TO: All NASD Members and Other Interested Persons
On June 2, 1983, the Securities and Exchange Commission ("SEC") approved amendments to Schedule E to Article IV, Section 2 of the Association's By-Laws ("Schedule E") which relates to the distribution of members' own securities and those of affiliates. The amendments became effective upon approval and are applicable to all offerings filed with the Association after June 2, 1983.
The amendments effect significant changes both with respect to offerings by members of their own securities and offerings by affiliates of members. The prior requirement that the public offering price be established, in certain circumstances, at the price recommended by two independent underwriters with the participation of independent counsel has been amended to require only the recommendation of one qualified independent underwriter. Prior requirements for operating history and profitability of a broker/dealer proposing to participate in a distribution have been eliminated, although the requirement for five years investment banking or securities business experience by a majority of management has been retained.
With respect to requirements applicable to a broker/dealer issuing its own securities, regardless of whether it anticipates participating in the distribution, several liberalizing amendments were approved. Prior requirements regarding financial statements, transfer restrictions on securities of the member held by affiliates, specifications as to the size and duration of the offering, and limitation on the timing of any subsequent offering have been eliminated.
The text of Schedule E as amended, a copy of which is attached hereto, should be closely studied for a complete understanding of present requirements. Any questions concerning this notice or the applicability of Schedule E to any fact situation, may be directed to Dennis C. Hensley at (202) 728-8258.
Sincerely,
Gordon S. Macklin
President
SCHEDULE E
DISTRIBUTION OF SECURITIES OF MEMBERS AND AFFILIATES
Section 1 — General
No member or person associated with a member shall participate in the distribution of a public offering of securities issued or to be issued by the member or an affiliate of the member and no member shall issue securities except in accordance with this Schedule.
Section 2 — Definitions
For purposes of this Schedule, the following words shall have the stated meanings:
(a) Affiliate —
(1) a company which controls, is controlled by or is under common control with a member.
(2) For purposes of subsection 2(a)(l) hereof,
(i) a company will be presumed to control a member if the company beneficially owns 10 percent or more of the outstanding voting securities of a member which is a corporation, or beneficially owns a partnership interest in 10 percent or more of the distributable profits or losses of a member which is a partnership;
(ii) a member will be presumed to control a company if the member and persons associated with the member beneficially own 10 percent or more of the outstanding voting securities of a company which is a corporation, or beneficially own a partnership interest in 10 percent or more of the distributable profits or losses of a company which is a partnership;
(iii) a company will be presumed to be under common control with a member if:
(1) the same natural person or company controls both the member and company by beneficially owning 10 percent or more of the outstanding voting securities of a member or company which is a corporation, or by beneficially owning a partnership interest in 10 percent or more of the distributable profits or losses of a member or company which is a partnership; or
(2) a person having the power to direct or cause the direction of the management or policies of the member or the company also has the power to direct or cause the direction of the management or policies of the other entity in question.
(3) The provisions of paragraphs (1) and (2) hereof notwithstanding, none of the following shall be presumed to be an affiliate of a member for purposes of this Schedule E:
(i) an investment company registered with the Securities and Exchange Commission pursuant to the Investment Company Act of 1940, as amended;
(ii) a "separate account" as defined in Section 2(a)(37) of the Investment Company Act of 1940, as amended;
(iii) a "real estate investment trust" as defined in Section 856 of the Internal Revenue Code;
(iv) a "direct participation program" as defined in Article III, Section 34 of the Rules of Fair Practice.
(b) Bona fide independent market—a market in a security which:
(1) is registered pursuant to the provisions of Sections 12(b) or 12(g) of the Securities Exchange Act of 1934 or issued by a company subject to Section 15(d) of such Act, unless exempt from those provisions;
(2) has an aggregate trading volume for the 12 months immediately preceding the filing of the registration statement of at least 100,000 shares;
(3) has outstanding for the entire twelve-month period immediately preceding the filing of the registration statement, a minimum of 250,000 publicly held shares; and
(4) in the case of over-the-counter securities, has had at least three bona fide independent market makers for a period of at least 30 days immediately preceding the filing of the registration statement and the effective date of the offering.
(c) Bona fide independent market maker — a market maker which:
(1) continually maintains net capital as determined by Rule 15c3-l of the General Rules and Regulations under the Securities Exchange Act of 1934 of $50,000 or $5,000 for each security in which it makes a market, whichever is less;
(2) regularly publishes bona fide competitive bid and offer quotations in a recognized interdealer quotation system;
(3) furnishes bona fide competitive bid and offer quotations to other brokers and dealers on request; and
(4) stands ready, willing and able to effect transactions in reasonable amounts, and at his quoted prices, with other brokers and dealers.
(d) Company — a corporation, a partnership, an association, a joint stock company, a trust, a fund, or any organized group of persons whether incorporated or not; or any receiver, trustee in bankruptcy or similar official or any liquidating agent for any of the foregoing, in his capacity as such.
(e) Effective date — the date on which an issue of securities first becomes legally eligible for distribution to the public.
(f) Immediate family — parents, mother-in-law, father-in-law, husband or wife, brother or sister, brother-in-law or sister-in- law, children, or any relative to whom financial support is contributed directly or indirectly by an employee of, or person associated with, a member.
(g) Parent — any entity affiliated with a member from which member the entity derives 50 percent or more of its gross revenues or in which it employs 50 percent or more of its assets.
(h) Person — any natural person, partnership, corporation, association, or other legal entity.
(i) Public director — a person elected from the general public to the board of directors of a member or its parent which has made a public distribution of an issue of its own securities. Such person shall not beneficially own five percent or more of the outstanding voting securities of the member or its parent and shall not be engaged in the investment banking or securities business or be an officer or employee of the member or its parent, or be a member of the immediate family of an employee occupying a managerial position with a member or its parent.
(j) Public offering — any primary or secondary distribution of securities made pursuant to a registration statement or offering circular including exchange offers, rights offerings, offerings made pursuant to a merger or acquisition, straight debt offerings and all other securities distributions of any kind whatsoever except any offering made pursuant to an exemption under Section 4(1) or 4(2) of the Securities Act of 1933.
(k) Qualified independent underwriter* — a member which:
(1) is actively engaged in the investment banking or securities business and which has been so engaged, in its present form or through predecessor broker/dealer entities, for at least five years immediately preceding the filing of the registration statement;
(2) in at least three of the five years immediately preceding the filing of the registration statement has had net income from operations of the broker/dealer entity or from the pro forma combined operations of predecessor broker/dealer entities, exclusive of extraordinary items, as computed in accordance with generally accepted accounting principles;
(3) as of the date of the filing of the registration statement and as of the effective date of the offering:
a. if a corporation, a majority of its board of directors or, if a partnership, a majority of its general partners, are persons who have been actively engaged in the investment banking or securities business for the five-year period immediately preceding the filing of the registration statement;
b. if a sole proprietorship, the proprietor has been actively engaged in the investment banking or securities business for the five-year period immediately preceding the filing of the registration statement;
(4) has actively engaged in the underwriting of public offerings of securities for at least the five-year period immediately preceding the filing of the registration statement;
(5) is not an affiliate of the entity issuing securities pursuant to Section 3 of this Schedule; and
(6) has agreed in acting as a qualified independent underwriter to undertake the legal responsibilities and liabilities of an underwriter under the Securities Act of 1933, specifically including those inherent in Section 11 thereof.
(l) Registration statement — a registration statement as defined by Section 2(8) of the Securities Act of 1933; notification on Form 1A filed with the Securities and Exchange Commission pursuant to the provisions of Rule 255 of the General Rules and Regulations under the Securities Act of 1933; or any other document, by whatever name known, initiating a registration or similar process for an issue of securities which is required to be filed by the laws or regulations of any federal or state agency.
(m) Settlement — the distribution of the net proceeds from an offering to the issuer or selling stockholders.
Section 3 — Participation in Distribution of Securities of Member or Affiliate
(a) No member shall underwrite, participate as a member of the underwriting syndicate or selling group, or otherwise assist in the distribution of a public offering of an issue of debt or equity securities issued or to be issued by the member or an affiliate of the member unless the member is in compliance with subsection 3(b) and either subsection 3(c) or 3(d) below, depending on the nature of the member's participation.
(b) In the case of a member which is a corporation, the majority of the board of directors, or in the case of a member which is a partnership, a majority of the general partners or, in the case of a member which is a sole proprietorship, the proprietor as of the date of the filing of the registration statement and as of the effective date of the offering shall have been actively engaged in the investment banking or securities business for the five year period immediately preceding the filing of the registration statement.
(c) If a member proposes to underwrite, participate as a member of the underwriting syndicate or selling group, or otherwise assist in the distribution of a public offering of debt or equity securities subject to this Section without limitation as to the amount of securities to be distributed by the member, one or more of the following three criteria shall be met:
(1) the price at which an equity issue or the yield at which a debt issue is to be distributed to the public is established at a price no higher or yield no lower than that recommended by a qualified independent underwriter which shall also participate in the preparation of the registration statement and the prospectus, offering circular, or similar document and which shall exercise the usual standards of "due diligence" in respect thereto; provided, however, that an offering of securities by a member which has not been actively engaged in the investment banking or securities business, in its present form or as a predecessor broker/ dealer, for at least the five years immediately preceding the filing of the registration statement shall be managed by a qualified independent underwriter; or
(2) the offering is of a class of equity securities for which a bona fide independent market exists as of the date of the filing of the registration statement and as of the effective date thereof; or
(3) the offering is of a class of securities rated Baa or better by Moody's rating service or BBB or better by Standard & Poor's rating service or rated in a comparable category by another rating service acceptable to the Association.
(d) A member may participate as a member of the underwriting syndicate or selling group in the distribution of a public offering of debt or equity securities subject to this Section without regard to the requirements of subsection (c), if the member restricts its participation to an amount not exceeding ten percent of the total dollar amount of the offering and the offering is underwritten on a firm commitment basis and managed by a qualified independent underwriter.
Section 4 — Escrow of Proceeds
(a) All proceeds from an offering by a member of its securities shall be placed in a duly established escrow account and shall not be released therefrom or used by a member in any manner until the member has complied with Section 5 hereof.
(b) Any member offering its securities pursuant to this Schedule shall disclose in the registration statement offering circular, or similar document a date by which the offering is reasonably expected to be completed and the terms upon which the proceeds will be released from the escrow account described in subsection (a) hereof.
Section 5 — Net Capital Computation
Any member offering its securities pursuant to this Schedule shall immediately notify the Corporation when the offering has been terminated and settlement effected and it shall file with the Corporation a computation of its net capital computed pursuant to the provisions of Rule 15c3-l of the General Rules and Regulations under the Securities Exchange Act of 1934 (the net capital rule) as of the settlement date. If at such time its net capital ratio as so computed is more than 10:1 or, net capital fails to equal 120 percent of the minimum dollar amount required by Rule 15c3-l or, in the event the provisions of Rule 15c3-l(f) are utilized in making such computation, the net capital is less than seven percent of aggregate debit items as computed in accordance with Rule 15c3-3a, all monies received from sales of securities of the offering must be returned in full to the purchasers thereof and the offering withdrawn, unless the member has obtained from the Securities and Exchange Commission a specific exemption from the net capital rule. Proceeds from the sales of securities in the offering may be taken into consideration in computing net capital ratio for purposes of this section.
Section 6 - Audit Committees
Any member or parent of a member which makes a public offering of an issue of its securities shall be required to establish within twelve months of the effective date of said offering an audit committee composed of members of the board of directors (except that it shall not include the chief accounting or chief financial officer of the member or its parent) and the functions of the audit committee shall include the following:
(a) to review the scope of the audit;
(b) to review with the independent auditors the corporate accounting practices and policies and recommend to whom reports should be submitted within the company;
(c) to review with the independent auditors their final report;
(d) to review with internal and independent auditors overall accounting and financial controls; and
(e) to be available to the independent auditors during the year for consultation purposes.
Section 7 - Public Director
Any member or parent of a member which makes a public offering of an issue of its securities shall cause to be elected to its board of directors within twelve months of the effective date of said offering a public director who shall serve as a member of the audit committee.
Section 8 — Periodic Reports
Any member which makes a distribution to the public of an issue of its securities pursuant to this Schedule, shall send to each of its shareholders or, in the case of debt offerings, to each of its investors:
(1) quarterly, a summary statement of its operations; and
(2) annually, independently audited and certified financial statements.
Section 9 - Offerings Resulting in Affiliation or Public Ownership of Member
If an issuer proposes to direct all or part of the proceeds from a public offering to a member or exchange securities by means of a public offering for an interest in a member, and the member is, or as a result of the proposed transaction would be, an affiliate of the issuer, or if an issuer proposes to engage in any offering which results in the public ownership of a member, the offering shall be subject to the provisions of this Schedule E to the same extent as if the offering were of securities issued by the member.
Section 10 - Registration Statements for Intrastate Offerings
Any member offering its securities pursuant to an exemption under Section 3(a)(11) of the Securities Act of 1933 shall disclose in the registration statement at a minimum that information suggested by the Securities and Exchange Commission in Securities Act Release No. 5222 (January 3, 1972).
Section 11 — Suitability
Every member underwriting an issue of its securities, or securities of an affiliate, pursuant to the provisions of Section 3 hereof, who recommends to a customer the purchase of a security of such an issue shall have reasonable grounds to believe that the recommendation is suitable for such customer on the basis of information furnished by such customer concerning the customer's investment objectives, financial situation, and needs, and any other information known by such member. In connection with all such determinations, the member must maintain in its files the basis for its determination.
Section 12 - Discretionary Accounts
Notwithstanding the provisions of Article III, Section 15 of the Corporation's Rules of Fair Practice, or any other provisions of law, a transaction in securities issued by a member or an affiliate of a member shall not be executed by any member in a discretionary account without the prior specific written approval of the customer.
Section 13 — Sales to Employees — No Limitations
Notwithstanding the provisions of the Board of Governors' Interpretation With Respect To "Free-Riding And Withholding," a member may sell securities issued by a member or an affiliate of a member to its employees; potential employees resulting from intended mergers, acquisitions, or other business combination of members resulting in one public successor corporation, or persons associated with it; and the immediate family of such employees or associated persons without limitation as to amount and regardless of whether such persons have an investment history with the member as required by that Interpretation.
Section 14 — Filing Requirements; Coordination with Corporate Financing Interpretation
(a) Notwithstanding the provisions of the "Interpretation of the Board of Governors — Review Of Corporate Financing" relating to factors to be taken into consideration in determining underwriter's compensation, the value of securities of a new corporate member succeeding to a previously established partnership or sole proprietorship member acquired by such member or person associated therewith, or created as a result of such reorganization, shall not be taken into consideration in determining such compensation.
(b) All offerings of securities included within the scope of this Schedule shall be subject to the provisions of the "Interpretation of the Board of Governors — Review Of Corporate Financing", and documents and filing fees relating to such offerings shall be filed with the Corporation pursuant to the provisions of that Interpretation. The responsibility for filing the required documents and fees shall be that of the member issuing securities, or, in the case of an issue of an affiliate, the managing underwriter or, if there is none, the member affiliated with the issuer.
Section 15 — Predominance of Schedule E
If the provisions of this Schedule E are inconsistent with any other provisions of the Corporation's By-Laws, Rules of Fair Practice or Uniform Practice Code, or of any interpretation thereof or resolution of the Board of Governors, the provisions of this Schedule shall prevail.
Section 16 — Requests for Exemption from Schedule E
The Corporate Financing Committee of the Board of Governors, upon written request, may in exceptional and unusual circumstances, taking into consideration all relevant factors, exempt a member unconditionally or on specified terms from any or all of the provisions of Schedule E which it deems appropriate. Unless waived by the party requesting an exemption, a hearing shall be held upon a request before the Corporate Financing Committee, or a Subcommittee thereof designated for that purpose.
Section 17 — Violation of Schedule E
A violation of the provisions of this Schedule shall constitute conduct inconsistent with high standards of commercial honor and just and equitable principles of trade and a violation of Article III, Section 1 of the Corporation's Rules of Fair Practice and possibly other sections, especially Sections 2 and 18, as the circumstances of the case may indicate.
* In the opinion of the National Association of Securities Dealers, Inc. and the Securities and Exchange Commission the full responsibilities and liabilities of an underwriter under the Securities Act of 1933 attach to a "qualified independent underwriter" performing the functions called for by the provisions of Section 3 hereof.
