Underwriting Compensation Received by Members in Public Corporate Equity Offerings

EXECUTIVE SUMMARY

The NASD^® is publishing the results of a recent study of underwriting compensation received in the distribution of public corporate equity offerings. The NASD analyzed the amount of actual compensation received in such offerings during calendar year 1991 and used it to predict levels of compensation that might be expected for various sizes and types of offerings. These predicted compensation values, expressed as a percentage of offering proceeds, should provide members and their counsel with guidance regarding the typical amount of underwriting compensation for various offerings and the generally accepted levels of underwriting compensation as determined by the NASD.

The NASD published the results of an earlier study of underwriting compensation in Notice to Members 83-15on April 8, 1983. The findings of this study supersede the results reported in the 1983 Notice.

NASD COMPENSATION GUIDELINES

The Corporate Financing Rule, Article III, Section 44 of the Rules of Fair Practice states that no member or person associated with a member shall receive compensation or participate in a public offering of securities if the underwriting compensation in connection with the public offering is unfair or unreasonable. Determinations of the fairness or reasonableness are made by comparing the proposed compensation to the NASD underwriting compensation guidelines, which represent the maximum amount of compensation "underwriters and related persons" may receive in a public offering. Underwriters and related persons include underwriters, underwriter's counsel, financial consultants and advisers, finders, members of the selling and distribution group, any member participating in the public offering, and any and all other persons associated with or related to, as well as members of the immediate family, of any of the aforementioned persons.

The NASD's Corporate Financing Department (Department) has direct responsibility for the review of underwriting compensation. To ensure compliance with the compensation guidelines, the Department reviews public offerings before their effective dates and aggregates all items of value proposed to be received by underwriters and related persons. The Department then compares the total compensation, expressed as a percentage of offering proceeds, to the appropriate guideline applicable to the offering. For the Department to issue an opinion expressing "no objections" to the underwriting compensation, such compensation must be equal to or less than the maximum applicable guideline.

In determining the maximum amount of compensation that is considered fair and reasonable, the NASD considers the size of the offering and the amount of risk assumed by the underwriter, which is determined by whether the offering is being underwritten on a firm commitment or best efforts basis and whether the offering is an initial or secondary offering. The maximum guideline amount generally will vary directly with the amount of risk assumed by the underwriter and inversely with the dollar amount of offering proceeds. Firm commitment offerings are permitted higher levels of compensation than best efforts offerings due to the risk involved in an underwriter purchasing the securities for resale versus simply utilizing its best efforts to place the securities for the issuer. In addition, a firm commitment initial public offering (IPO) is generally permitted higher compensation than a firm commitment secondary offering because the underwriter is dealing with an unseasoned issuer and is likely to incur higher costs in introducing the issuer to prospective underwriters and investors. The higher percentage levels of compensation permitted in smaller offerings recognizes that certain fixed costs are involved in any distribution, regardless of size.

METHODOLOGY

To predict levels of underwriting compensation accurately, the Department analyzed the amount of compensation received, as disclosed in the final offering document or prospectus, for 874 corporate equity offerings filed with the Department during calendar year 1991. All items of underwriting compensation received by underwriters and related persons were considered, including: cash discounts or commissions; accountable and non-accountable expense reimbursements; warrants, options, cheap stock, and other securities and rights to acquire securities received by underwriters and related persons; finders fees paid for introducing the underwriter and the issuer; rights of first refusal; financial consulting and advisory fees; and all other items of value received in connection with the offering.

The offerings were organized into three categories: 402 firm commitment IPOs, 380 firm commitment secondary offerings, and 92 best efforts offerings. For each of the three categories, the staff performed a regression analysis to predict expected amounts of compensation for certain size offerings in each category.

RESULTS

The attached table indicates the gross proceeds of the offering (in millions of dollars) and the predicted percentage of gross proceeds, exclusive of any over-allotment option, that might be allocated to underwriting compensation for firm commitment IPOs, firm commitment secondary offerings, and best efforts corporate equity offerings. The amounts shown do not represent the compensation actually received in any one offering or the mathematical average for all offerings of a particular size reviewed during 1991. Such amounts also do not reflect the compensation originally proposed to be received when the offerings were filed with the NASD.

It should also be made clear that the amounts of compensation shown are predicted amounts for corporate equity offerings. Such offerings frequently produce higher levels of underwriting compensation and their proposed levels often exceed the NASD guidelines. The study did not include corporate debt offerings because they usually have lower amounts of underwriting compensation than equity offerings.

In addition, the study did not cover direct participation programs and real estate investment trusts because Appendix F to Article III, Section 34 of the Rules of Fair Practice limits them to a maximum underwriting compensation of 10 percent. Therefore, all such offerings have underwriting compensation equal to or less than 10 percent, with an additional .5 percent allowed for the reimbursement of bona fide due diligence expenses.

Questions regarding this Notice may be directed to the NASD Corporate Financing Department at(202)728-8258.

¹ This table contains the results of a regression analysis of an overall population and not mathematical averages for each category. This data should be considered only in connection with the explanation of methodology contained in the attached Notice.