetings. The Council's role is to develop, update, and coordinate the Continuing Education program and to recommend specific content to the SROs for the Regulatory Element and minimum core curricula for the Firm Element.

      In the future, industry representatives will be selected to serve three-year terms through a nominating-committee process designed to maintain representation of a broad cross section of industry firms. The Council will continue to evaluate the program and recommend changes to the SROs as necessary to ensure that the Regulatory and Firm Elements are responsive to industry needs and changes over time.
      2.
      Q. Why does the program consist of two elements?
      A. The Regulatory Element is applicable to all persons registered with an SRO within their first 10 years in the business. Because the Regulatory Element is intended to enhance education and training in broad-based regulatory, compliance, and ethical issues, a "one size fits all" approach is initially contemplated for persons engaged in limited or full-service aspects of the securities business and in a variety of jobs.

      The Firm Element is designed to ensure that firms provide ongoing education and training to persons who deal directly with individual, institutional, and investment banking customers. This element will focus on topics tailored specifically to the job functions and products handled by those people. Accordingly, the Firm Element has sufficient flexibility to meet the needs of all firms irrespective of their size or product mix.
      3.
      Q. Who will be covered by the program?
      A. Every person registered for 10 years or less will be covered by the Regulatory Element and will be required to take the regulatory portions within 120 calendar days after then-second, fifth, and tenth anniversaries. The Firm Element requirements shall apply to all "covered registered persons" (salespeople, traders, investment bankers, and others who conduct a securities business with customers, and their first-line immediate supervisors) for as long as they are considered "covered registered persons." The term "customer" applies to retail, institutional, and investment banking customers, but does not include other broker/dealers.
      4.
      Q. Will registered personnel located outside the United States be covered?
      A. Yes and the Council is considering what special accommodations may be necessary to deliver the program to such individuals.
      5.
      Q. Will anyone be grandfathered or exempted?
      A. Grandfathering applies to the Regulatory Element only. Those who have been registered more than 10 years and who have not been the subject of a serious disciplinary action (suspension, bar, fine of $5,000 or more, or a statutory disqualification) during the most recent 10 years will be grandfathered from the Regulatory Element.
      6.
      Q. Are branch managers "covered registered persons" within the Firm Element?
      A. Yes. Branch managers are covered registered persons because they directly supervise salespeople in the branch. If a branch manager also has customer accounts, then his/her supervisor is a "covered registered person" as well.
      7.
      Q. Are research analysts "covered registered persons" within the Firm Element?
      A. Yes, if they communicate directly with or engage in sales presentations to customers.
      8.
      Q. Will either element contain pass/fail tests?
      A. No. The Council recommended that the program should focus on increased education and training rather than on periodic examinations.
      9.
      Q. How will the program be administered?
      A. The Regulatory Element will be delivered through computer-based training, in which participants will work through problems and/or scenarios at computer terminals located in an NASD PROCTOR center or other specified location.

      The Firm Element will be delivered by firms and may include written materials, videos, audio tapes, classroom training, direct broadcasts, or other media
      10.
      Q. What is the rationale behind discontinuing the Regulatory Element after 10 years?
      A. Because information to be transmitted through the Regulatory Element is primarily of a compliance, regulatory, and ethical nature, it was perceived that individuals registered for more than 10 years without a significant disciplinary action would have adequately absorbed this material and that this would be reflected in their manner of doing business. In addition, all registered individuals who are "covered registered persons" will continue to be subject to the requirements of the Firm Element throughout their careers.
      11.
      Q. In the Regulatory Element, will there be a way to verify that individuals have completed the computer-based training?
      A. Yes. The CRD system will track and communicate anniversary dates and evidence of completion for the Regulatory Element. The computer-based systems used to transmit the training information can also capture, store, and analyze data as to who took the training, when, where, and other information — in a manner similar to that of the industry qualification testing now conducted through the NASD PROCTOR system.
      12.
      Q. What is the expected fee for each Regulatory Element session at an NASD PROCTOR center?
      A. The current estimate is about $75; however, the ultimate fee will depend on the overall costs for the program, which will operate on a revenue-neutral basis and be subject to periodic independent audits.
      13.
      Q. For those firms with internal computer systems and the capability to interface with the NASD PROCTOR system, will there be an opportunity to deliver the Regulatory Element material through these systems?
      A. Initial delivery of the Regulatory Element will be on the PROCTOR system; however, the potential for internal delivery on firm computer systems is under discussion. Obviously, arrangements to permit internal delivery depend on the development of appropriate safeguards to ensure the integrity of the program and the ability to capture the necessary information for feedback.
      14.
      Q. Is the content of the Firm Element left entirely up to the individual firms?
      A. No. The firms will be required to update training plans annually to demonstrate that they meet certain prescribed minimum standards with respect to subject material to be disseminated to their "covered registered persons" based on their needs, products, and lines of business.
      15.
      Q. Will "covered registered persons" need to participate in formal Firm Element training programs every year?
      A. Not necessarily. There are no set schedules or required number of hours for the Firm Element, but coverage must be sufficient to meet the criteria established by SRO rules. For example, it may not be necessary to include every "covered registered person" within each calendar year if the firm is engaged exclusively in limited lines of business.
      16.
      Q. Is the annual compliance meeting required under Section 27 of the NASD Rules of Fair Practice adequate to demonstrate compliance with the requirements of the Firm Element?
      A. Not in and of itself. It can certainly be used as an occasion on which to transmit information or conduct training. However, firms must address their own needs with regard to sales practices and product training and carry out effective programs. In most instances, a significant expansion of material covered at the annual compliance meeting will probably be necessary. Also, it may be appropriate to transmit some material in a more timely manner than waiting for scheduled annual compliance meetings.
      17.
      Q. Can the requirements of the Firm Element be met through continuation of the significant internal training and education programs already in place at some firms?
      A. Possibly. For firms with comprehensive ongoing training programs in place, the requirements may result primarily in expanded record keeping, more formalized planning, and the incorporation of any minimum criteria specified by the SROs. It is likely, however, that most firms will need to substantially increase their education and training efforts to meet or exceed these requirements.
      18.
      Q. Will it be necessary for each "covered registered person" to meet personally with his/her supervisor annually to determine the training requirement for that person?
      A. No. However, some firms may elect to conduct such meetings to ascertain individual needs or to do so during regular performance reviews.
      19.
      Q. Can firms use training materials or presentations prepared or delivered by outside entities to satisfy the requirements of the Firm Element?
      A. Yes, provided that they meet the same standards established for firms.
      20.
      Q. If firms use materials or presentations prepared or delivered by outside entities to satisfy the requirements of the Firm Element, who is responsible for the content?
      A. Individual firms have the ultimate responsibility for the content and adequacy of material or presentations, regardless of who prepares or presents the material.
      21.
      Q. How can firms obtain guidance on designing and implementing internal training programs adequate to meet the requirements of the Firm Element?
      A. The Council anticipates producing a compilation of guidelines taking into account comments and questions received while rule enactment is pending. These guidelines would not be rules but would offer suggestions intended to help firms devise appropriate and reasonable programs consistent with their own unique characteristics and businesses.
      22.
      Q. Will sessions devoted exclusively to selling skills or prospecting fulfill the requirements of the Firm Element?
      A. No.
      23.
      Q. How will materials or presentations used by firms to satisfy the Firm Element be checked or evaluated?
      A. Training plans, materials, outlines, and other required documentation must be retained for regulatory examination (upon request or during routine sales practices examinations) for conformance with standards prescribed by SRO rules. In addition, firms will be required to maintain evidence of participation and completion by their "covered registered persons".
      24.
      Q. What authority does the Council have to require firms to transmit specific information or carry out training in specific areas?
      A. None directly. Explicit authority for the requirements and enforcement of the continuing education program will be established in rules promulgated by the SROs.
      25.
      Q. If a "covered registered person" has an insurance license and fulfills insurance continuing education obligations, can that serve as a substitute for the Firm Element?
      A. Perhaps it may comprise a portion of the Firm Element requirements relating to insurance-related securities products, but it is unlikely that most insurance programs will meet all minimum standards prescribed under this program.
      26.
      Q. Will study materials be available?
      A. A content outline will be prepared for the Regulatory Element. Guidelines will be published for the Firm Element and it is anticipated that additional study materials will be developed and made available by individual firms, product originators, and other outside entities.
      27.
      Q. When will the Continuing Education rules be enacted?
      A. It is expected that the rules will receive SEC approval in January 1995.
      28.
      Q. When will the Regulatory Element actually go into effect?
      A. The Regulatory Element is slated to begin on July 1, 1995. Thus, persons with two-, five-, and 10-year registration anniversaries on or after July 1, 1995 will be required to participate in accordance with those dates.
      29.
      Q. When and how will the Firm Element become effective?
      A. The Firm Element will also begin on July 1, 1995, and, for most firms, will necessitate a two-tier implementation process. Firms will be required to have completed their written training plans by July 1, 1995. The Council and the SROs recognize that firms will likely require additional time to develop and prepare materials, plan budgeting needs, and arrange scheduling; however, the actual implementation of the plan must begin no later than January 1, 1996.

      It is anticipated that regulatory examination for Firm Element compliance will also proceed in accordance with the preceding schedule. For example, written training plans are subject to inspection by July 1, 1995, and firm records should demonstrate programs in progress as of January 1,19%.
      30.
      Q. How will people be phased into the program initially?
      A. Individuals will be phased into the Regulatory Element based on their registration date or, if applicable, based on the date of the most recent disciplinary action against them. For example, persons who became registered in October 1990 would enter the program having been registered for more than four years and would first be required to participate in the Regulatory Element around October 1995 (within 120 calendar days after their fifth anniversary of continuous registration). In October 2000 they would again participate to complete their 10-year cycle. Thereafter, they will be exempted from the Regulatory Element, provided they have no serious disciplinary action within the most recent 10-year period.

      The Firm Element will begin for all "covered registered persons" no later than January 1,19%, in accordance with their firms' written plans.
      31.
      Q. How does a serious disciplinary action affect one's status in the Regulatory Element?
      A. A serious disciplinary action would effectively pre-empt one's original registration date as a trigger for entry into the full 10-year cycle of the Regulatory Element. Within 120 days of imposition of the disciplinary action, that individual will be required to participate in a Regulatory Element session, followed by additional sessions at the second, fifth, and tenth anniversaries of the date of the disciplinary action.
      32.
      Q. Is a serious disciplinary action the only factor that might mandate reentry into the Regulatory Element?
      A. No. A federal or state regulatory authority or self-regulatory organization may require re-entry into the Regulatory Element as part of a sanction in a disciplinary matter.
      33.
      Q. How will the registration date be calculated for individuals who have acquired multiple registrations (For example: The Series 6 in 1988 plus the Series 7 in 1991)?
      A. The original registration date (1988 in the above example) will be used, provided that the person has remained continuously registered since that time.
      34.
      Q. How will temporary lapses in registration be handled?
      A. These will be treated similar to the way in which qualification testing is handled. If individuals become unregistered for less than two years, they will maintain their original registration date, but will first be required to participate in any Regulatory Element program that may have been missed during the period in which they were unregistered. For example, an individual whose registration lapses at four and a half years who wishes to reactivate at what would be his/her six-year anniversary must complete the fifth year Regulatory Element before reactivation of registration.
      35.
      Q. What will be the status of a person who becomes unregistered for a two-year period or more?
      A. This person would begin the entire registration process anew. He or she would be required to take the appropriate qualification examinations) and would enter the Regulatory Element at the beginning of its 10-year cycle.
      36.
      Q. What regulatory consequences will result when an individual does not complete the required continuing education?
      A. Non-compliance with Regulatory Element requirements will result in an individual's registration being deemed inactive until he/she fulfills all applicable elements. Firms must ensure that those deemed inactive are not permitted to engage in activities requiring registration. Failure to comply with Firm or Regulatory Element requirements may subject the firm and individuals to disciplinary action.
      37.
      Q. Will firms that are members of two or more SROs be subject to redundant inspections for compliance with the continuing education requirements?
      A. The SROs will coordinate their field inspection efforts to avoid any unnecessary regulatory overlap for joint members. The SROs are especially committed to developing a consistent approach to examining for and enforcing the Firm Element requirements.

    • 94-58 SEC Approves New NASD Limit Order Protection Rule

      SUGGESTED ROUTING

      Senior Management
      Institutional
      Legal & Compliance
      Systems
      Trading

      Executive Summary

      On June 29, 1994, the Securities and Exchange Commission (SEC) approved a proposed Interpretation to Article III, Section 1 of the NASD Rules of Fair Practice that prohibits a member firm from trading ahead of its customer's limit orders in a firm's market-making capacity.1 Accordingly, the Interpretation is now in effect.

      Approval of the Limit Order Protection Interpretation thus eliminates the so-called "Manning safe harbor" that permitted a member firm to trade ahead of its customers' limit orders in the firm's market-making capacity if the firm adequately disclosed to its customers that the firm may accept a limit order and then trade ahead of it in the process of discharging its market-making obligations. The enactment of this Limit Order Protection Interpretation by the NASD reflects the ongoing effort of the NASD and The Nasdaq Stock Market, Inc., to ensure investor protection and enhance market quality. The affirmative obligation for a firm to protect its customer's limit orders and to give those orders standing over its own market-making activity enhances opportunities for price improvement that directly benefit public investors.

      Background And Description Of The Interpretation

      The issue of limit-order protection in The Nasdaq Stock Market™ was highlighted in 1985 when a customer alleged that a member firm accepted his limit order, failed to execute it, and failed to discharge its fiduciary duties by trading ahead of the customer's order without notifying the customer that it was doing so. In the Manning decision, the SEC affirmed the findings of an NASD disciplinary proceeding whereby the NASD determined that, upon accepting a customer's limit order, a member undertakes a fiduciary duty and cannot trade for its own account at prices more favorable than the customer's limit order unless the member provides clear disclosure and the customer understands the priorities that will govern the order.2

      In July 1993, the NASD Board of Governors reviewed the background of the Manning disclosure safe harbor and voted to replace it with the Limit Order Protection Interpretation that would eliminate the Manning safe-harbor approach and prohibit a member from trading ahead of a customer's limit order. Because of the significance of the change to The Nasdaq Stock Market, the Board authorized a Notice to Members soliciting comment on how elimination of the safe harbor and adoption of rules prohibiting trading ahead of customer limit orders would affect the operation of member firms and the treatment of investors' orders.3 The Board also solicited comment on any unintended effects or unacceptable consequences of any new requirements on member firms. Specifically, comment was requested on the impact of the requirements on an integrated broker/dealer handling its own customer order flow, on customers limit orders received from other member firms (member-to-member trades), and on market liquidity.

      After full consideration of the concerns articulated during the comment process, the Board reaffirmed its decision to eliminate the disclosure safe harbor and to adopt the Limit Order Protection Interpretation.4 In light of numerous comments from member firms of the adverse market impacts that could result from application of the Interpretation to member-to-member limit orders, however, the Board determined to defer application of the Interpretation to these limit orders until a special task force could examine the ramifications of extending the Interpretation to include these limit orders. Accordingly, the Limit Order Protection Interpretation approved by the SEC does not apply to member-to-member limit orders.

      Under the Interpretation approved by the SEC, a member firm cannot accept and hold its customer's limit order in a Nasdaq security and continue to trade that security for its own market-making account at prices that would satisfy the customer's limit order. The Interpretation, however, does not mandate that a member firm accept limit orders from its customers.

      In addition, the Board recognized that member firms handling and committing substantial capital to institutional orders generally have reached a separate understanding as to the execution parameters for those orders. Accordingly, the Interpretation provides that a firm may attach terms and conditions governing the acceptance of a limit order, provided that such terms and conditions are made clear to the customer at the time that the order is accepted.

      Following are answers to questions frequently asked about the Interpretation.

      Question #1: Must a firm accept a customer's limit order?
      Answer: No. The Interpretation specifically provides that the NASD does not impose any obligation upon members to accept and handle limit orders from any or all of its customers.
      Question #2: If a firm assesses commission-equivalent charges on its customers' limit orders, does the Interpretation require that the firm not trade ahead of the limit order at the "gross" limit price (including the commission-equivalent charge), or at the "net" limit price (excluding the commission-equivalent charge)?
      Answer: The interpretation requires that the firm provide protection for customer limit orders at the "net" limit price, exclusive of any markup, markdown, commission, or commission equivalent charged. If a member intends to protect a customer limit order at a price net of an amount equal to a sales credit or other internal credit charged, then the price at which the limit order is to be protected must be clearly explained to the customer. Any transaction effected by the member at a price equal or superior to the price agreed upon with the customer for protection of the limit order will obligate the member to immediately execute such limit order.
      Question # 3: Does the Interpretation apply to limit orders placed by large institutions?
      Answer: The Interpretation does not distinguish between institutional and retail customers because language in the Interpretation that allows members to establish specific terms and conditions on each order clearly encompasses the handling of institutional orders. The NASD notes that filling institutional-sized orders generally involves best-effort commitments and the commitment of substantial capital that many times results in agreement upon separate execution parameters. Accordingly, members accepting institutional orders on a best-efforts basis that may involve trading to cover a short position or buying stock along with the institution would not violate the Interpretation as long as the member maintains a clear understanding with its clients of the terms and conditions under which the order is being executed.
      Question #4: Does the Interpretation require a member to disclose the terms and conditions under which it will accept a limit order in a particular fashion?
      Answer: The Interpretation provides that the terms and conditions under which customer limit orders are accepted by a firm must be made clear to customers at the time their orders are accepted so that trading ahead in the firms' market-making capacity does not occur. Thus, the Interpretation clearly mandates clarity and specificity by the firms in making each of their customers aware of the terms and conditions under which their limit orders are accepted. However, the Interpretation does not dictate the means by which members must make this disclosure. The SEC also stated that the Interpretation "establishes that a member holding its customer's limit order may not continue to trade for its own position without executing that limit order under the specific terms and conditions that the customer understands and accepts."
      Question #5: If a member provides an automated service for the entry of limit orders without human intervention, is the member still obligated to disclose the specific terms and conditions under which it will accept each limit order?
      Answer: Regardless of how a limit order is transmitted by a customer to a member, the Interpretation clearly mandates clarity and specificity by the firms in making each of their customers aware of the terms and conditions under which their limit orders are accepted.
      Question #6: If a member firm routes limit orders to an affiliated firm for execution, are these limit orders subject to the Interpretation or are they considered member-to-member limit orders?
      Answer: For purposes of the Interpretation, if a member controls or is controlled by another member, both members shall be considered a single entity. Thus, if a customer's limit order is accepted by one affiliate and forwarded to another affiliate that it controls for execution, the firms are considered a single entity and the market-making unit must protect the limit order as if it were its own and, thus, may not trade ahead of that limit order.

      It is a facts-and-circumstances analysis to determine whether one member controls or is controlled by another member. For example, the NASD would view the following factors as indications of a "control" relationship between two members:
      •  common ownership;
      •  the existence of a common parent corporation or partnership;
      •  ownership by one member of a significant amount of the voting securities of another member; or
      •  ownership by one member of a significant partnership interest in another member.
      NASD staff is available to assist members in determining whether a "control" relationship may exist between the member and another firm.
      Question #7: Does the Interpretation apply to orders routed by one firm to another for execution?
      Answer: Assuming the two firms are not deemed to be one entity under the Interpretation because of a "control" relationship, the Interpretation does not apply to member-to-member limit orders. The NASD is reviewing the appropriateness of application of the Interpretation to these orders. Any expansion of the scope of the Interpretation to include these orders will require NASD Board and SEC approval.

      In addition, the Interpretation emphasizes that any member accepting customer limit orders owes those customers duties of "best execution" regardless of whether the orders are executed through the member's market-making capacity or sent to another member for execution. Accordingly, the Interpretation reiterates that the best execution Interpretation requires members to use reasonable diligence to ascertain the best inter-dealer market for the security and buy or sell in such a market so that the price to the customer is as favorable as possible under prevailing market conditions. The Interpretation also emphasizes that order-entry firms should continue to routinely monitor the handling of their customers' limit orders regarding the quality of the execution received.
      Question #8: If a firm holds a customer limit order to buy 500 shares of XYZ at 20 1/4 and purchases 200 shares of XYZ at 20 1/8 in its market-making capacity, must the market maker execute the full 500 shares at 20 1/4 or only 200 shares at 20 1/4? Would the answer be the same if the limit order were an all-or-none (AON) order?
      Answer: The market maker need only execute 200 shares of the limit order in this instance. However, the market maker would have to continue to protect the remaining 300 shares. If the limit order were an AON order, the market maker would not have to execute the limit order unless the market maker traded in an amount equal to or greater than the size of the AON limit order.
      Question #9: Does the Interpretation apply to odd-lot orders?
      Answer: No.
      Question #10: Do Small Order Execution System (SOESSM) trades activate the execution of limit orders?
      Answer: Yes. Any transaction effected by a member at a price equal or superior to the price agreed upon with the customer for protection of the limit order will obligate the member to immediately execute such limit order.
      Question #11: If a non-market maker holds a customer limit order, can it trade ahead of that limit order?
      Answer: No. Even though the Interpretation speaks in terms of members trading in their market-making capacity, it would be inconsistent with a member's best execution obligation if the member were to trade ahead of a customer's limit order when it is not acting as a market maker in the security. It has never been the NASD's position that members can trade ahead of their customer's limit orders when not acting as a market maker.
      Question #12: Does the Interpretation apply to all Nasdaq® securities or just Nasdaq National Market® securities?
      Answer: The Interpretation applies to all Nasdaq securities.

      Questions regarding this Notice should be directed to James Cangiano, Senior Vice President, Market Surveillance, at (301) 590-6424; Glen Shipway, Senior Vice President, Nasdaq Market Operations, at (203) 385-6250; Robert Aber, General Counsel, at (202) 728-8290; or Thomas Gira, Assistant General Counsel, at (202) 728-8957.


      1 See Securities Exchange Act Release No. 34279 (June 29, 1994).

      2 In the Matter of E.F. Button & Co., Securities Exchange Act Release No. 25887 (July 6, 1988).

      3 See Notice to Members 93-47 (July 23, 1993).

      4 See Notice to Members 93-67 (October 1993).


      Text Of Interpretation To Article III, Section 1 Of The NASD Rules Of Fair Practice

      To continue to ensure investor protection and enhance market quality, the NASD Board of Governors is issuing an Interpretation to the Rules of Fair Practice dealing with member firm treatment of their customer limit orders in Nasdaq securities. This Interpretation will require members acting as market makers to handle their customer limit orders with all due care so that market makers do not "trade ahead" of those limit orders. In the interests of investor protection, the NASD is eliminating the so-called disclosure "safe harbor" previously established for members that fully disclosed to their customers the practice of trading ahead of a customer limit order by a market-making firm.

      Interpretation

      Article III, Section I of the Rules of Fair Practice states that:

      A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade.

      The Best Execution Interpretation states that: In any transaction for or with a customer, a member and persons associated with a member shall use reasonable diligence to ascertain the best inter-dealer market for the subject security and buy or sell in such a market so that the resultant price to the customer is as favorable as possible to the customer under prevailing market conditions. Failure to exercise such diligence shall constitute conduct inconsistent with just and equitable principles of trade in violation of Article III, Section 1 of the Rules of Fair Practice.

      In accordance with Article VII, Section 1(a)(2) of the NASD By-Laws, the following interpretation under Article III, Section 1 of the Rules of Fair Practice has been approved by the Board:

      A member firm that accepts and holds an unexecuted limit order from its customer in a Nasdaq security and that continues to trade the subject security for its own market-making account at prices that would satisfy the customer's limit order, without executing that limit order under the specific terms and conditions by which the order was accepted by the firm, shall be deemed to have acted in a manner inconsistent with just and equitable principles of trade, in violation of Article III, Section 1 of the Rules of Fair Practice. Nothing in this section, however, requires members to accept limit orders from their customers.

      By rescinding the safe harbor position and adopting this Interpretation of the Rules of Fair Practice, the NASD Board wishes to emphasize that members may not trade ahead of their customer limit orders in their market-making capacity even if the member had in the past fully disclosed the practice to its customers prior to accepting limit orders. The NASD believes that, pursuant to Article III, Section 1 of the Rules of Fair Practice, members accepting and holding unexecuted customer limit orders owe certain duties to their customers that may not be overcome or cured with disclosure of trading practices that include trading ahead of the customer's order. The terms and conditions under which customer limit orders are accepted must be made clear to customers at the time the order is accepted by the firm so that trading ahead in the firms' market-making capacity does not occur. For purposes of this Interpretation, a member that controls or is controlled by another member shall be considered a single entity so that if a customer's limit order is accepted by one affiliate and forwarded to another affiliate for execution, the firms are considered a single entity and the market-making unit may not trade ahead of that customer's limit order.

      The Board also wishes to emphasize that all members accepting customer limit orders owe those customers duties of "best execution " regardless of whether the orders are executed through the member's market-making capacity or sent to another member for execution. As set out above, the best execution Interpretation requires members to use reasonable diligence to ascertain the best inter-dealer market for the security and buy or sell in such a market so that the price to the customer is as favorable as possible under prevailing market conditions. The NASD emphasizes that order-entry firms should continue to routinely monitor the handling of their customers' limit orders regarding the quality of the execution received.

    • 94-57 Nasdaq National Market Additions, Changes, And Deletions As Of June 28, 1994

      SUGGESTED ROUTING

      Legal & Compliance
      Operations
      Systems
      Trading

      As of June 28, 1994, the following 68 issues joined the Nasdaq National Market®, bringing the total number of issues to 3,688:

      Symbol

      Company

      Entry Date

      SOES Execution Level

      ABRX

      ABR Information Services Inc.

      5/26/94

      200

      FRES

      Fresh America Corp.

      5/26/94

      500

      LZTN

      Lazer-Tron Corporation

      5/26/94

      200

      NPSP

      NPS Pharmaceuticals, Inc.

      5/26/94

      500

      NFLD

      Northfield Laboratories, Inc.

      5/26/94

      1000

      OCTA

      Octagon, Inc.

      5/26/94

      500

      OCTAW

      Octagon, Inc. (Cl A Wts exp 2/16/99)

      5/26/94

      200

      PENN

      Penn National Gaming, Inc.

      5/26/94

      500

      QHGI

      Quorum Health Group, Inc.

      5/26/94

      200

      SMCO

      Simpson Manufacturing Co., Inc.

      5/26/94

      200

      WINN

      Winston Hotels, Inc.

      5/26/94

      500

      TRPS

      Tripos Inc.

      5/31/94

      200

      MATE

      Matewan BancShares, Inc.

      6/1/94

      200

      PLLL

      Parallel Petroleum Corporation

      6/1/94

      200

      APHT

      Aphton Corp.

      6/2/94

      500

      LJPC

      La Jolla Pharmaceutical Company

      6/3/94

      200

      LJPCW

      La Jolla Pharmaceutical Company (Wts exp 6/3/99)

      6/3/94

      200

      PSAI

      Pediatric Services of America, Inc.

      6/3/94

      200

      SIGA

      Sigma Circuits, Inc.

      6/3/94

      200

      WBCI

      WFS Bancorp, Inc.

      6/3/94

      200

      WAVE

      Wavefront Technologies, Inc.

      6/3/94

      1000

      DAWK

      Daw Technologies, Inc.

      6/6/94

      200

      FPBK

      First Patriot Bankshares Corporation

      6/6/94

      200

      MICM

      MICOM Communications Corp.

      6/6/94

      500

      APGG

      Apogee, Inc.

      6/7/94

      200

      EDUC

      Educational Development Corporation

      6/8/94

      200

      KBKC

      KBK Capital Corporation

      6/9/94

      500

      MTRN

      Metrotrans Corporation

      6/9/94

      200

      COGI

      Consolidated Graphics, Inc.

      6/10/94

      500

      IMAXF

      Imax Corporation

      6/10/94

      200

      CDPT

      CDP Technologies, Inc.

      6/14/94

      500

      DMED

      Diametrics Medical, Inc.

      6/14/94

      200

      FNBN

      FNBCorp.

      6/14/94

      200

      AECI

      American Electronic Components Inc.

      6/16/94

      200

      NSSY

      Norwalk Savings Society

      6/16/94

      200

      CINE

      Cinergi Pictures Entertainment Inc.

      6/17/94

      500

      CCSCR

      Coherent Communications Systems Corporation (Rts 7/21/94)

      6/17/94

      200

      CCSCV

      Coherent Communications Systems Corporation (WI)

      6/17/94

      200

      FHPCA

      FHP International Corporation (Pfd A)

      6/17/94

      500

      GEER

      Geerlings & Wade, Inc.

      6/17/94

      500

      GLFD

      Guilford Pharmaceuticals Inc.

      6/17/94

      500

      MTLI

      MTL, Inc.

      6/17/94

      500

      MODL

      Model Imperial, Inc.

      6/17/94

      200

      PHARY

      Pharmacia Corporation (ADR)

      6/17/94

      500

      VFLX

      Vanflex, Inc.

      6/17/94

      200

      TWHH

      Transworld Home HealthCare Inc.

      6/20/94

      200

      TWHHW

      Transworld Home HealthCare Inc.

      6/20/94

      200

      BPLX

      Bio-Plexus, Inc.

      6/21/94

      500

      DSfTR

      Interscience Computer Corporation

      6/21/94

      200

      INTRW

      Interscience Computer Corporation (Wts exp 11/15/96)

      6/21/94

      200

      CFWC

      CFW Communications Company

      6/23/94

      200

      STAF

      CareerStaff Unlimited, Inc.

      6/23/94

      1000

      CGRO

      Crop Growers Corporation

      6/23/94

      200

      FLMK

      Foilmark, Inc.

      6/23/94

      200

      GWRX

      Geoworks

      6/23/94

      500

      MRSA

      Marisa Christina, Incorporated

      6/23/94

      200

      TRND

      Trend-Lines, Inc.

      6/23/94

      500

      REDI

      Reddi Brake Supply Corp.

      6/24/94

      200

      TOWV

      Stratosphere Corporation

      6/24/94

      200

      TOWVW

      Stratosphere Corporation (Wts exp 2/22/99)

      6/24/94

      200

      THTX

      TheraTx, Incorporated

      6/24/94

      500

      THBC

      Troy Hill Bancorp, Inc.

      6/24/94

      200

      BPRXL

      Bradley Pharmaceuticals, Inc. (D Wts exp 12/9/96)

      6/27/94

      200

      MCBS

      Mid Continent Bancshares, Inc.

      6/27/94

      500

      WCII

      Winstar Communications, Inc.

      6/27/94

      200

      CLTDF

      Computalog Ltd.

      6/28/94

      500

      NPIX

      Network Peripherals, Inc.

      6/28/94

      500

      VJET

      ValuJet Airlines, Inc.

      6/28/94

      200

      Nasdaq National Market Symbol and/or Name Changes

      The following changes to the list of Nasdaq National Market securities occurred since May 26, 1994:

      New/Old Symbol

      New/Old Security

      Date of Change

      ONEC/CCAL

      OneComm Corp./Cencall Communications Corp.

      5/27/94

      ONECW/CCALW

      OneComm Corp.(Wts)/Cencall Communications Corp. (Wts)

      5/27/94

      XRAY/XRAY

      DENTSPLY International Inc/Dentsply International Inc.

      5/27/94

      MDAL/IMGA

      MedAlliance Inc/ImageAmerica Inc.

      6/1/94

      CITI7GACC

      Citicasters, Inc/Great American Communications Co.

      6/8/94

      DRAXF/DEPLF

      Draxis Health Inc/Deprenyl Research Ltd.

      6/9/94

      MOXY/MOXYV

      McMoran Oil & Gas Co. (S/D 6/17/94)/ McMoran Oil & Gas Co. (WI)

      6/13/94

      UMED/UMED

      Unimed Pharmaceuticals, Inc/Unimed Inc. Mark VII, Inc/MNX, Inc.

      6/16/94

      MVII/MNXI

      Latin American Casinos Inc/Repossession Auction Inc.

      6/20/94

      LACI/REPO

      Latin American Casinos Inc. (Wts 12/12/96)/

      6/20/94

      LACIW/REPOW

      Repossession Auction Inc. (Wts 12/12/96)

      6/20/94

      SILVW/SILVW

      Sunshine Mining and Refining Company (Wts 3/9/99) Sunshine Mining Company (Wts 3/9/99)

      6/21/94

      Nasdaq National Market Deletions

      Symbol

      Security

      Date

      AMPX

      Ampex Corporation (Cl A)

      5/26/94

      WTPR

      Wetterau Properties Inc.

      5/26/94

      STCP

      The Stephen Company

      5/27/94

      BNKW

      BankWorcester Corporation

      5/31/94

      CRGN

      Cragin Financial Corp.

      6/1/94

      EFTL

      Envirofil, Inc.

      6/1/94

      TFSB

      The Federal Savings Bank (New Britain, CT)

      6/1/94

      VYBN

      Valley Bancorporation

      6/1/94

      LDAKM

      LIDAK Pharmaceuticals

      6/2/94

      RADS

      Radiation Systems, Inc.

      6/6/94

      UNIF

      Uniflex, Inc.

      6/8/94

      CBCXE

      Cambridge Biotech Corp.

      6/9/94

      ENGY

      Energy Ventures, Inc.

      6/9/94

      SIDY

      Science Dynamics Corporation

      6/10/94

      LAIS

      Advanced Interventional Systems, Inc.

      6/13/94

      WMBS

      West Mass Bankshares, Inc.

      6/15/94

      GENC

      General Cable Corporation

      6/17/94

      TKCR

      TakeCare, Inc.

      6/17/94

      FEBC

      First Eastern Corp.

      6/20/94

      USCLQ

      USA Classic, Inc.

      6/21/94

      CMPX

      Comptronix Corporation

      6/22/94

      HSRS

      H.S. Resources, Inc.

      6/22/94

      KDON

      Kaydon Corporation

      6/22/94

      UWSI

      United Wisconsin Services, Inc.

      6/22/94

      MIKA

      Medical Imaging Centers of America, Inc.

      6/23/94

      QUAD

      Quadrex Corporation

      6/23/94

      ACLB

      Allied Clinical Laboratories, Inc.

      6/24/94

      CNTX

      Centex Telemanagement, Inc.

      6/24/94

      FORB

      Fortune Bancorp, Inc.

      6/24/94

      FORBP

      Fortune Bancorp, Inc. (Cum Conv Pfd A)

      6/24/94

      GTWY

      Gateway Financial Corporation

      6/27/94

      INBC

      Independence Bancorp, Inc.

      6/28/94

      SFTIF

      SOFTIMAGE Inc.

      6/28/94

      Questions regarding this Notice should be directed to Mark A. Esposito, Supervisor, Market Listing Qualifications, at (202) 728-8002. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-56 Fixed Income Pricing System Additions, Changes, And Deletions As Of June 28, 1994

      SUGGESTED ROUTING

      Senior Management
      Corporate Finance
      Institutional
      Legal & Compliance
      Municipal
      Operations
      Systems
      Trading

      As of June 28, 1994, the following bond was added to the Fixed Income Pricing SystemSM. This bond is not subject to mandatory quotation:

      Symbol

      Name

      Coupon

      Maturity

      CQB.GG

      Chiquita

      9.125

      3/1/04

      The bond listed above is subject to trade-reporting requirements. Questions pertaining to trade-reporting rules should be directed to Bernard Thompson, Assistant Director, NASD Market Surveillance, at (301) 590-6436.

    • 94-55 Members Reminded To Report Address, Contact Changes To NASD

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance
      Registration

      The Membership Department would like to remind members of the importance of keeping the names of executive representatives, as well as mailing addresses for branch offices, up to date. Making certain that Central Registration Depository (CRD) is kept informed of changes in address and contact people ensures that regular notices and special mailings will be properly directed. This is especially important at this time because we are approaching the period for elections.

      Article III, Section 3 of the NASD By-Laws requires each member to appoint and certify to the NASD one "executive representative." The executive representative of your firm must be a registered principal and a senior manager within the firm. The individual designated will represent, vote, and act in all NASD affairs, and will receive NASD mailings, including Notices to Members, Regulatory & Compliance Alert, and updates to the NASD Manual.

      To change the address for mailings sent to branch offices, or to update the contact name, a properly executed Schedule E of Form BD must be sent to CRD. Notifications submitted on U.S. Post Office address change cards cannot be processed.

      To change the executive representative of your firm, you must submit written notification to the NASD Corporate Secretary. The form to use for this purpose is included with this Notice. You may submit the original or a photocopy to:

      Joan Conley
      Corporate Secretary
      c/o Membership Department
      9513 Key West Avenue
      Rockville,MD 20850.


      EXECUTIVE REPRESENTATIVE FORM

      Date: __________________________________________________________________

      NASD Member Firm:._____________________________________________________

      FirmCRD#:______________________________________________________________

      The NASD Member Firm referenced above designates (name)__________________________,

      Social Security #_________________________, CRD #_________________________ , as

      Executive Representative to the NASD as of (date)_____________________________. This

      person is a member of the firm's senior management and is a registered principal with the firm.


      Name of person preparing this form:____________________________________________

      Telephone number:________________________________________________________

      Return this form to:

      Joan Conley, Corporate Secretary

      Executive Representative Program

      c/o Membership Department

      National Association of Securities Dealers, Inc.

      9513 Key West Avenue

      Rockville,MD 20850

    • 94-54 NASD Solicits Public Comment On Approaches Governing Award Of Punitive Damages In Arbitration

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance

      Executive Summary

      At its May 1994 meeting, the NASD Board of Governors approved the issuance of a Notice to Members soliciting comment on the Report of the Subcommittee on Punitive Damages of the NASD Legal Advisory Board. The Report proposes a number of approaches that the NASD might adopt for the award of punitive damages in arbitration. Comments received on or before September 1, 1994, will be considered. The complete text of the Report follows this Notice.

      Background

      Since November 1992, a subcommittee of the NASD Legal Advisory Board (LAB)* has studied possible approaches to the award of punitive damages in arbitration, a difficult area with which both the NASD and its National Arbitration Committee (NAC) have grappled for a number of years. Set forth below is the final report of the LAB subcommittee.** Although the Board of Governors (Board) has yet to determine whether to endorse any or all of the recommendations contained in the report, the Board believes the Report, which is thoughtful and well researched, provides a useful framework for discussing this controversial area.

      Accordingly, the Board has determined to publish the Report for public comment.

      In reviewing the Report, several points should be borne in mind. First, it is the NASD's objective to develop an approach toward the award of punitive damages that will be fair to all arbitration participants, whether they are investors, associated persons, or member firms. The NASD urges commenters to consider the manner in which implementation of the individual recommendations would affect both claimants and respondents. In addition, the NASD welcomes any additional approaches that commenters believe would help achieve a fair balance of the interests of arbitration participants.

      Second, the Report is the product of a LAB subcommittee. Neither the full subcommittee nor the LAB as a whole necessarily agrees with any or all of the recommendations in the Report. Nonetheless, the LAB believes the Report's recommendations provide a useful discussion vehicle, and the Board shares this view.

      Third, the Report's recommendations should not be viewed as a "package." Rather, the recommendations represent alternatives that the LAB subcommittee believes the NASD should consider adopting, whether individually or in combination.

      Fourth, in reviewing the Report, commenters should bear in mind that certain changes have occurred since the Report was finalized in October 1993. These changes relate to the following portions of the Report:

      • Section III(D) of the Report recommends that the NASD establish a system for referring arbitration cases to an enforcement body as an alternative to awarding punitive damages. Since the Report was finalized, the Board approved an NAC recommendation to amend Section 5 of the Code of Arbitration Procedure so as to reinforce arbitrators' inherent authority to initiate disciplinary referrals. The amendment, filed with the Securities Exchange Commission (SEC), is awaiting approval.

      • Section III(E) of the Report recommends the creation of an offer of judgment rule that would be modeled after Rule 68 of the Federal Rules of Civil Procedure. As proposed by the subcommittee, the offer of judgment rule would entitle the defending party to make an offer of judgment until several days before an arbitration hearing. If such an offer were declined and the final award assessed were less than the offer of judgment, the arbitration claimant would be required to reimburse the offerer for costs incurred after the date of the offer. As noted in the Report, the NASD has requested SEC approval of a rule change that would establish a variant of the offer of judgment procedure recommended in the Report. Since the Report was finalized, the SEC published the NASD's proposal for comment. The comments received were overwhelming negative, and the SEC staff requested that the NASD consider withdrawing the proposal. On May 27, 1994, the proposal was withdrawn to permit the NASD to review possible revisions to the proposal that could be made with a view toward resubmission.

      NAC Action

      Commenters should be aware that since early 1991 the NAC has been studying the issue of punitive damages, and has independently considered several of the approaches discussed in the Report. As summarized below, the NAC has reached conclusions that are in varying degrees consistent or inconsistent with the recommendations of the LAB subcommittee.

      • Rationale for Award of Punitive Damages—The NAC has recommended that all awards of punitive damages articulate the legal standard applied in determining to award such damages, as well as the facts that the arbitrators found to constitute a basis for the award. The NAC believes that requiring such articulation will, among other things, alert members of the securities industry to the types of conduct that can lead to punitive damages, and thereby deter similar conduct in the future. Thus, the views of the NAC are generally consistent with those set forth in Section III(A) of the Report.

      On a related issue, the NAC has recommended that arbitrators be deemed to have exceeded their authority when the facts they cite as warranting the award of punitive damages fail to satisfy the applicable legal standard. This recommendation is intended to facilitate vacatur of punitive damage awards under existing juridical standards, which generally preclude appeals of arbitration awards.

      • Appeals—The NAC has proposed making an appellate review process available within the NASD for awards of punitive damages that exceed $200,000, or the denial of punitive damages when compensatory damages exceed $200,000. In contrast, Section III(B) of the Report proposes that only decisions to award punitive damages (not decisions to deny requests for such damages) be appealable.

      • Arbitration Training-Section III(C) of the Report recommends enhancements to arbitrators' qualifications and training. Based on an NAC recommendation, mandatory arbitrator training has been in effect since early 1993. Topics covered in the mandatory training include assessment of damages (including punitive dam ages and the relevant standards). In addition, an accelerated training pro gram implemented in 1993 gives particular emphasis to the training of persons who chair arbitration panels. Thus, commenters should be aware that the NASD has already undertaken steps to improve the quality of arbitrator training.

      • Standard for Award of Punitive Damages—The NAC, Like the LAB subcommittee, recommends standardization of the level of scienter that must be demonstrated before punitive damages may be awarded. Further, both the NAC and the LAB subcommittee generally agree that punitive damages should not be awarded on the basis of vicarious liability. See Section III(F) of the Report.

      • Bifurcation—Section III(H) of the Report recommends bifurcating arbitration proceedings so as to separate consideration of punitive damages from other aspects of the arbitration proceeding. The NAC has previously rejected this concept on grounds that it would increase costs and delay the arbitration process.

      • Caps on Awards of Punitive Damages—Section III(I) of the Report recommends imposing caps on punitive damages. Although the NAC initially rejected caps out of concern that they might increase the incidence of punitive damage awards, the NAC subsequently revisited the issue, and now believes that caps would be acceptable if tied to a formula, such as a stated multiple of compensatory

      • Sharing Punitive Damage Awards with Regulators—Section III(J) of the Report recommends requiring arbitration complainants to share a portion of punitive damage awards with state, federal, or quasi-governmental regulators. The NAC has rejected such a requirement based on questions that certain courts have raised as to the permissibility of such sharing, as well as indications that SEC staff would not be supportive of such a proposal.

      Request for Comments

      The Board is soliciting comments from members and interested persons to assist the NASD in arriving at standards governing the award of punitive damages that will be fair to all arbitration participants. Comments must be submitted no later than September 1, 1994, and be addressed to Joan C. Conley, Corporate Secretary, National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.


      * The LAB was created in 1988 as a standing committee of the Board of Governors to offer advice to and initiate ad hoc assignments for the Board. Prominent members of the private securities bar, in-house counsel for Nasdaq issuers, and academicians who specialize in securities law have served on the LAB since the group's formation. The current chairman of the LAB is David S. Ruder, former Chairman of the Securities and Exchange Commission and a former member of the NASD Board of Governors.

      ** Sanford Rrieger (Fried, Frank, Harris, Shriver & Jacobson, New York, New York), Robert N. Rapp (Calfee, Halter & Griswold, Cleveland, Ohio), and John R. Worthington (MCI Communications Corporation, Washington, D.C.) have served on the subcommittee, which is chaired by Arthur F. Mathews (Wilmer, Cutler & Pickering, Washington, D.C.).


      Report Of The Subcommittee On Punitive Damages Of The NASD Legal Advisory Board

      Introduction

      The Subcommittee on Punitive Damages recommends that the NASD place significant limitations on the award of punitive damages in NASD arbitrations. Awards of punitive damages in securities arbitration have associated costs that often outweigh their benefits. The NASD should establish stringent guidelines to ensure that arbitrators only award punitive damages in the most meritorious cases, and award them only in accordance with a procedure that properly and fairly affords respondents sufficient procedural due process to protect against excessive and arbitrary punitive awards.

      Part I of this Report provides background on recent trends in securities arbitration including the award of punitive damages and surveys the issues that courts have been struggling with in connection with the award of punitive damages by courts and juries, as well as in arbitration. Part II presents the reasons we believe punitive damages should be circumscribed. Finally, Part III sets forth a series of guidelines that we recommend the NASD should adopt to govern the award of punitive damages in securities arbitration.

      I. Recent Trends in Securities Arbitration Law
      A. Recent General Trends in Securities Arbitration

      The number of securities arbitrations has grown by leaps and bounds in recent years. In 1992 alone, the number of customer arbitrations filed with self-regulatory organizations ("SRO's") was between 5,000 and 6,000.1 This contrasts sharply with approximately 800 filed in 1980. Although this increase may be due in part to the rise in business activity over that time, it is clear that there is a trend toward both customers and brokerage firms choosing arbitration over litigation as a forum for resolving securities disputes.2

      The growth in arbitration is rooted in the Supreme Court's sanction of securities arbitration in recent years. Until the late 1980's, disputes under the federal securities laws could not be subject to compulsory arbitration because there was no assurance that the rights prescribed by the federal securities laws would be vindicated through arbitration.3 In 1987, however, the Supreme Court ruled that Congress had expanded the power of the Securities and Exchange Commission sufficiently to ensure the adequacy of arbitration procedures and to ensure that arbitration would do justice to plaintiffs' rights under the securities statutes.4 The Court's ruling, coupled with a longstanding federal policy favoring arbitration, guaranteed that courts would interpret arbitration agreements liberally.5

      In addition to the jump in the volume of arbitrations, the dollar amounts of the awards in securities arbitrations have been rising as well. The total dollar value of punitive damages awarded in the first half of 1992 more than doubled from that of previous six-month periods, although the total number of awards remained relatively constant. The proportion of punitive to compensatory awards rose as well from .7-to-1 to 1.3-to-1.6 Examples of large punitive awards from NASD arbitrators in 1992 alone are awards of $3.5 million,7 $1.7 million,8 $l million,9 and $505,000.10 This trend is likely to continue. On October 11, 1993, an NASD arbitration panel ordered Dean Witter to pay $700,000 in punitive damages to a former branch manager, who alleged that he was defamed and that he was terminated for refusing to condone certain illegal activities.11
      B. The Murky Law of Punitive Damages in Securities Arbitration

      The award of punitive damages in securities arbitration, like arbitration itself, is a hybrid. The Securities Exchange Act of 1934, the principal federal statute relied upon in most securities litigation, expressly prohibits the award of punitive damages.12 However, punitives are permitted under most states' laws, hi fact, all states, except nine, provide that punitive damages may be awarded to civil plaintiffs in addition to compensatory damages.13

      A much more murky area of the law is whether and under what circumstances arbitrators of securities disputes may award punitive damages. The Federal Arbitration Act ("FAA") does not specifically provide for punitive damages in arbitration. The FAA, enacted in 1947,14 codified the United States Arbitration Act passed originally in 1925.15 The purpose of the 1925 Act was to "make valid and enforcible [sic] agreements for arbitration contained in contracts involving interstate commerce ... or which may be the subject of litigation in the Federal courts."16

      The current version of the FAA provides that arbitration agreements shall be "valid, irrevocable and enforceable,"17 and courts have interpreted the FAA as a "congressional declaration of a liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary."18 In light of this federal policy, courts have given "precedence to the contract provisions allowing punitive damages" even if the parties apply a state's law that bars punitive damages in arbitration.19

      In addition to the FAA and the courts' interpretations of that statute, the Uniform Code of Arbitration and the Securities Industry Conference on Arbitration ("SICA") have sanctioned punitive damages. SICA, which is composed of representatives of the SRO's, the Securities Industry Association and members of the public, is responsible for formulating the Uniform Code of Arbitration. The Uniform Code is the model arbitration code available for use by SRO's. SICA discusses the Code in its Arbitrator's Manual, which states that "arbitrators can consider punitive damages as a remedy."20

      The American Arbitration Association, which is the primary arbitral forum that is not operated by an SRO, and the NASD, have both approved of punitive damages, at least tacitly. The NASD itself has stated that pre-dispute arbitration agreements should not limit the ability of arbitrators to make "any award."21 The AAA has stated that arbitrators may grant "any remedy or relief' which they deem "just and equitable and within the scope of the agreement of the parties... ."22

      The confusion over whether arbitrators may award punitive damages arises when state law bans or limits punitive damages in arbitration or otherwise. Often, parties contract to apply New York law, or another state's law that prohibits punitive damages in arbitration, and at the same time, contract to apply the rules of the AAA, which allows them. A court reviewing an award of punitives rendered in an arbitration must reckon it with the relevant state law, and when that law disallows punitives, many judges are left scratching their heads. The leading case proscribing punitive damages in arbitration is the New York case of Garrity v. Lyle Stuart. Inc.23

      In Garrity, the court ruled that, under New York law, an arbitrator is not permitted to award punitive damages, even if the parties choose to allow them.24 The court based its reasoning first on the notion that the power to award punitive damages is reserved to the state, and second, on procedural defects in the arbitration process such as the lack of a mechanism to review awards and arbitrators' unbridled discretion in making them.25

      After the decision in Garrity. courts have split on whether to allow punitives in arbitration when state law prohibits them. Some courts have held that punitive damages are permitted in arbitration, even if the parties explicitly apply New York law, because the parties explicitly or implicitly agreed to punitive damages in their agreement.26 The rationale of these courts is that a choice of law provision merely designates the substantive law to be applied in determining whether the conduct of the parties was illegal. The choice of law provision does not deprive the arbitrators of their power to award punitive damages. According to these courts, this power is vested in arbitrators by dint of their choice to arbitrate in accordance with the rules of the AAA, and the FAA gives force to the wishes of the parties.27 Conversely, courts have held that if the parties do not explicitly or implicitly agree to punitive damages, then they are not permitted in arbitration.28

      Other courts have backed away from a requirement of express or implied agreement for punitives. One court held that, even if the parties contract to apply New York law, the plaintiff has a right to punitive damages unless the parties specifically waive that right.29 Another held that because the arbitration contract was broad as to the matters subject to arbitration, the broad agreement included claims for punitive damages, thereby authorizing the arbitrator who heard the matter to grant punitives.30

      Thus, there is a tension, indeed a clash, between the rules of the AAA (and the FAA, which gives force to the rules), and state laws that bar or impede punitive damages. FAA rules govern an arbitration if three conditions are met: (1) the transaction involves interstate commerce;31 (2) the parties have signed a written agreement;32 and (3) there is an independent basis for federal jurisdiction.33 The FAA does not independently grant federal jurisdiction to plaintiffs in arbitration.34 Thus, if jurisdiction is based solely on diversity, state law governs the dispute, absent an agreement to the contrary.35

      Notwithstanding the applicability of the FAA to arbitration, the Act in and of itself does not guarantee the availability of punitive damages if the parties are silent on the question of punitive damages.36 In much the same way, the FAA does not confer an independent right to arbitration.37 It merely provides the right to arbitration according to the wishes of the parties as expressed.38 Thus, if an arbitration agreement applies state law, and is silent on the question of punitives, then state law governs the availability of punitive damages.39 However, if the parties evince an intent to allow punitive damages, then, as long as the FAA applies, punitive damages are allowed, even if state substantive law governs the arbitration.
      C. Constitutional Attacks on Punitive Damages, and the Supreme Court's Unclear Guidance

      Law reform advocates in a potpourri of recent law journal articles,40 as well as business defendants in a troika of Supreme Court cases commencing in 1989,41 have argued that "punitive damages punish defendants without employing the procedural safeguards of criminal law, thereby blurring the distinction between public and private law," and that "punitive damages raise due process concerns because the awards are irrational and unpredictable.42 Indeed, during the Bush Administration, measures to limit punitive damages were key features of former Vice-President Quayle's proposed Agenda for Civil Justice Reform.43

      In 1989, in Browning-Ferris Industries v. Kelco Disposal, Inc.,44 the Supreme Court rejected a constitutional claim that an award of punitive damages violated the Eighth Amendment's prohibition against excessive fines. In an antitrust suit based on predatory pricing allegations, plaintiff Kelco obtained a jury award of $51,000 in compensatory damages and $6 million in punitive damages.45 The Supreme Court did not address the question of whether punitive damages that are grossly disproportionate to compensatory damages violate traditional judicial principles of proportionality in punishment, that is, a rule of criminal law that insists that we "let the punishment fit the crime." Nor did the Supreme Court determine whether the magnitude of a punitive damage award is reviewable under the Due Process Clause of the Fourteenth Amendment. The Court expressly reserved the issue of "proportionality review" of punitive damage awards for a future case, acknowledging in dicta, however, that "[t]here is some authority in our opinions for the view that the Due Process Clause places outer limits on the size of a civil damages award made pursuant to a statutory scheme."46

      In Pacific Mutual Life Insurance Co. v. Haslip47 the Supreme Court affirmed a judgment where the jury awarded plaintiff Haslip a total damages award of $1,040,000, of which at least $840,000 was attributed to punitive damages. The punitive damages were more than four times the amount of compensatory damages and more than 200 times plaintiff Haslip's out-of-pocket expenses of approximately $3,500 to $4,000.48 The Supreme Court indicated that the Due process Clause puts limitations on punitive damage awards, and suggested that the punitive damages awarded plaintiff Haslip — four times greater than compensatory damages — were "close to the line" of constitutional impropriety.49

      In essence, the Haslip Court held that due process requires that any system, or scheme accommodating the award of punitive damages, contain sufficient procedural safeguards to assure that the size of "a punitive award is reasonably related to the goals of deterrence and retribution."50 In finding that Alabama's punitive damages scheme complied with requisite constitutional due process concerns, the Haslip Court considered the following important criteria51:
      (i) The conduct in question "evidenced intentional malicious, gross, or oppressive fraud."52
      (ii) The jury was not given unlimited discretion in determining whether to award punitive damages. The jury was instructed about (a) the discretionary nature of punitive damages, (b) the purpose of punitive damages (not to compensate the plaintiff, but rather to punish the defendant and to deter future misconduct), and (c) its duty to focus on the character and degree of the wrong. "The instructions thus enlightened the jury as to the punitive damages' nature and purpose, identified the damages as punishment for civil wrongdoing of the kind involved, and explained that their imposition was not compulsory."53
      (iii) There was sufficient post-trial review by the trial judge including procedures requiring the judge to reflect in the record the court's reasons for sustaining a punitive verdict or for setting it aside as excessive.54
      (iv) Appellate review in Alabama requires both a "comparative analysis" with other punitive awards allowed in similar cases, and an application of substantive standards including consideration of the following seven standards to assure that the punitive award does not "exceed the amount that will accomplish society's goals of punishment and deterrence."
      (a) whether there is a reasonable relationship between the punitive damages award and the harm likely to result from the defendant's conduct as well as the harm that actually has occurred; (b) the degree of reprehensibility of the defendant's awareness, any concealment, and the existence and frequency of similar past conduct; (c) the profitability to the defendant of the wrongful conduct and the desirability of removing that profit and of having the defendant also sustain a loss; (d) the "financial position" of the defendant; (e) all the costs of litigation; (f) the imposition of criminal sanctions on the defendant for its conduct, these to be taken in mitigation; and (g) the existence of other civil awards against the defendant for the same conduct, these also to be taken in mitigation.55
      (v) Even though the defendant's wealth was relevant to appellate review, the jury in Alabama was not allowed to consider defendant's wealth. "The fact finder must be guided by more than the defendant's net worth. Alabama's plaintiffs do not enjoy a windfall because they have the good fortune to have a defendant with a deep pocket."56
      The Haslip Court also noted in dicta that "there is much to be said in favor" of state legislatures creating rules regarding punitive damages, including the adoption of a heightened burden of proof — a standard of "clear and convincing evidence."57 Since 1991, at least four courts have found state punitive damages systems unconstitutional in light of the due process requirements articulated in Haslip.58

      Last term, the Court affirmed — by a plurality — a punitive damages award with a compensatory/punitive ratio of 526-to-1 in TXO Production Corp. v. Alliance Resources Corp.59 Notwithstanding the ruling, substantive and procedural due process protections for defendants who must pay punitives are alive and well.

      In the TXO case, the plaintiff, TXO, filed a declaratory judgment action against Alliance in West Virginia state court. The declaratory judgment was to remove a cloud on title to an interest in oil and gas development rights on a tract of land known as Blevins Tract. Earlier, Alliance agreed to assign its interest in the tract to TXO in exchange for royalties and agreed further to return the consideration paid if TXO's attorney determined that "title had failed."60 TXO brought the declaratory judgment action, when, according to the West Virginia Supreme Court of Appeals, TXO knew that it was a frivolous action and TXO's real intent was to reduce its royalty payments to Alliance.61 In addition to defending the declaratory judgment action, Alliance counterclaimed for slander of title. A West Virginia jury returned a verdict in Alliance's favor for $19,000 in actual damages and $10 million in punitive damages — 526 times the actual damages.62

      In upholding the award, Justice Neely of the West Virginia Supreme Court of Appeals ruled that punitive damages of this magnitude were suitable if the defendants were really mean, but punitives of only five times compensatory damages were suitable if the defendants were not "really mean" but merely "really stupid."63 Not surprisingly, the really mean defendants in TXO challenged the award on both substantive and procedural due process grounds.64

      The United States Supreme Court rejected both challenges and affirmed the award.65 The plurality opinion by Justice Stevens upheld the award based on the harm that was likely to occur, had TXO's scheme been successful, as opposed to the harm that actually occurred.66 Notwithstanding the fact that the Court affirmed the award, the Court left open the door to challenges to punitives damages under both substantive and procedural due process grounds.67 With respect to substantive due process, the plurality stated that whether a punitive damages award violates due process rests on a reasonableness test.68 In TXO, the award was appropriate based on four factors: (1) the amount at stake; (2) the bad faith of the party being punished; (3) the presence of a larger pattern of fraud, trickery and deceit; and (4) the wealth of the party being punished.69 Thus, defendants against whom punitive damages are imposed may argue that absent any one of these factors, an award of punitive damages that is highly disproportionate violates the substantive Due Process Clause.

      On the procedural due process front, the Court had less to say. The important point, however, is not that the plurality found no violation, but rather that it performed an analysis in the first place.70 In fact, earlier in the opinion, the plurality stated, "Assuming that fair procedures were followed, a judgment that is a product of that process is entitled to a strong presumption of validity."71 In addition, all of the Justices seemed to believe that a process that includes the availability of some sort of appeal of a punitive damages award is constitutionally necessary.72 Thus, there is no doubt that under existing Supreme Court precedent punitive damages are susceptible to procedural due process attacks.
      II. Arguments For and Against Punitive Damages in Securities Arbitration The Subcommittee believes that the NASD should strictly limit punitive damages in arbitration.73 Although there are certain justifications for them, punitive damages are, as a general rule, costly to administer and provide little deterrence above and beyond the civil, administrative and criminal enforcement provisions of federal and state securities laws. Thus, the NASD should limit punitive damages, as discussed in Part III below, to the few cases in which they would be most appropriate.
      A. Reasons to Limit Punitive Damages
      1. Due Process Guarantees, Required for Punitive Damages, are Inefficient to Administer

      In light of the Supreme Court decisions in Haslip and TXQ. and their progeny in federal and state courts, an award of punitive damages in securities arbitration triggers application of the due process guarantees of the United States Constitution. These guarantees are costly and difficult to administer and their application is reason enough to severely limit punitive damages in this forum. The Fourteenth Amendment applies when the state deprives "any person of life, liberty, or property, without due process of law ..." Thus, in order for due process protections to apply, there must be so-called state action.74 The state action must go beyond mere acquiescence of private action in a state or federal statute;75 there must be "something more" than that.76 The award of punitive damages in arbitration is state action that meets the "something more" test for at least two reasons: imposing punitive damages is a public function, and, the government compels membership in an SRO.

      According to the public function theory, if private persons engage in governmental functions — assume the role of the state — their activities are subject to the same Constitutional restrictions that are imposed on the state itself.77 Awarding punitive damages — awarding any damages —is a traditional public function reserved to the state and accomplished through judges and juries.78 Performing this public function satisfies the "something more" required by the Supreme Court. An award of punitives, by its nature, is state action.

      The second reason the award of punitives is state action is because the government compels participation in serf-regulatory organizations. Federal law requires broker/dealers to be members of SRO's, and as a result, to be subject to the SROs' rules of arbitration.79 The government may compel membership in an organization, but it may not do so if the organization's procedures would violate the Constitution if the procedures were imposed by the government itself.80 Private actors acting under state compulsion are considered state actors.81 Since the government could not impose punitive damages without providing the defendant due process guarantees, it cannot compel membership in the NASD unless the NASD provides similar guarantees.

      Although the Supreme Court held long ago that due process rights may be waived,82 the waiver process itself is cumbersome. Any waiver must be clear — voluntary, knowing and intelligent — and the consequences of the waiver must be disclosed.83 Thus, in order to obviate due process requirements in the arbitration context, each and every predispute agreement would have to contain, at a minimum, a statement explaining what rights the defendant is waiving and the consequences of that waiver.

      Moreover, Congress intended that self-regulatory organizations, in another context, provide due process protections. In section 15A of the Securities Exchange Act of 1934, Congress set forth elaborate procedural protections, to be provided by the SRO, for persons who are denied membership in the SRO and for members who are disciplined by it.84 Although disciplinary proceedings brought by an SRO is a different context than arbitration, the analogy makes it clear that Congress did not intend the SRO's to be immune from providing due process guarantees.85
      2. Effective Enforcement of the Securities Laws Reduces the Need for Punitive Damages in Arbitration

      Although there may be certain areas of the law where punitive damages are a necessary part of law enforcement, the securities area is not one of them. The capital markets in the United States are governed by a highly developed and technical set of laws and regulations enforced by federal and state law agencies, as well as by SRO's. Thus, punitive damages add little deterrence to the present system.

      First, the NASD itself is an effective regulator. NASD enforcement governs all aspects of the business of member firms and ensures that they "observe high standards of commercial honor and just and equitable principles of trade . . . ."86 NASD sanctions include fines, censure, suspension, bars, expulsion, restitution or any other fitting measure.87 The task of ensuring compliance with NASD rules rests with the NASD's District Business Conduct Committees (DBCCs) — the NASD's primary enforcement arm — located in each of the NASD's eleven districts. Responsibility for compliance also falls on the Market Surveillance Committee (MSC), which is similar to the DCBBs, but is a central review for cases involving possible violations of market-related NASD and SEC rules.88

      There are many avenues to trigger the NASD disciplinary process. Under the NASD Rules of Practice,89 any person who feels aggrieved by an act of a member may file a complaint with a DBCC. Arbitrators themselves may refer a matter to an SRO for disciplinary action if they feel that a rule or statute has been violated.90 Finally, according to the NASD's By-Laws, NASD members must report most allegations of misconduct to a Central Registration Depository, which the NASD monitors monthly.91 It is no wonder that NASD enforcement is rigorous. In fact, on several occasions, the SEC has approved of, and praised, the NASDs' disciplinary program.92

      Regulation by the SROs is only one level of securities enforcement. Also important is the web of federal securities laws enforced by the SEC (and other federal law enforcement officials). These statutes, and the SECs' historic enforcement program, are very effective. The SEC's enforcement powers have recently been augmented by passage of the Securities Enforcement Remedies and Penny Stock Reform Act of 1990.93 Among other things, the SEC may now bring an action in federal district court for civil penalties, assess monetary penalties in administrative proceedings against regulated entities, issue cease and desist orders, require disgorgement of ill-gotten gains, and seek orders prohibiting persons from serving as officers or directors of public companies. Although the SEC does not prosecute criminal violations of the securities laws, the Commission refers matters to the Department of Justice for criminal prosecution.94

      In addition to the federal statutes and regulations, the states have developed a wholly separate regime to regulate securities transactions. Today, virtually every state has blue sky laws administered by a state official who performs enforcement functions similar to those performed by the SEC.95
      3. The Present System Provides Sufficient Deterrence to Limit the Need for Punitive Damages in Arbitration

      Not only is there no enforcement gap in the regulation of securities, but the presence of punitive damages serves little purpose when viewed in light of the penalties that already exist. Many of the penalties for securities laws violations have multipliers built into them that serve the same function as punitive damages. For example, the Remedies Act provides for enhanced civil monetary penalties if a violation involves fraud, deceit, manipulation, or deliberative or reckless conduct; it provides for even further enhancement if the harm resulted in substantial loss, or created a significant risk of substantial loss, to other persons.96 Similarly, the Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 provide for treble civil monetary penalties in some cases.97 Because these enhanced penalties exceed the net harm that the defendant caused, this provides the extra pinch required for deterrence; there is no reason to make further adjustments through punitive damages in private arbitration cases.98

      In addition, punitive damages are hardly necessary because other intangible costs, which are associated with any action brought against a broker-dealer, serve as a deterrent. The purpose of punitive damages is to penalize the defendant above and beyond punishment provided by compensatory damages alone. Although this rationale may be sensible in some contexts, it does not make sense here because the defendants are in the business of providing a service to the public. As a result, they face intangible costs every time they lose an arbitration: damage to their reputations — perhaps their most valuable asset.99 As providers of services, their reputations are essential to attract new business and maintain the old. Any firm's reputation is damaged by cases brought against it by disgruntled investors. This is sufficient incentive, above and beyond compensatory damages, to deter misconduct.
      4. Public Policy Concerns Are Implicated When Arbitrators Are Granted the Power to Award Punitive Damages

      One of the strongest reasons to limit punitive damages, and the one adopted by the court in Garrity. is that the power to punish as a general rule should belong to the state, not to an independent panel of arbitrators. As the Supreme Court has noted, punitive damages "are not compensation for injury. Instead, they are private fines levied by civil juries to punish reprehensible conduct and to deter its future occurrence."100 The fines are quasi-criminal,101 and, as such, public policy concerns favor that they should be levied by the state. The jury that awards punitive damages is, at a minimum, carefully controlled by the judge in the case, and presumably given a series of considerations to take into account in deciding whether to award punitives. An arbitration panel, however, has unlimited discretion to punish as it sees fit. Such discretion is anathema to our system of civil and criminal justice.
      B. Justification for Allowing Punitive Damages

      As discussed above, the deterrent value of punitive damages, and their contribution to the effective enforcement of the securities laws, or other rules governing brokers, have never been clearly demonstrated. Still, some members of the Subcommittee believe that justification for allowing punitive damages may be found in the marginal increase in deterrence that punitive damages provide. Federal and state legislative bodies have vested regulatory agencies and self-regulatory organizations with substantial disciplinary powers, and enforcement has historically been aggressive. Nevertheless, misconduct and disregard of duties owed to the investing public do continue to occur. The availability of punitive damages in securities arbitrations may be an incentive to sue, and, as such, increase the costs associated with particular misconduct and thus impact the incidence of wrongdoing.

      To be sure, there is an economic justification for allowing punitive damages.102 In an economic context, setting damages above the quantifiable harm can make sense. The cost of avoidance should be borne by the wrongdoer. The expected damages associated with a particular choice of action — presumably a reckless or intentional act — should be set higher than the actual harm if the result is a decrease in the probability that the offense will be committed. Blatant disregard of supervisory responsibility is one example of relative costs associated with choices of action that produce economic injury to investors. Compensating injured investors for actual loss associated with misconduct does not efficiently deter when viewed in relation to the cost of avoidance not incurred by the perpetrators and their organizations.

      It is not within the scope of this Report to engage in debate over an economic analysis of punitive damages. It must be recognized that there is an economic justification for such awards in securities arbitrations where the improper conduct is preventable at a cost. At the same time, it is possible to provide so many sanctions that brokers will be "overdeterred." Such overdeterrence will chill them from efficiently executing orders, providing new services, and so forth. This Subcommittee is not in complete agreement on the applicability and force of the arguments on either side. There is no doubt, however, that the continuing debate over the proper role of punitive damages in securities arbitrations must take into account notions of deterrence of intentional malicious, and reckless acts, compensation to the victim for such acts, and the smooth functioning of the securities markets.
      III. Recommendations to Govern the Award of Punitive Damages in Securities Arbitration

      For the above reasons, we recommend that the NASD limit punitive damages in arbitration and institute a series of procedures to guide their award. The following procedures would serve this purpose by making the award of punitive damages fairer and less arbitrary, and by ensuring that arbitrators award punitives in only the most appropriate cases.103
      A. Require Written Decisions in All Cases of Punitive Damages

      Arbitration panels awarding punitive damages should set forth in writing their reasons for doing so. There are several reasons for this seemingly mundane task. First, it will facilitate any appeal of the award of punitives, discussed below, which seems to be required after TXO and Haslip. Second, it is necessary to ensure that the public is clear on why the defendant is being punished. Although the written decision may not facilitate "specific" deterrence — the defendant will smart from any award of punitive damages and is unlikely to forget about it — it is necessary for "general" deterrence. The written decision is also important to ensure that there has been no due process violation. The defendant should fully comprehend why it is paying a punitive fine.

      The current NASD Code of Arbitration Procedure provides for only a cursory written decision. Although the awards must be in writing, they must include only the names of the parties and counsel, a summary of issues, the relief requested and awarded, a statement of issues resolved, and other names and dates.104 Similarly, the Securities Arbitration Rules of the AAA provide only that the award "shall be in writing, signed by a majority of the arbitrators, and shall include a statement regarding the disposition of any statutory claims.105 These requirements are insufficient. The NASD should demand a more detailed written decision providing the basis for the decision to award punitives, the basis for the amount, and findings of fact and conclusions of law.
      B. Institute a Right to Appeal an Award of Punitive Damages

      Any award of punitive damages should be appealable by the party against whom the award is rendered. The current system offers a very limited right to appeal in arbitration. The FAA authorizes review and vacatur under circumstances limited to procedural defects,106 and courts have interpreted this section narrowly.107 Errors of fact and law are not reviewable and thus cannot be the basis to vacate an arbitrator's award.108 However, after the TXQ and Haslip decisions, it is arguably unconstitutional to impose any punitive damages award that is not appealable. Although the TXO decision itself was a plurality, all of the Justices seem to agree that an appeal is constitutionally necessary.109

      The right to appeal an award of punitive damages should include an appeal of the amount of the award as well as the decision itself to award punitives.110 The right of appeal should belong only to the party against whom the damages are assessed. Since punitive damages are discretionary, it is always in the power of the arbitrators to withhold an award of punitives.111

      The appellate body should consist either of a three person committee of the NASD Board of Governors or of a panel of three experienced arbitrators drawn from a pool. The committee or panel would be available at all times to review the award of punitives. The appellate board will have to ensure itself, by using a standard of "clearly erroneous," that the arbitrators below found the requisite level of culpability — malicious intent — and that the intent was proven by clear and convincing evidence. If the appellate board is reviewing findings of law, the standard to be applied, as always, should be de novo. If the appellate panel also is reviewing the amount of damages, which may not be necessary if punitive damages are capped, it would have to employ another standard such as grossly or clearly excessive.
      C. Enhance Arbitrator Qualification. Training and Guidance

      The NASD must enhance arbitrator qualification. In order to resolve a case properly, the arbitrators need to conduct an inquiry usually done by experts. The SRO's, however, currently lack the controls necessary to ensure that arbitrators are well-qualified.112 The SRO's fail to verify background information provided by arbitrators, and they lack formal standards of education and experience necessary to qualify an arbitrator. The SRO's make no effort to determine the arbitrators' training needs and lack mandatory training for them.113 Thus, the NASD should focus carefully on qualification and establish a system to carefully select and train arbitrators. The system should focus on their backgrounds and experiences, as well as their performance in previous arbitrations. In addition, the NASD should provide to all arbitrators as guidance a written statement of the elements that must be found and the analysis that must occur, in determining whether, and if so, in what amount, punitive damages should be awarded. Such written statement of guidance presumably would summarize and synthesize all of the relevant factors noted in the Haslip and TXO cases.
      D. Establish a System of Referral to an Enforcement Body

      The NASD should require arbitrators to refer cases, in which they have awarded punitives, to an enforcement body, and to weigh whether referral to an enforcement body in lieu of awarding punitive damages is more apt in a particular case.114 This would not be a review or appeal of the arbitrator's decision, rather it would provide for a separate look at the defendant to make sure that it was properly sanctioned. The referral system could take several forms. For example, it could be limited to cases where arbitrators award punitive damages over a certain amount, or greater than a certain proportion to the compensatory award;115 or to cases where arbitrators feel referral to an enforcement authority, in lieu of granting punitives to a single private plaintiff, better serves the interests of deterrence and retribution. Limiting referral to only large punitive awards might encourage arbitrators to keep their awards low so that additional enforcement action is not taken against the defendant, yet some measure of punitives is awarded.

      The infrastructure for a referral system is already in place. Arbitrators could refer their cases to the NASD's District Business Conduct Committees. The DBCC's district examiners already report to the DBCC's on member compliance based on information collected through examination and surveillance.116 Thus, they are equipped to pursue reports filed by arbitrators.
      E. Institute an "Offer of Judgment" Rule

      The NASD should establish an "offer of judgment" procedure similar to Rule 68 of the Federal Rules of Civil Procedure.117 An offer of judgment rule would entitle the defending party to make an offer of judgment at any time up until several days prior to the arbitration. If the final judgment assessed against the defendant is less than the offer of judgment, the claimant would pay the costs incurred after the date of the offer. In order to have the intended effect, punitive damages would have to be included in determining the final judgment.118

      This rule would limit punitive damages to the cases in which they are truly called for. Unless plaintiffs are fairly certain that they will succeed in a claim for punitives, they will settle their claim for an offer of judgment of compensatory damages plus one cent. If the defendant makes this offer and the plaintiff refuses it, the only way the plaintiff can avoid paying costs is if the arbitrators award punitives. Otherwise, even a judgment in the full amount of compensatory damages requested by the plaintiff will be less than the offer of judgment. However, if plaintiffs are convinced that they will receive punitives, they can refuse the offer and hope for the best, knowing that they may be stuck paying all costs incurred after the day of the offer.

      Several variations on an offer of judgment are possible. If costs are small, one alternative is to require the plaintiff to pay, in addition to costs, part of the difference between the amount of the offer and the final judgment as a penalty.119 In most cases, this difference would likely be insignificant since the defendant has no incentive to make an offer of judgment far greater than the compensatory award, lest it actually be accepted. Moreover, this system unfairly penalizes plaintiffs who receive less than full compensatory relief for reasons that have nothing to do with punitive damages.120
      F. Increase the Level of Misconduct — Scienter —Required for Punitive Damages

      The NASD should standardize the level of scienter defendants must have before arbitrators can award punitives. The level required should be greater for punitives than for other types of damages; after all, the point is to punish the defendant above and beyond the punishment inflicted by compensatory damages. Thus, the defendant should have done something especially egregious to deserve an enhanced punishment. In TXO, the Supreme Court upheld the award of punitives based, in part, on TXO's bad faith and on the fact that the scheme employed was "part of a larger pattern of fraud, trickery and deceit. . . .121 Furthermore, many states' laws provide for a heightened level of scienter for punitive damages.122

      The level of scienter arbitrators presently require in cases where they award punitives is varied. In one recent arbitration, the arbitrators found that the misconduct was "reckless and callous" and found that the defendant showed "blatant disregard" for firm rules and industry rules and regulations.123 In several other cases the arbitrators found willful or intentional misconduct.124 In still others, the misconduct was merely "grossly negligent."125 In one case, the arbitration panel found only that the defendant violated an undefined "standard of supervision."126

      The standard should be increased to willful, wanton and malicious conduct before arbitrators may impose punitive damages. Anything short of this is not justified in light of TXO.127 and should not give rise to the serious sanction of punitive damages. Punitive damages are intended to target the few bad apples who purposefully harm the investing public for their own personal gain. They should not punish unduly the brokerage firm that acted negligently, or even recklessly. The compensatory damages that the defendant will no doubt have to pay in cases of negligence or recklessness will be sufficient to deter such conduct.

      A related question is whether arbitrators can award punitive damages vicariously against employers or whether the plaintiff must prove complicity. Broker/dealers may in some cases try to defend investor suits on the grounds that they were unaware of the conduct of their employees. It is not clear when courts will credit such defenses in federal securities law cases. Under section 20 of the Exchange Act128 and section 15 of the Securities Act129 liability extends to controlling persons such as employers, but both controlling person provisions contain good faith or "lack of knowledge" defenses. Furthermore, there is no clear guidance as to when principles of respondent superior or "duty to supervise" will trigger derivative liability.130 Whether punitive damages may be imposed vicariously is a question of state law,131 and most states allow it.132 Indeed, in Haslip, the Supreme Court sanctioned imposition by an Alabama state court of punitive damages against the defendant insurance company on a respondeat superior strict liability basis.133 A better approach, however, is the one at which Justice Kennedy hints in his concurring opinion in TXO. According to Justice Kennedy, the reason that the punitive damages in TXO were not violative of due process is because TXO acted with such extreme malice. Kennedy stated explicitly that a situation of vicarious liability would be different.134 Thus, punitives should not be imposed unless the employer itself acted maliciously.
      G. Increase the Standard of Proof Required Before Punitive Damages are Awarded

      In addition to enhancing the level of misconduct plaintiffs must prove before arbitrators may impose punitive damages, the NASD should enhance the standard of proof for that misconduct. Arbitrators do not generally enunciate a standard by which they find certain facts to be true; there is no reason to do so because the findings are not appealable. The standard which arbitrators should employ is "clear and convincing evidence." This standard is higher than "preponderance of the evidence" used generally for factual determinations in civil cases, but lower than "beyond a reasonable doubt" commonly associated with criminal cases. The standard is justified because of the nature of punitive damages: they are a punishment beyond compensatory damages but do not rise to the level of criminal fines. Approximately one-half the states, including New York, employ the heightened standard of proof of "clear and convincing evidence" for punitive damages.135 Colorado goes even further and requires proof "beyond a reasonable doubt."136
      H. Bifurcate the Proceeding for the Determination on Punitive Damages

      In order to implement a heightened standard for punitive damages — for both the level of misconduct required as well as the standard of proof of that misconduct — the NASD should bifurcate the arbitration proceeding and separate the decision to award punitives. In addition to the advantage of employing different standards for the award of punitives, bifurcation also would allow the parties to introduce evidence bearing on punitive damages that is not relevant — and may be prejudicial — to a determination of liability, such as evidence of the wealth of the defendant.137 Schwartz and Behrens in their recent law review article on Punitive Damages Reform138 point out that bifurcation "meets the spirit of the Haslip case and is supported by the American Law Institute . . . the American Bar Association, and the American College of Trial Lawyers."139 Recently, this concept has been accepted by the Tennessee Supreme Court in Hodges v. S.C. Toof & Co.140
      I. Place a Cap on Awards of Punitive Damages

      The NASD should place a cap on punitive damages. Caps on damages meet the competing goals of allowing arbitrators to award punitives where they deem them necessary while making sure that other arbitrators do not abuse their discretion and award punitive damages beyond a reasonable amount. Many state systems have limited punitive damages either by imposing an absolute dollar cap, or by limiting punitive damages in proportion to the compensatory award.141

      Similarly, in the arbitration context, the NASD could limit awards to a given dollar amount or anchor them to the compensatory award, or both. One possible scheme would be to limit punitive damages in all cases to a maximum of $250,000.142 In fact, 86 percent of all punitives awarded in securities arbitration over the past three years were less than $250,000. A cap of that amount seems more than adequate.143

      Another possible scheme would be to limit punitive damages to the amount of the compensatory award (a 1-to-1 cap). In fact, over the past three years, punitive damage awards averaged only 1.1 times compensatory awards.144 Thus, a cap of 1-to-1 would not unduly limit the arbitrator's discretion. If a 1-to-1 cap is not acceptable, the cap should in no case be greater than 2-to-1. A 2-to-1 cap is equivalent, in total damages, to the current treble damages structure of both the Clayton Antitrust Act145 and the Racketeer Influenced and Corrupt Organizations Act.146

      Finally, another scheme would be to institute the cap of the amount of the compensatory award and adopt a rule that in no case could the punitive award be over $500,000. The theory behind the two pronged limitation is that if the defendant is already paying over $500,000 in a compensatory award, the possibility of paying another $500,000 in addition to that is sufficient punishment and deterrence.147
      J. Divide the Award Between Plaintiff and Regulator

      The purpose behind punitive damages is to punish the broker-dealer, not to provide a windfall to the plaintiff. Thus, the NASD should provide that a portion of each award, such as sixty, seventy or even eighty percent, go to the state or federal government or to another quasi-governmental regulator. For example, portions of all punitive awards could be paid into the S.I.P.C. Fund. This system would alleviate the misguided incentives that drive certain undeserving plaintiffs (or their counsel) to seek punitive awards. In fact, nine states have similar schemes in place.148 The portion of the award to go to the public could be directed to the NASD itself or to any federal or state governmental agency including the federal or state treasury. Arbitration panels should be instructed that it would be improper to circumvent this scheme by enhancing an award so that the plaintiff receives the same award he would have received absent such a rule.
      K. Prioritize Payment so that Compensatory Damages are Paid First

      Defendants should pay punitive damages arising out of an action after paying all compensatory damages. Cases may arise where a broker/dealer has claims pending against it from multiple plaintiffs for both compensatory and punitive damages. In those cases, the defendant should pay all of the compensatory awards before paying the punitive awards.149 If a defendant is insolvent, or nearly insolvent, it is improper for one plaintiff to receive compensatory damages, plus a windfall of punitive damages, while a second plaintiff receives nothing.

      Conclusion

      The NASD should carefully limit punitive damages because they are costly and difficult to administer, and the purported benefits are not particularly well served in the securities arbitration context. The securities laws, and the sanctions they provide through SEC, SRO, and DOJ enforcement, at administrative, civil and criminal levels, are adequate to deter would-be violators of those laws. Thus, the NASD should adopt the guidelines, restrictions and procedures discussed in this Report to govern the award of punitive damages in securities arbitrations. These procedures would guarantee that any award of punitive damages does not violate due process under the Constitution and ensure that awards of punitives are fair, reasonable, and limited to appropriate cases.


      Endnotes

      1 See Howard Spierer, Explosion in Securities Arbitration Cases Explored by Section Panel. Litigation News, Feb. 1993 at 8; Jonathan M. Moses, Federal Prosecutors, in Rare Step. File Charges in Securities Arbitration Case. Wall Street Journal, Jan. 29, 1993 at A6; Carole Gould, Securities ADR: Is it Fair to Investors? 10 Alternatives to the High Cost of Litigation 165 (Nov. 1992).

      2 See, e.g., Edward W. Morris, Punitive Damages in Securities Arbitration. Rev. Sec. & Comm. Reg, at 167 (Sept. 21, 1988) (noting decision in Shearson/American Express. Inc. v. McMahon. 482 U.S. 220 (1987) and overburdened civil dockets caused shift from litigation to arbitration). According to a GAO Report, since arbitration clauses were first deemed enforceable in Shearson/American Express. Inc. v. McMahon. 482 U.S. 220 (1987), many fewer securities disputes are being litigated in the courts. See United States General Accounting Office, Securities Arbitration: How Investors Fare 48-49 (May 1992).

      3 See, e.g., Wilko v. Swan. 346 U.S. 427 (1953), overruled by. Rodriguez de Ouijas v. Shearson/American Express. Inc., 490 U.S. 477 (1989).

      4 McMahon. 482 U.S, at 238 (Exchange Act rights adequately vindicated under arbitration). Two years later, the Supreme Court expanded the holding in McMahon to include claims under the Securities Act. Rodriguez de Ouijas v. Shearson/American Express. Inc., 490 U.S. 477,484 (1989).

      5 Rodriguez de Ouijas. 490 U.S, at 481; see also Moses H. Cone Memorial Hosp. v. Mercury Constr. Corp., 460 U.S. 1,24(1983).

      6 5 Securities Arbitration Commentator. Chart D (May 1993).

      7 Gage v. CIGNA Sec. Inc., No. 90-01371, 1992 WL 123187, at *2 (NASD Mar. 10, 1992).

      8 Hickman v. PaineWebber. Inc., No. 90-03354, 1992 WL 390284, at *2 (NASD Sept. 9, 1992).

      9 Harper v. Shearson Lehman Bros., Inc., No. 91-00508, 1992 WL 233396, at *4 (NASD Mar. 26, 1992).

      10 Kelly v. PaineWebber. Inc., No. 91-03187, 1992 WL 389966, at *4 (NASD Sept. 15, 1992).

      11 Michael Siconolfi, Dean Witter Ordered to Pay Fired Manager. Wall St. J., Oct. 12, 1993, at Cl.

      12 Section 28(a) of the 1934 Act expressly states that "no person permitted to maintain a suit for damages under the provisions of this title shall recover, through satisfaction of judgment in one or more actions, a total amount in excess of his actual damages on account of the act complained of." See also. 5D Arnold S. Jacobs, Litigation and Practice Under Rule 10b-5, § 260.03[e] (2d ed. 1986); Green v. Wolf Corp., 406 F.2d 291, 303 (2d Cir. 1968), cert, denied. 395 U.S. 977 (1969) (rejecting argument that punitives were available for an implied cause of action under Rule 10b-5).

      13 The nine states are Connecticut, Michigan, Nebraska, Washington, Georgia, Louisiana, Massachusetts, Indiana and New Hampshire. 1 James D. Ghiardi and John J. Kircher, Punitive Damages Law and Practice § 4.01 (1985 & Supp. 1992); See One Year After 'Haslip.' State Systems for Awards Mostly Withstand Challenge. 24 Sec. Reg. & L. Rep. 347 (March 13, 1992); Stipanowich, Punitive Damages in Arbitration: Garrity v. Lyle Stuart. Inc. Reconsidered. 66 B.U. L. Rev. 953, 955 n. 10 (1986).

      14 9 U.S.C. §§ 1-14 (1947).

      15 Pub. L. 68-401, 43 Stat. 883 (Feb. 12, 1925).

      16 Committee on the Judiciary, Report to Validate Certain Agreements for Arbitration, H. Rep. No. 96, 68th Cong., 1st Sess. 1 (1924).

      17 9 U.S.C. § 2 (1988).

      18 Cone Memorial Hosp., 460 U.S. 1 at 24.

      19 Bonar v. Dean Witter Reynolds. Inc., 835 F.2d 1378,1387 (11th Cir. 1988) (footnote omitted).

      20 SICA, The Arbitrator's Manual at 26 (May, 1992).

      21 NASD Manual, Rules of Fair Practice, Article III § 21(f)(4) 12171 (1993).

      22 American Arbitration Association, Securities Arbitration Rules § 43 (Sept. 1, 1987).

      23 353 N.E.2d 793 (N.Y. 1976).

      24 Garrity, 353 N.E.2d at 794.

      25 Id, at 796.

      26 See Todd Shipyards Corp. v. Cunard Line. Ltd., 943 F.2d 1056 (9th Cir. 1991) (punitives allowed based on FAA, even though parties contracted to apply New York law); Bonar, 835 F.2d 1378 (same).

      27 Lee v. Chica. 983 F.2d 883, 888 (8th Cir. 1993) (when the parties "agree to arbitrate under the rules of AAA and the arbitration issues involve interstate commerce, the FAA gives force to the rules of the AAA"); Bonar. 835 F.2d at 1387; Todd Shipyards. 943 F.2d at 1062-63.

      28 See Mastrobuono v. Shearson Lehman Hutton. Inc., 812 F. Supp. 845, 848 (N.D. 111, 1993) (vacating $400,000 punitive award where New York law governed and the agreement did not explicitly or by incorporation authorize punitives); Complete Interiors. Inc. v. Behan. 558 So. 2d 48, 51 (Fla. Dist. Ct. App. 1990) ("the better view is that punitive damages may not be awarded by an arbitrator absent an express provision authorizing such relief in the arbitration agreement or pursuant to a stipulated submission").

      29 See Pierson v. Dean. Witter. Reynolds. Inc., 742 F.2d 334, 337 (7th Cir. 1984).

      30 Willis v. Shearson/American Express. Inc., 569 F. Supp. 821, 823, 824 (M.D.N.C. 1983).

      31 9 U.S.C. §§ 1, 2, 4 (1988); Willis. 569 F. Supp, at 823 ("the Court must be satisfied that there is a written agreement... and that the contract.. .evidences a transaction involving interstate commerce") (citation omitted).

      32 9 U.S.C. §§ 1, 2,4 (1988); see Willis. 569 F. Supp, at 823.

      33 9 U.S.C. §§1,2,4(1988).

      34 Dorn v. Dora's Transp., Inc., 562 F. Supp. 822, 824 (S.D.N.Y. 1983).

      35 Fahnestock & Co. v. Waltman, 935 F.2d 512, 518 (2d Cir.), cert, denied. 112 S. Ct. 380 (1991); cf. Barbier v. Shearson Lehman Hutton. Inc., 948 F.2d 117, 120 (2d Cir. 1991) (court first applied FAA because there was diversity jurisdiction and transaction involved interstate commerce, then, since FAA preserves wishes of the parties, court applied state law because that was their stated desire).

      36 Fahnestock. 935 F.2d at 519.

      37 Mastrobuono. 812 F. Supp, at 847.

      38 Fahnestock. 935 F.2d at 517. In fact, the legislative history to the original 1925 Act explains that the need for the law stemmed from English courts attempting to safeguard their own jurisdiction; they refused to enforce arbitration agreements because, they felt, such agreements deprived them of their jurisdiction. This attempt became embedded in English common law courts and was adopted by their American counterparts. It was this tendency that the FAA countered.

      "The [arbitration] bill declares simply that such agreements for arbitration shall be enforced, and provides a procedure in the Federal courts for their enforcement." H. Rep. No. 96, 68th Cong., 1st Sess. 2 (1924).

      39 See Barbier. 948 F.2d at 121-22 (punitives not permitted if choice of law provision cites New York law).

      40 See, e.g., Stephen Daniels & Joanne Martin, Myth and Reality in Punitive Damages. 75 Minn. L. Rev. 1 (1990); Theodore B. Olson & Theodore J. Boutrous, Jr., Constitutional Restraints on the Doctrine of Punitive Damages. 17 Pepp. L. Rev. 907 (1990); Michael Rustad & Thomas Koenig, The Historical Continuity of Punitive Damages Awards: Reforming the Tort Reformers. 42 Am. U. L. Rev. 1269 (1993); Victor E. Schwartz & Mark A. Behrens, Punitive Damages Reform – State Legislatures Can And Should Meet The Challenge Issued By The Supreme Court Of The United States In Haslip. 42 Am. U. L. Rev. 1365 (1993); Victor E. Schwartz & Liberty Magadan, Challenging the Constitutionality of Punitive Damages: Putting Rules of Reason on an Unbounded Legal Remedy. 28 Am. Bus. L. J. 485 (1990); David G. Owen, The Moral Foundations of Punitive Damages. 40 Ala. L. Rev. 705 (1989); see also. John C. Jeffries, Jr., A Comment on the Constitutionality of Punitive Damages. 72 Va. L. Rev. 139 (1986); Malcolm E. Wheeler, The Constitutional Case for Reforming Punitive Damage Procedures, 69 Va. L. Rev. 269 (1983).

      41 See Browning-Ferris Indus, v. Kelco Disposal. Inc., 492 U.S. 257 (1989); Pacific Mutual Life Ins. Co. v. Haslip. 499 U.S. 1 (1991); TXO Production Corp. v. Alliance Resources Corp., 113 S. Ct. 2711 (1993).

      42 Foreword. Symposium On Civil Justice Reform. 42 Am. U. L. Rev. 1245, at 1250 (1993).

      43 See President's Council on Competitiveness, Agenda For Civil Justice Reform in America. 8, 22 (Aug. 1991); see also Dan Quayle, Civil Justice Reform. 41 Am. U. L. Rev. 559, 561-69 (1992).

      44 492 U.S. 257.

      45 Id at 282.

      46 Id at 276. Several Supreme Court Justices had previously invited future due process challenges to high punitive damage awards. See Bankers Life & Casualty Co. v. Crenshaw. 486 U.S. 71, 86-89 (1988).

      47 111 S.Ct. 1032(1991).

      48 Id at 1037 and n.2.

      49 Id at 1046.

      50 Id at 1045.

      51 This analysis of Haslip is adopted from Schwartz & Behrens, Punitive Damages Reform. 42 Am. U. L. Rev. at 1374-82.

      52 Haslip. HI S.Ct, at 1046.

      53 Id at 1044.

      54 Id at 1044.

      55 Id at 1045 (citing Green Oil Corp. v. Hornsby. 539 So. 2d 218, 222 (Ala. 1989)).

      56 Haslip. Ill S.Ct, at 1045.

      57 Idatl046n.ll.

      58 See Johnson v. Hugo's Skateway. 974 F.2d 1408 (4th Cir. 1992) (Virginia); Mattison v. Dallas Carrier Corp., 947 F.2d 95 (4th Cir. 1991) (South Carolina); Alexander & Alexander. Inc. v. B. Dixon Evander & Assocs., 596 A.2d 687 (Md. Ct. Spec. App. 1991), cert, denied. 605 A.2d 137 (1992); Games v. Fleming Landfill. Inc., 413 S.E. 2d 897 (W. Va. 1991). See also Owens-Illinois. Inc. v. Zenobia. 601 A.2d 633 (Md. 1992) (raising burden of proof for punitive damages to showing of "actual malice"); Gamble v. Stevenson. 406 S.E. 2d 350 (S.C. 1991) (adopting more detailed post-verdict review); Hodges v. S.C. Toof &Co., 833 S.W. 2d 896 (Term. 1992) (raising burden of proof, developing new review standards, and tightening standard for assessing punitive damages).

      59 113 S.Ct. 2711 (1993)

      60 Id at 2715.

      61 Id at 2714-2716.

      62 Id at 2717.

      63 TXO Production Corp. v. Alliance Resources Corp., 419 S.E. 2d 870, 887 (W. Va. 1992).

      64 Petition for Writ of Certiorari Granted. 113 S. Ct. 584 (1992). Justice Neely's motives in upholding the award of punitive damages may have been suspect. Justice Neely has stated previously his penchant for transferring money from out of state defendants to injured local plaintiffs. Richard Neely, The Product Liability Mess 4 (1988) ("As long as I am allowed to redistribute wealth from out-of-state companies to injured in-state plaintiffs, I shall continue to do so. Not only is my sleep enhanced when I give someone else's money away, but so is my job security, because the in-state plaintiffs, their families, and their friends will reeled me"). In her dissent, Justice O'Connor explained in detail why it is quite likely that the jury was influenced by the fact that TXO is a large, out-of-state corporation. TXO, 113 S. Ct, at 2736-2739 (O'Connor, Jr., dissenting).

      65 Id at 2718. The Court spun a web of confusion on this case. The controlling decision was a plurality by Justice Stevens and joined by Justices Rehnquist and Blackmun. Justice Kennedy joined only in parts I and IV and filed an opinion concurring in part and concurring in the judgment. Justices Scalia and Thomas filed a concurring opinion, and Justice O'Connor filed a dissenting opinion in which Justice White joined and in which Justice Souter joined as to parts U-B-2, II-C, UI, and IV.

      66 Id at 2721-2723.

      67 Seven justices agreed, in one way or another, that the Due Process Clause imposes substantive limits on excessive punitive damages awards. See Id, at 2731 (speaking for Chief Justice Rehnquist, and Justices Stevens and Blackmun); Kennedy, J., concurring in part at 2724; O'Connor, J., dissenting at 2740-2741 (joined by Justices White and Souter).

      68 Id at 2720. In a concurring opinion, Justices Scalia and Thomas disagree that the substantive due process clause has any bearing on excessive punitive damages. Id at 2727 (Scalia, J., concurring).

      69 Id at 2722.

      70 Presumably Justices Scalia and Thomas agree as well as they state that the since the jury was instructed on the purposes of punitive damages and the award was reviewed, it should be upheld. Id at 2726 (Scalia, J., concurring).

      71 Id at 2720.

      72 See Id at 2719-2720; Kennedy, J., concurring in part at 2724; Scalia, J., concurring at 2727; O'Connor, J., dissenting at 2740.

      73 Indeed, one member of the Subcommittee believes that punitive damages should be proscribed outright in all private arbitration schemes. He realizes, however, that this view may be politically unacceptable.

      74 National Collegiate Athletic Ass'n v. Tarkanian, 488 U.S. 179,191 n. 11 (1988) (citation omitted).

      75 Flagg Bros., Inc. v. Brooks. 436 U.S. 149, 164 (1978) (statute declaring warehouseman's lien legal not state action).

      76 Lugar v. Edmondson Oil Co., 457 U.S. 922, 939 (1982).

      77 John Nowak, Ronald Rotunda, J. Nelson Young, Constitutional Law. 502 (2d ed. 1984). See also Smith v. Allwright. 321 U.S. 649, 663 (1944) (selection of party nominees for general election was state action); Marsh v. Alabama. 326 U.S. 501, 509 (1946) (first and fourteenth amendments applied to company owned town).

      78 See Garrity, 353 N.E.2d 793; Edmonson v. Leesville Concrete Co., 111 S. Ct. 2077, 2085 (1991).

      79 15 U.S.C. § 78o(b)(8) (1988).

      80 See Keller v. State Bar of California. 496 U.S. 1 (1990) (state bar association); Abood v. Detroit Bd. of Educ. 431 U.S. 209 (1977) (labor unions).

      81 Adickes v. S.H. Kress & Co., 398 U.S. 144,170-71 (1970).

      82 D.H. Overmyer Co. v. Frick Co., 405 U.S. 174,185 (1972).

      83 Fuentes v. Shevin. 407 U.S. 67, 94-97 (1972).

      84 Exchange Act § 15A(h), 15 U.S.C. § 78o-3(h) (1988). For example, in any proceeding by a registered securities association to determine if a member, or person associated with a member, should be disciplined, the association must bring specific charges, give notice of the charges, provide an opportunity to defend, and keep a record. Any disciplinary action must be accompanied with a statement setting forth the wrongful acts committed, the provision of the law violated, and the sanction imposed. Id

      85 See also Silver v. NYSE. 373 U.S. 341 (1963); Intercontinental Indus, v. American Stock Exchange. 452 F.2d 935 (5th Cir. 1971), cert, denied. 409 U.S. 842 (1972).

      86 NASD Manual. Rules of Fair Practice, Art. m § 1 (1993).

      87 NASD Notice to Members 93-32 at 201 (May 1993).

      88 See Id

      89 NASD Manual. Art. IV § 2 (1993).

      90 SICA, The Arbitrator's Manual at 33 (May, 1992).

      91 NASD By-Laws, Article IV and Schedule C, Part V.

      92 See SEC 1990 Annual Report at 42 (National Business Conduct Committee "operates an effective and thorough program"); SEC 1991 Annual Report at 41-42 (inspection revealed that MSC was performing its duties properly and districts conduct effective regulatory programs).

      93 Pub. L. No. 101-429,104 Stat. 931 (Oct. 15, 1990).

      94 Securities Act of 1933 §§ 21(e), 24, 15 U.S.C. §77 (1988); Securities Exchange Act of 1934 § 34, 15 U.S.C. §§ 78u,78u-l,78ff(1988).

      95 See generally 2 Marc I. Steinberg and Ralph C. Ferrara, Securities Practice; Federal and State Enforcement § 12:03 (1992); Hazen at §§ 8.1-8.5.

      96 Securities Act of 1933 § 20(d)(2), 15 U.S.C. § 77t(d)(2) (1988); Exchange Act of 1934 § 21(d)(3)(B), 15 U.S.C. § 78u(d)(3)(B) (1988); Investment Company Act of 1940 § 42(e)(2), 15 U.S.C. § 80a-41(e)(2) (1988); Investment Advisers Act of 1940 § 209(e)(2), 15 U.S.C. § 80b-9(e)(2) (1988).

      97 Exchange Act § 21A(3), 15 U.S.C. § 78u-l (1988).

      98 Frank H. Easterbrook and Daniel R. Fischel, Optimal Damages in Securities Cases. 52 U. Chi. L. Rev. 611, 633-34 (1985).

      99 See 1 Marc I. Steinberg and Ralph C. Ferrara, Securities Practice: Federal and State Enforcement § 5:10 (1992) (tarnishing of reputation "may well have negative, if not a fatal, impact on one's current as well as prospective business affairs and opportunities") (injunction context).

      100 International Brotherhood of Elec. Workers v. Foust. 442 U.S. 42, 48 (1979) (citation omitted). See also Garrity. 353N.E.2dat796.

      101 Jeffrey W. Grass, The Penal Dimensions of Punitive Damages. 12 Hastings Const. L.Q. 241, 247 (1985) (concluding punitives are "penal in nature, spirit, and jurisprudence, and thus mandate higher standards of procedural protection") (footnote omitted); John C. Jeffries, Jr., A Comment on the Constitutionality of Punitive Damages. 72 Va. L. Rev. 139, 151 (1986) (asserting that punitives are quasi-criminal form of punishment).

      102 See, e.g., David Friedman, An Economic Explanation of Punitive Damages. 40 Ala. L. Rev. 1125 (1989).

      103 Any procedures to govern punitive damages should be adopted by all SRO's to ensure consistency. Thus, the NASD should work with the other SRO's to develop uniform standards.

      104 NASD, Code of Arbitration Procedure § 41 (1992).

      105 American Arbitration Association, Securities Arbitration Rules § 42 (Sept. 1, 1987).

      106 9 U.S.C. § 10 (1988). The circumstances are: (a) the award was procured by corruption, fraud or undue means; (b) there was evident partiality or corruption by the arbitrator; (c) the arbitrator was guilty of misconduct by refusing to postpone a hearing or hear certain evidence; (d) misbehavior prejudiced the rights of a party; or (e) arbitrators exceeded their power or failed to execute a mutual, final, and definite award. Id

      107 Todd Shipyards Corp. v. Cunard Line. Ltd., 943 F.2d 1056, 1060 (9th Cir. 1991).

      108 Associated Teachers of Huntington. Inc. v. Board of Educ. 306 N.E.2d 791, 795 (N.Y. 1973); Amicizia Societa Navegazione v. Chilean Nitrate and Iodine Sales Corp., 274 F.2d 805, 808 (2d Cir.), cert, denied. 363 U.S. 843 (1960) (arbitrators' findings of fact and law are conclusive and unreviewable); cf. United Steelworkers of America v. Enterprise Wheel & Car Corp., 363 U.S. 593, 596 (1960) ("refusal of courts to review the merits of an arbitration award is the proper approach to arbitration under collective bargaining agreements"). See also SICA, The Arbitrator's Manual at 29-32 (May, 1992) (adopting FAA's limited scope of review); NASD Code of Arbitration Procedure § 41(b) (1992) ("[u]nless the applicable law directs otherwise, all awards rendered pursuant to this Code shall be deemed final and not subject to review or appeal").

      109 See TXO. 113 S. Ct, at 2719-20, 2724, 2727, 2740.

      110 If the NASD institutes a cap on punitive damages, discussed below, it may not be necessary to provide a right to appeal the amount of the award.

      111 William L. Prosser & W. Page Keeton, The Law of Torts § 2 at 14 (5th ed. 1984); see also Baghdady v. Sadler. No. 92-1214, 1992 U.S. App. Lexis 23571 (1st Cir. Sept. 9, 1992) (no review appropriate for claimant's dissatisfaction with award), cert, denied. 113 S. Ct. 1815 (1993). One possible exception to this rule would be if one member of an arbitration panel states that an appealable issue exists.

      112 United States General Accounting Office, Securities Arbitration: How Investors Fare 55-59 (May 1992). Since the issuance of the cited GAO report, the NASD has undertaken several steps to enhance and reinforce arbitrator qualification and evaluation. These steps include the establishment of: a subcommittee of the NASD's National Arbitration Committee to review arbitrator credentials; minimum experience and qualification criteria; procedures for verifying the qualifications of potential arbitrators; mandatory arbitrator training programs; and a regularized arbitrator evaluation process to assess competency.

      113 Id

      114 Currently, arbitrator training materials describe the NASD's disciplinary process, and arbitrators are asked whether they believe information revealed in an arbitration record should be the subject of a disciplinary referral.

      115 This limit may not be necessary if the NASD chooses to place a cap on all punitive damages, discussed below.

      116 See NASD Notice to Members 93-32 at 204 (May 1993) ("District examiners in the field report to the DBCC regarding member compliance with the aforementioned rules and regulations based on information collected through various examination and surveillance programs").

      117 The members of the Subcommittee are not unanimous with regard to the recommendation to establish an "offer of judgment" procedure. One member of the Subcommittee disapproves of this recommendation in its entirety.

      In June 1993, the NASD proposed establishing an offer of judgment procedure, which would be available in cases in which compensatory damage claims exceeded $250,000. Under the proposal, either party (not merely the defending party) would be permitted to submit an offer. The SEC is currently revising the proposal.

      118 See generally Jay N. Varon, Promoting Settlements and Limiting Litigation Costs by Means of the Offer of Judgment: Some Suggestions for Using and Revising Rule 68. 33 Am. U. L. Rev. 813, 834 (1984) ("courts should include items such as statutory penalties, treble or punitive damages, and prejudgment interest as permitted in computing the plaintiffs final judgment") (footnote omitted).

      119 See generally Roy D. Simon, Jr., The Riddle of Rule 68. 54 Geo. Wash. L. Rev. 1, 58 n.271 (1985). Variations on this scheme are to limit the percentage of the difference to be paid to a small amount, such as five percent, or to institute a sliding scale, similar to the Rule in Alaska. The Alaska rule is five percent of the difference up to $100,000, three percent of the difference for the next $400,000 and one percent of any additional difference. Id

      120 An offer of judgment rule conceivably could apply equally to defendants as well as plaintiffs so that defendants would be required to pay a percentage of the difference between the judgment and their own offer. Such a rule, however, would serve only to turn a punitive damages award into a super-punitive award as the defendant would have to pay the punitive award itself plus a percentage of the punitive award on top of that, which would be the difference between the offer and the final judgment.

      121 TXO. 113S.Ct, at 2722

      122 Ala. Code § 6-11-20 (1992); Cal. Civil Code § 3294 (Deering 1993); Colo. Rev. Stat. § 13-25-127(2) (1992); Minn. Stat. § 549.20(1) (1992); Or. Rev. Stat. § 30.925 (1991); see also Turtle v. Raymond. 494 A.2d 1353, 1363 (Me. 1985); Wangen v. Ford Motor Co., 294 N.W.2d 437 (Wis. 1980).

      123 Pon v. Shearson Lehman Hutton Am. Express. No. 1990-001920, 1992 WL 426433 (NYSE Sept. 10, 1992).

      124 See Peters v. Princeton Financial Group, Nos. 90-02932, 90-03202, 91-00066, 91-00353, 91-00536, 91-00537, 1992 WL 123203, at *3 (NASD Feb. 13, 1992) ("intentional, fraudulent, willful, wanton, and malicious" conduct"); Gage v. CIGNA Sec. Inc., No. 90-01371, 1992 WL 123187 at *2 (NASD Mar. 10, 1992) ("willful, wanton, and methodical" conduct): Griffin v. Graystone Nash, Inc., No. 91-03069 (NASD Oct. 6, 1992) (intentional fraud).

      125 Bialilew v. Shearson Lehman Hutton. Inc., No. 90-03245, 1992 WL 233307, at *2 (NASD Apr. 6, 1992) (gross negligence): Hickman v. PaineWebber. Inc., No. 90-03354, 1992 WL 390284, at *2 (NASD Sept. 9, 1992) (gross negligence in supervising employee who committed "egregious breach" of fiduciary duty).

      126 Mendez v. J. Alexander Sec. Inc., No. 91-00236, 1992 WL 124369, at *1 (NASD Mar. 10, 1992) (undescribed "standard of supervision").

      127 TXO. 113 S. Ct, at 2722 (stating that the jury may reasonably have determined that TXO "set out on a malicious and fraudulent course" to win back royalty payments it ceded to Alliance).

      128 15 U.S.C. § 78(t) (1988).

      129 15 U.S.C. § 77(o) (1988).

      130 See, e.g., Ferrara & Sanger, Derivative Liability in Securities Law: Controlling Person Liability. Respondeat Superior and Aiding and Abetting. 40 Wash. & Lee L. Rev. 1007 (1983); Fitzpatrick & Carman, Respondeat Superior and the Federal Securities Laws: A Round Peg in a Square Hole, 12 Hofstra L. Rev. 1 (1983); Note. Section 20(a) or Respondeat Superior?: An Update. 44 Wash. & Lee L. Rev. 919 (1987); Kuehnle, Secondary Liability Under the Federal Securities Laws — Aiding and Abetting. Conspiracy. Controlling Person, and Agency: Common-Law Principles and The Statutory Scheme. 14 J. Corp. L. 313 (1989); cX Branson, Collateral Participant Liability Under the Securities Laws – Charting the Proper Course, 65 Ore. L. Rev. 327 (1986); Daniel R. Fischel, Secondary Liability Under Section 10(b) of the Securities Exchange Act of 1934. 69 Cal. L. Rev. 80 (1981); David S. Ruder, Multiple Defendants in Securities Law Fraud Cases: Aiding and Abetting. Conspiracy. In Pari Delicto. Indemnification, and Contribution. 120 U. Pa. L. Rev. 597 (1972).

      131 See Aldrich v. Thomson McKinnon Sec, Inc., 756 F.2d 243, 247 (2d Cir. 1985) (applying New York law); Davis v. Merrill Lynch, 906 F.2d 1206 (8th Cir. 1990) (applying South Dakota law); Malandris v. Merrill Lynch. 703 F.2d 1152, 1174 (10th Cir. 19811. cert, denied. 464 U.S. 824 (1983)(applying Colorado law).

      132 See Dan B. Dobbs, Handbook on the Law of Remedies 214 (1973); William L. Prosser, The Law of Torts §§ 2,12 (1971).

      133 Haslip, UlS.Ct, at 1041.

      134 TXO. 113 S. Ct, at 2725-26 (Kennedy, J., concurring).

      135 See. Victor E. Schwartz and Mark A. Behrens, Punitive Damages Reform – State Legislatures Can And Should Meet The Challenge Issued By The Supreme Court Of The United States In Haslip. 42 Am. U. L. Rev. 1365, at 1380-81 and nn.98, 99 (1993). The American Bar Association in 1987, the American College of Trial Attorneys in 1989, and the American Law Institute in 1991 have all recommended that the "clear and convincing evidence" standard be used for punitive damages cases. Id at 1381 and nn.95-97.

      136 1 James D. Ghiardi and John J. Kircher, Punitive Damages Law and Practice § 9.12 (1985 & Supp. 1992).

      137 See Ga. Code Ann. § 51-12-5.1(d)(2) (1987); Md. Cts. and Jud. Proc. Code Ann. § 10-913 (1987); Mo. Rev. Stat. § 510.263(2)(3) (1987); Mont. Code Ann. § 27-1-221(7)(a) (1987); N.J. Stat. Ann. § 2A:58C-5 (1987); Utah Code Ann. § 78-18-1(2) (1989) (evidence of wealth not admissible until finding of liability for punitives); see generally Punitive Damages § 5.36. See also Haslip. 111 S. Ct. 1032.

      138 Schwartz and Behrens, Punitive Damages Reform. 42 Am. U.L. Rev. 1365.

      139 IAat 1382-83 and nn.105-109.

      140 833 S.W. 2d 896 (Tenn. 1992).

      141 States that have placed caps on punitive damages are Colorado, Connecticut, Florida, Kansas, Oklahoma, Texas, and Virginia. See, e.g., Colo. Rev. Stat. § 13-21-102; Tex. Civ. Prac. & Rem. §§ 41.001-41.008 (West Supp. 1992). The Alabama Supreme Court recently held unconstitutional a state statute, Ala. Code § 6-11-21 (1992), which limited punitive damages to $250,000. Henderson v. Alabama Power Co., Nos. 1901875, 1901946, 1993 LEXIS 584 (June 25, 1993).

      142 The Subcommittee is not in complete agreement on this point. One member would recommend instituting caps on punitive damages based only on the amount of the compensatory award and avoid any cap of a specific dollar amount.

      143 The American College of Trial Attorneys recommended limiting punitive damages to twice the amount of compensatory damages or $250,000, whichever is greater. The American Law Institute favors a somewhat similar approach. See Schwartz and Behrens, Punitive Damages Reform. 42 Am. U. L. Rev, at 1379 and nn.83-84. See also. 5 Securities Arbitration Commentator at 5 (May 1993). One concern with instituting this type of cap is that arbitrators who normally set awards far less than the cap may gravitate toward it, assuming it to be an acceptable amount.

      144 Securities Arbitration Commentator at chart A (May 1993).

      145 Clayton Antitrust Act § 4,15 U.S.C. § 15(a) (1988).

      146 Racketeer Influenced and Corrupt Organizations Act § 901(a), 18 U.S.C. § 1964(c) (1988).

      147 The larger the punitive award the greater the deterrent value will be. At one point, however, the punishment must be limited. If firms are "overdeterred" their very business operations will be chilled from operating effectively.

      148 The nine states are Colorado, Florida, Georgia, Illinois, Iowa, Montana, New York, Oregon and Utah. See, e.g., Colo. Rev. Stat. § 13-21-102(4) (1992); Fla. Stat. Ann. § 768.73 (West Supp. 1993); Mo. Rev. Stat § 537.675 (1991).

      Several states have recently overturned their statutes on constitutional or discriminatory grounds. Kirk v. Denver Pub. Co., 818 P.2d 262 (Colo. 1991) (violates takings clause); McBride v. General Motors Corp., 737 F. Supp. 1563 (M.D. Ga. 1990) (law discriminates against plaintiffs). Recently, the Eleventh Circuit certified to the Florida Supreme Court the question of whether a statute directing a portion of punitive awards to the state applies to arbitration. Miele v. Prudential Bache Sec. 986 F.2d459 (1 lth Cir. 1993).

      149 Cf. Abate v. AC&S. Inc., Baltimore City Circuit Court, Consolidated File No. 89236704 (insurance context).

    • 94-53 SEC Proposes Amendments To Regulation T

      SUGGESTED ROUTING

      Senior Management
      Government Securities
      Institutional
      Legal & Compliance
      Operations

      Executive Summary

      The Board of Governors of the Federal Reserve System is seeking comments on proposed amendments to Regulation T (Credit by Brokers and Dealers) regarding settlement of securities purchases and the status of government securities transactions. Comments on the proposed changes should be received by August 15, 1994.

      Background

      On August 18, 1992, the Board of Governors of the Federal Reserve System (Board) published an advance notice of proposed rulemaking requesting public comments in connection with a general review of Regulation T. The review is not yet complete, but the Board believes that certain developments warrant the publication of three proposed amendments in two areas.

      Proposed Amendment

      Three Day Settlement (T+3)

      In light of the adoption by the Securities and Exchange Commission (SEC) of a rule shortening the standard settlement period for securities transactions from five to three business days (T+3), the Board proposes to shorten the time periods specified in Regulation T for customers to meet margin calls or make full cash payment by a corresponding two days. Related amendments would raise the de minimis amount below which liquidation of unpaid transactions is not required from $500 to $1,000, require brokers seeking extensions of the payment periods to obtain them from their designated examining authority (DEA), and clarify that foreign settlement periods are used to calculate when restrictions in the cash account are applied to foreign securities.

      Regulation T has always required cash payment for securities purchases within seven business days of trade date. The seven-day period was initially chosen for the cash account because it was felt that a customer should have no obligation to pay for securities before they were delivered. The two days permitted beyond settlement date provide a short period of time for resolution of problems before the broker is required to act under Regulation T, that is, either obtain an extension on the customer's behalf (if it is determined that a valid reason exists) or sell out the customer's position.

      The Board's advance notice was issued before the SEC proposed its rule adopting a T+3 settlement period. The advance notice mentioned the Group of Thirty's recommendation of a world-wide settlement standard of T+3 and said the Board "may consider shortening the time for customer payment once the settlement period is shortened from the current five days." The Board supported the SEC when it proposed requiring T+3 settlement, calling the proposal "an important and achievable step" to reduce potential systemic disturbances to financial markets and to the economy. The SEC also received several comment letters stating that the implementation of T+3 settlement will require the Board to address the possible shortening of its Regulation T payment periods. Those letters were forwarded to Board staff for consideration in the context of the ongoing Regulation T review.

      The Board proposes to reword Regulation T to specifically incorporate the standard settlement cycle and the current two-day cushion. Instead of requiring payment within "seven business days," the regulation would require payment within "one payment period," with "payment period" being defined as the standard settlement period in the United States plus two business days. This will not change the operation of the rule at this time, but once the new language is put into place the conversion to T+3 next year will automatically result in a reduction in the amount of time brokers can give their customers to pay for securities or to meet initial margin calls. Future changes in settlement periods by the SEC will similarly be automatically reflected in the Board's rule without the necessity of further amendment.

      The payment periods in Regulation T can be extended for exceptional circumstances if the broker applies to a self-regulatory organization (SRO) for an extension. In 1988, the New York Stock Exchange (NYSE) sought SEC approval of a rule that would require a broker seeking a Regulation T extension to obtain the extension from the NYSE if the NYSE is the broker's designated examining authority (DEA). The proposal was noted by the Board in the advance notice, as was a suggestion by the Credit Division of the Securities Industry Association that brokers be permitted to grant customer extensions without approval of an SRO. The SEC approved the NYSE rule firing in May 1994. In its approval order, the SEC stated that it does not agree with assertions that the objectives of the Securities Exchange Act of 1934 (the Act) could be better met by implementing a uniform system of sharing extension information. As to the other objections raised by commenters (and also raised with the Board pursuant to the advance notice), the SEC found that "the regulatory benefits from the NYSE rule outweigh any competitive concerns raised by the commenters." Finally, the SEC said it does not agree with those commenters who argue that broker/dealers should not be required to submit requests for extensions of time to either their DEA or any SRO. The Board believes, along with the SEC, that a good case has been made to restore to the broker's DEA sole responsibility for granting and monitoring extensions of time and the language proposed by the Board today reflects this conclusion.

      Government Securities

      In light of the recent enactment of the Government Securities Act Amendments of 1993, the Board proposes to exempt most transactions involving government securities from the restrictions of Regulation T. This would be accomplished with two separate but related actions. First, Regulation T would exclude government securities brokers and dealers who register with the SEC under section 15C of the Act from the definition of "creditor" in Regulation T. Second, general broker/dealers effecting customer transactions that could be effected by a section 15C broker/dealer could record the transactions in a new government securities account in which the other restrictions in Regulation T would not apply.

      Before the enactment of the Government Securities Act of 1986, broker/dealers who limited themselves to transactions in government securities were not subject to a comprehensive regulatory scheme and were not required to be registered with the SEC. Although such brokers were within the definition of "creditor," there was no practical way to enforce Regulation T for them. The Government Securities Act of 1986 required SEC registration of all non-bank government securities brokers and dealers under a new section 15C of the Act. The Government Securities Act of 1986 also added the term "government securities" to the Act.

      The advance notice invited comment on two areas involving government securities: repurchase agreements (repos) and the borrowing and lending of securities. The advance notice explained that the Board has not specified the exact treatment of repos while noting that repos of government securities do not raise credit issues under Regulation T because the good faith loan value of such securities is often close to 100 percent of their current market value. Many of the commenters suggested that the Board create a new account for exempted securities that could be used for transactions such as repos and forward transactions. Most of the commenters supported exemption of government securities from §220.16 of Regulation T. This would allow loans of government securities without the current requirement that a broker document the reason for the borrowing stems from a short sale or failure to receive securities required for delivery.

      Under today's proposal, whenever a general broker/dealer effects a transaction for a customer that could be effected by a section 15C broker, the transaction could be recorded in a new government securities account. The account would allow these transactions to be effected without regard to other restrictions in Regulation T. The account would be permissive; brokers could continue to let customers who wish to use the cash or margin account for transactions involving government securities do so. It would allow institutional customers who cannot or will not use a margin account to engage in government securities transactions not specifically authorized in the cash account. For example, the government securities account could be used to effect purchases of government securities on credit or for cash as well as repos and reverse repos. Borrowing and lending of government securities could also be effected in the proposed account without being subject to the "permitted purpose" requirement in §220.16 of Regulation T that requires brokers to limit and document the reasons for their securities borrowings. The account would also permit net settlement of offsetting purchases and sales of government securities. Government securities purchased or deposited in a margin account would still be subject to the current Regulation T rules and would therefore still be available to finance the purchase of other securities in a margin account.

      The Board is not proposing to include additional types of exempted securities, such as municipal securities, in the proposed government securities account. Government securities constitute an unusually deep and liquid market and are subject to a unique scheme of regulation, as evidenced by the Government Securities Act of 1986.

      NASD members that wish to comment on the proposed amendments should do so by August 25, 1994. Comments should refer to Docket R-0840 and should be sent to:

      William Wiles, Secretary Board of Governors of the Federal Reserve System 20th Street and Constitution Avenue, NW
      Washington, DC 20551

      Members are requested to send copies of their comment letters to:

      Joan Conley,
      Corporate Secretary National Association of Securities Dealers, Inc.
      1735 K Street, NW
      Washington, DC 20006-1500

      Questions concerning this Notice may be directed to Derick Black, District Coordinator, NASD Compliance Department, at (202) 728-8225.

    • 94-52 Mail Vote—NASD Solicits Member Vote On Proposed Amendments To The NASD By-Laws To Facilitate The NASD Manual Revision;

      Last Voting Date: August 29, 1994

      SUGGESTED ROUTING

      Senior Management
      Legal & Compliance

      Executive Summary

      The NASD invites members to vote on proposed amendments to the NASD By-Laws to prepare for a planned new numbering scheme for the NASD Manual; to correct certain minor errors found in the By-Laws; and to provide for Board approval of future spelling and numbering changes. The last voting date is August 29, 1994. The text of the amendment follows this Notice.

      Background

      The NASD is developing a proposal to reorganize the NASD Manual to make it easier for members and others to use. This will be a non-substantive reordering of the existing rules, interpretations, and other provisions of the Manual to present the rules more logically in the Manual. This project will require certain changes in numbering and terminology in the NASD By-Laws and rules. Changes that the NASD is currently aware of are described below. To facilitate the Manual revision, the NASD is seeking approval of an amendment to the By-Laws that would allow the Board to make future editorial changes to numbering or spelling in the By-Laws without a member vote.

      As described previously in Notice to Members 93-15, the amendments are the second phase of a multi-part program, the purpose of which is to make all rule approval and amendment procedures under the NASD By-Laws uniform and to make the Manual easier to use. The program envisions that all rules in the Manual, including not only the current Rules of Fair Practice but also such specialized rules as the Government Securities Rules, The Nasdaq Stock Market Rules (Schedule D to the By-Laws), Code of Arbitration Procedure, etc., will be numbered consecutively throughout the Manual and considered together as "Rules." The entire body of requirements affecting members, including the Certificate of Incorporation, By-Laws, and Rules, will be referred to as the "rules of the Corporation." The proposed changes to the By-Laws reflect these changes in terminology. In addition, a common numbering and naming scheme for subdivisions within a Rule will be used.

      Description of Proposals

      The sections of Article I of the By-Laws have been rearranged so that the definitions are now in alphabetical order for easier use. As discussed above, the term "Rules" will be used in the Manual revision to refer to all rules that may now be referred to by various names, but for purposes of new Article I, Section s, the existing names for these types of rules have been retained to provide examples of the types of rules that are included. To make the provision more broadly applicable, however, the language "any other rules" has been added. This would include, for example, the text of Schedules that are proposed to be converted to rules in the Manual revision project.

      Article III, Section 7 is amended to reflect that, as part of the Manual revision project, the term "Rules of Fair Practice" will be eliminated and replaced with the general term "Rules." In Section 10 of the same Article, the reference to Article I has been changed to reflect the new order of the definitions that are to be placed in alphabetical order and relettered, as described above.

      In Article IV, Section 4, references to specific Rules of Fair Practice will be changed to the proposed new Rule numbers that will be used in the Manual revision project. These new numbers will not be printed in the Manual until the entire revision is completed. Also in Section 4, an existing, erroneous cross-reference to Section 2(b) has been corrected.

      In Article V, Sections 3 and 4, references to Rules of Fair Practice and the Code of Procedure have been changed to the more general term "other rules" as part of the Manual revision project.

      In Article VII, Section 1, references to the "Rules of Fair Practice" have been changed to "Rules" to conform to the new terminology used in the Manual revision. In light of this change, former subsection (a)(3), which gave the Board general authority to adopt rules and interpretations to implement the Securities Exchange Act of 1934, will duplicate subsections (a)(2) and (4), which do essentially the same thing. The reference to implementing the provisions of the Act is duplicative of Article XII, Section 1 (text below), which provides that the Board is authorized to adopt Rules "to carry out the purposes of the Corporation and of the Act." Therefore, it is proposed to delete subsection (a)(3) as part of the Manual revision project.

      To make the numbering scheme of the By-Laws internally consistent, using the method employed throughout the rules in the proposed Manual revision wherein subdivisions follow the format of (a)(1)(A)(i), the subsection numbers in lower-case Roman numerals in Article VII, Sections 3 and 4 have been replaced with Arabic numbers. In Section 7(c), the reference to Article III, Section 8 should have been changed to Section 9 when those sections were renumbered. In Article VII, Section 8 the proposed changes are related to the renumbering of subsections in Section 4 to conform to the standard numbering scheme.

      The proposed changes to Articles VIII and IX are to correct the same erroneous cross-reference described previously under Article VII, Section 7(c).

      The proposed change to Article XII reflects the new terminology of "Rules" rather than "Rules of Fair Practice" that will be used in the Manual revision.

      Finally, the amendment to Article XVII would provide latitude for the Board to approve minor changes to spellings or numbering in the By-Laws to correct errors or to conform to the renumbering of Rules referred to in the By-Laws, without the necessity of a membership vote. Such changes would continue to be called to the attention of members through the regular CCH Report Letters updating the looseleaf Manuals. This will not only reduce delays in making rule changes effective, but will also result in administrative cost savings. A member vote will continue to be required for substantive changes to the NASD By-Laws.

      Request For Vote

      The NASD Board of Governors believes that the proposed amendment to the By-Laws will facilitate the updating and simplifying of the Manual and will aid the Board in making minor corrections to the By-Laws in a timely manner, subject to approval by the Securities and Exchange Commission, without the costs and delays inherent in sending proposed numbering and spelling changes to nearly 6,000 members for a mail vote. Please mark the attached ballot according to your convictions and mail it in the enclosed, stamped envelope to The Corporation Trust Company. Ballots must be postmarked no later than August 29, 1994.

      Questions concerning this Notice should be directed to T. Grant Callery, Vice President and General Counsel, at (202) 728-8285.

      Proposed Amendments to Articles I, III, IV, V, VII, VIII, IX, XII, and XVII of the NASD By-Laws

      (Note: New text is underlined; deleted text is in brackets.)

      * * *

      ARTICLE I

      Definitions

      When used in these By-Laws, and any rules of the Corporation, unless the context otherwise requires, the term:

      (a) "Act" means the Securities Exchange Act of 1934 as amended;
      (b) "bank" means (1) a banking institution organized under the laws of the United States, (2) a member bank of the Federal Reserve System, (3) any other banking institution, whether incorporated or not, doing business under the laws of any State or of the United States, a substantial portion of the business of which consists of receiving deposits or exercising fiduciary powers similar to those permitted to national banks, and which is supervised and examined by a State or Federal authority having supervision over banks, and which is not operated for the purpose of evading the provisions of the Act, and (4) a receiver, conservator, or other liquidating agent of any institution or firm included in clauses (1), (2) or (3) of this subsection;
      [(r)] (c) "Board" means the Board of Governors of the Corporation[.];
      [(c)] (d) "branch office" means an office defined as a branch office in [Article III, Section 27 of the Rules of Fair Practice] Rule;1
      [(d)] (e) "broker" means any individual, corporation, partnership, association, joint stock company, business trust, unincorporated organization or other legal entity engaged in the business of effecting transactions in securities for the account of others, but does not include a bank;
      [(e)] (f) "Commission" means the Securities and Exchange Commission;
      [(f)] (g) "Corporation" means the National Association of Securities Dealers, Inc.;
      [(g)] (h) "dealer" means any individual, corporation, partnership, association, joint stock company, business trust, unincorporated organization or other legal entity engaged in the business of buying and selling secur