Clarification of NASD Filing Requirements and Review Procedures for Offerings Made Pursuant to SEC Rule 415

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EXECUTIVE SUMMARY

The NASD is publishing the views of the Corporate Financing Committee on questions that members frequently ask when they are involved in offerings of securities to be conducted pursuant to SEC Rule 415. This Notice states the Committee's view that any transaction engaged in for the benefit of an issuer or its selling security holders that involves distributing securities "off the shelf" on a delayed or continuous basis constitutes participation in a public offering on behalf of the member. It also clarifies the filing obligations that members must comply with when they are involved in such offerings. In addition, this Notice presents the Committee's views as to participating in the preparation of the registration statement and exercising the usual standards of due diligence in respect thereto, when a qualified independent underwriter is involved in a Rule 415 offering.

BACKGROUND

On November 23, 1983, the Securities and Exchange Commission adopted SEC Rule 415 (17CFR 230.415 referred to as "Rule 415"). Rule 415 governs the offering of securities on a delayed or continuous basis. For the two years prior to its adoption, the NASD commented on a number of issues that it felt would impact the manner in which its members would participate in Rule 415 distributions. One of the NASD's principal concerns was that the compressed time schedules under which members must operate when they participate in Rule 415 offerings would impact the quality of disclosure in the prospectus and the ability of underwriters to perform adequate due diligence on the facts presented in the registration statement.

Since 1983, the Corporate Financing Department has received numerous inquiries regarding the review procedures it uses with respect to offerings conducted pursuant to Rule 415 and has been asked to render opinions on how certain provisions of Schedule E to the NASD By-Laws ("Schedule E") and the Interpretation of the Board of Governors — Review of Corporate Financing (the "Interpretation") should be applied to Rule 415 offerings.

The most frequent inquiries relate to: the definition of "participation in a public offering"; the procedures to be followed in connection with NASD filing requirements contained in the Interpretation and Schedule E; and the appropriate timing of a qualified independent underwriter's participation in the preparation of the offering documents.

Participation in a Public Offering and Filing Requirements

Frequently, members raise questions about when a member's activities in connection with a distribution subject to Rule 415 are considered to be "participation in a public offering" under NASD rules. Both the Interpretation and Schedule E provide that if a member is to participate in a distribution, it must file the appropriate documents with the Corporate Financing Department and seek an opinion from the Department that it has no objections to the underwriting terms and arrangements that are proposed.

This question first was raised in 1982 shortly after the Securities and Exchange Commission adopted Rule 415 on a temporary basis. The Department presented the issue to the Corporate Financing Committee for its consideration in September 1982. The Committee made a determination that the Department should review all offerings to be distributed under 415 on the basis of all information available at the time of filing with the exception of Rule 415 offerings on Form S-3 that are specifically exempt from filing under the Interpretation.*

In connection with Rule 415 offerings, the Committee determined to exempt from the filing requirements securities registered on Form S-3 because an issuer able to satisfy Form S-3's "registrant requirements" would be followed closely by investors and market professionals. The Committee also felt that the securities markets would efficiently determine a fair price for the securities being offered and that any underwriting compensation received by members ordinarily would be determined under very competitive circumstances (generally limited to normal brokerage transactions). The Committee did not believe that the same facts were present in Rule 415 offerings where the securities are registered on any form other than S-3.

Additionally, members should note that the Rule 415 S-3 exemption and the investment-grade rating filing exemption contained in the Interpretation do not apply to offerings otherwise required to be filed because they are subject to Schedule E.

Thus, it is the view of the Committee that the participation of a member in any offering of securities distributed pursuant to Rule 415 constitutes participation in a public offering. The Committee also concluded that any member who is named as a potential distribution participant in the registration statement or who may participate in any transaction that takes securities off the shelf is responsible for ensuring that a timely filing is made with the Department of the documents required to be filed by the Interpretation and/or Schedule E.

Participation in the Preparation of a Registration Statement and the Conduct of Due Diligence

Section 3(c)(l) of Schedule E and the provisions of the Interpretation concerning "Proceeds Directed to a Member" require that a qualified independent underwriter conduct due diligence, participate in the preparation of the registration statement and prospectus, and render a pricing opinion on the securities to be offered to the public. From time to time, the question arises as to what actions a member must take to satisfy the requirements that it participate in the preparation of a registration statement and exercise usual standards when conducting due diligence in respect to it. First, the Committee does not believe it appropriate to express an opinion on what constitutes "usual standards of due diligence." The NASD is aware that members, when acting as qualified independent underwriters, employ different due diligence procedures in connection with the distribution of public offerings. The Committee believes that members and their counsel must determine which procedures they will use and whether those procedures will permit them to represent to the NASD that they have exercised the usual standards of due diligence.

The NASD is aware that a qualified independent underwriter may be engaged to participate in the preparation of a registration statement at two distinct points in the registration process. One is when a determination has been made that Schedule E applies to the offering and the services of a qualified independent underwriter are retained prior to the filing of the registration statement. Second, when it is determined during the regulatory review process that Schedule E applies and the services of a qualified independent underwriter must be retained.

In the first instance, when the qualified independent underwriter is retained by the issuer prior to the initial filing of the registration statement, the NASD believes that a member acting as the qualified independent underwriter easily can conduct due diligence and participate in the preparation of the registration statement. The Department assumes that when the qualified independent underwriter submits its opinion letter, undertaking that it has participated in the preparation of the registration statement and has exercised the "usual" standards of due diligence with respect to the offering document, it has had full opportunity to obtain independent verification of the disclosures made in the registration statement.

In the second instance, the Department has reviewed the registration statement filed with it and has made the determination that, based on the facts presented, Schedule E applies to the offering and a qualified independent underwriter must be retained. In those circumstances, the qualified independent underwriter is retained after the registration statement has been drafted and filed with the appropriate reviewing bodies. While the qualified independent underwriter cannot participate in the "preparation" of the registration statement as originally filed, it can conduct due diligence with respect to the registration statement and prospectus document and require the issuer to amend the disclosures made therein if necessary. Thus, the member remains obligated to independently verify the disclosure in the offering document. The Committee recognizes that although the qualified independent underwriter has not been involved in the preparation of the registration from the beginning, it has had an opportunity to verify the facts disclosed in the registration statement and to require amendments to be filed if deemed necessary, and it does assume the legal responsibilities and liabilities of an underwriter under the Securities Act of 1933. As a result, the Committee feels that the member has participated in the preparation of the final registration statement that is declared effective.

Circumstances do arise however when the registration statement has not been declared effective and the qualified independent underwriter has not had an adequate opportunity to complete its due diligence investigation, and the issuer and the affiliated member request that the qualified independent underwriter be permitted to comply with its obligations after the effective date of the registration statement. In these circumstances, the NASD believes that the qualified independent underwriter must complete its due diligence investigation and provide the Department with necessary undertakings that it has participated in the preparation of the registration statement and is assuming the responsibilities and liabilities of an underwriter prior to the effectiveness of the registration statement. The NASD has determined that it is inappropriate for a member to act as a qualified independent underwriter if it has not been given the opportunity to complete its due diligence and to participate in the preparation of the registration statement prior to the effective date of the offering. In such cases, the NASD believes that it is not realistic, nor is it appropriate, for a qualified independent underwriter to attempt to fulfill its obligations under Schedule E.

Questions regarding this notice can be directed to Charles L. Bennett, Assistant Director, NASD Corporate Financing Department, at (202) 728-8258 or Richard J. Fortwengler, Assistant Director, NASD Corporate Financing Department at (202) 728-8254.

*Also exempt from filing are securities offered by a corporate, foreign government or foreign government agency that has non-convertible debt with a term of issue of at least four years, or non-convertible preferred securities, rated by a nationally recognized statistical rating organization in one of its four highest generic rating categories.