Notice To Members 95-7

SEC Approves NASD Proposal Amending Free-Riding And Withholding Interpretation Provisions

Published Date:

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Executive Summary

On December 7, 1994, in SEC Release No. 34-35059, File No. SR-NASD-94-15, the Securities and Exchange Commission (SEC) approved amendments to the NASD Free-Riding and Withholding Interpretation (Interpretation), an Interpretation of the Board of Governors under Article III, Section 1 of the NASD Rules of Fair Practice. The changes to the Interpretation affect:

  • stand-by purchase arrangements by restricted persons;

  • the definition of immediate family members, public offerings, and associated persons;

  • the use of the "carve out" mechanism for restricted persons in Investment Partnerships and Corporations;

  • issuer-directed securities; and

  • other provisions of the Interpretation.

The rule change was effective on December 7, 1994.

Background And Description

The Interpretation protects the integrity of the public offering system by ensuring that members make a bona fide public distribution of "hot-issue" securities and do not withhold such securities for their own benefit or use the securities to reward other persons who are in a position to direct future business to the member. Hot issues are defined by the Interpretation as securities of a public offering that trade at a premium in the secondary market whenever such trading commences. The Interpretation prohibits members from retaining the securities of hot issues in their own accounts and prohibits members from using sales of such securities to directors, officers, employees, and associated persons of members and other broker/dealers. It also restricts member sales of hot-issue securities to the accounts of specified categories of persons, including among others, senior officers of banks, insurance companies, registered investment companies, registered investment advisory firms, and any other persons within such organizations whose activities influence or include the buying or selling of securities. These basic prohibitions and restrictions are also made applicable to sales by members of hot-issue securities to accounts in which any such persons may have a beneficial interest and, with limited exceptions, to members of the immediate family of those persons restricted by the Interpretation.

The substantive amendments to the Interpretation are as follows.

Stand-By Arrangements

Before the amendments, the Interpretation prohibited the sale of a hot issue to a group of stand-by purchasers if any purchaser is restricted under the Interpretation and has a beneficial interest in the stand-by account. This prohibition could affect the successful completion of an offering in which some of the offered securities are not otherwise purchased during the offering period. The Interpretation has been amended to permit restricted accounts to purchase hot-issue securities pursuant to a stand-by arrangement (i.e., an agreement to purchase securities not purchased during the offering period) under certain conditions:

  • disclosure of the arrangement in the prospectus;

  • the arrangement is the subject of a formal written agreement;

  • the managing underwriter represents in writing no other purchases were available;

  • three-month holding period.

Members are reminded that when the securities are sold by the stand-by purchasers, such purchases would need to comply with all applicable regulatory requirements including prospectus delivery pursuant to Section 5 of the Securities Act of 1933 and Rule 10b-6 under the Securities Exchange Act of 1934.

Definition Of Immediate Family

The Interpretation previously restricted immediate family members of persons enumerated in Paragraph 2 (persons associated with broker/ dealers), and Paragraphs 3 and 4 (persons having a connection to the offering and individuals related to banks, insurance companies, and other institutional type accounts) of the Interpretation from participating in hot-issue distributions. The Interpretation defined immediate family members very broadly and included such persons as father-, mother-, brother-, and sister-in-law. The NASD determined that the immediate family member provisions often placed inequitable restrictions on a person with a fairly remote connection to a restricted person named in the Interpretation (e.g., the sister-in-law of a bank vice president), and often resulted in unduly burdensome compliance difficulties for members monitoring whether such persons are restricted or become restricted. The amendments to the immediate family member provisions will ensure that those persons with a substantial nexus to a restricted person will be similarly restricted under the Interpretation, provide a clearer test for NASD members in determining whether such persons are restricted, and eliminate the Interpretation's application to persons for whom the restriction did not serve an important regulatory purpose.

The amendments do the following:

  • retain the investment history exemption, and expand it to include the use of investment history at firms other than the member making the allocation. The burden of obtaining such information would remain with the firm making the sale;

  • the immediate family restrictions on persons enumerated in paragraphs 3 and 4 of the Interpretation are eliminated and the Interpretation only applies to the enumerated individuals in those categories and to persons who are supported directly or indirectly to a material extent by the restricted person;

  • the immediate family restrictions on persons associated with broker/ dealers continue to apply to persons supported by the restricted individual and to allocations by the restricted individual's firm, but no longer prohibit sales to non-supported family members of a person associated with a broker/dealer by a broker/dealer that does not employ the restricted person, where the restricted person has no ability to control the allocation of the hot issue.

It will continue to be a violation if it can be determined that the restricted person has a beneficial interest in the account to which an allocation is made.

Venture Capital Investors

The NASD concluded that bona fide venture-capital investors should be allowed to purchase a hot issue to maintain their percentage ownership in an entity, notwithstanding that the venture-capital investor may be a restricted person, or that such person may have a beneficial interest in the venture-capital account. Venture-capital investors often play a pivotal role in the continued viability of an entity before its public offering, and such an investor should be allowed to maintain his or her ownership interest after the entity completes its public offering.

The venture capital investor, to purchase the hot issue without implicating the Interpretation's restrictions, will have to meet these conditions:

  • one year of pre-existing ownership in the entity;

  • no increase in the investor's percentage ownership above that held for the three months before the filing of a registration statement in connection with the initial public offering;

  • a lack of special terms connection with the purchase; and

  • the venture-capital investor will not sell, pledge, hypothecate, or otherwise dispose of the securities for three months after the effective date of the registration statement in connection with the offering.

The NASD believes that the conditions imposed on the venture-capital investor ensure that the securities may be purchased by a bona fide venture-capital investor who has had an on-going interest in an entity, yet protects against any attempt to circumvent the Interpretation's restrictions by investing in an entity shortly before its public offering.

Investment Partnerships And Corporations

Before the amendments, the Interpretation, under Investment Partnerships and Corporations, generally disallowed sales of a hot issue to an investment partnership or corporation, or similar account (investment partnership) if a restricted person has a beneficial interest in the entity. In August 1992 and October 1993 Notices to Members, the NASD announced it was going to allow investment partnerships, on an interim basis, to use a carve-out mechanism to prevent restricted persons with an interest in an investment partnership from participating in hot-issue allocations. This carve-out mechanism required the NASD member making such allocation to set up a separate account for these transactions and obtain from the investment partnership and its accountant's documentation that indicates that the restricted persons are prevented from participating in a hot-issue allocation.

The NASD concluded that the carve-out methodology was the most equitable and appropriate approach for investment partnerships in which restricted persons have a beneficial interest, and the carve-out procedure has been codified under the Beneficial Interest section of the Interpretation. The carve-out procedure will not allow a person restricted under the Interpretation to receive a hot-issue allocation inconsistent with the Interpretation's provisions, but will not inequitably penalize persons not restricted under the Interpretation due to their interest in an investment partnership in which a restricted person also has an interest. A typical scenario is where a limited partnership with many limited partners is restricted under the Interpretation because one of the limited partners is an officer of an insurance company, and therefore restricted under Paragraph 4 of the Interpretation. Rather than restricting the whole limited partnership, the carve-out procedure would allow the limited partnership to purchase the hot issue by properly allocating the hot issue away from the restricted limited partner according to the specified requirements proposed.

In addition, the NASD believes that a beneficial interest, as defined under the previous Interpretation, should not be created by the receipt of a management fee based on the performance of an account. The NASD believes that investment partnerships and other similar accounts require that the management fee structure of such accounts include a performance-based component. Thus, an investment advisor restricted under Paragraph 4 of the Interpretation could restrict an entire investment partnership, in which no restricted persons have an interest, based solely on the investment advisor receiving a fee based on the performance of the securities in the investment partnership account. The NASD believes that the receipt of a performance-based fee, without the existence of any other beneficial interest, should not create such an interest.

Definition Of Public Offering

Under the previous Interpretation, the definition of a public offering included all distributions of securities, whether registered or unregistered under the Securities Act of 1933. The NASD concluded that the definition had the unintended effect of implicating the Interpretation's restrictions for bona fide private placements of securities that do not present the potential abuses that the Interpretation is intended to guard against. The amendment to the definition, which will not apply the Interpretation to a traditional private placement of securities, is appropriate because such distributions generally are limited in scope and have holding periods placed on the placed securities. Thus, such placements will not be within the purview of the Interpretation in that distribution is limited and that the potential for restricted persons to purchase the securities and resell or "flip" them in a short period of time is limited due to the resale restrictions associated with such offerings.

Associated Person Definition

Article I, Section (m) of the NASD By-Laws defines a "person associated with a member" to include a partner of a broker/dealer and any person who is directly or indirectly controlling or controlled by such member, whether or not such person is registered with the Association. The NASD has found that a certain degree of confusion exists as to the status of passive investors in broker/ dealers, such as broker/dealer limited partners, equity owners, or subordinated lenders.

The NASD believes that, under certain circumstances, such persons should not be restricted as persons associated with a broker/dealer for purposes of the Interpretation due to their limited, passive investment in a broker/dealer. Thus, the NASD has determined that if a person owns or has contributed 10 percent or less to a broker/dealer's capital, such person should not be construed to be an associated person; provided that such ownership interest is a passive investment, the person does not receive hot issues from the member in which he or she has the ownership interest, and that the broker/dealer is not in a position to direct hot issues to the person. The NASD believes that the limitations placed on such persons not to be considered associated persons will prevent the same from attempting to use their ownership interests in a broker/dealer to effect the purchase of hot issues, and circumvent the Interpretation's objective of a bona fide distribution of a hot issue. This definition is being used only to determine restriction under the Interpretation and should not be construed as determinative of whether a person is associated with a broker/dealer for other purposes.

Persons Associated With Limited Business Broker/Dealers

Similar to the status of persons with a limited ownership interest in a broker/ dealer, the NASD concluded that persons associated with certain broker/ dealers that transact a limited securities business should also not be restricted as associated persons under Paragraph 2 of the Interpretation. Specifically, the Interpretation has been amended so that persons associated with broker/dealers whose business is limited to direct participation programs or investment company/ variable product securities will not be restricted under the Interpretation to the same extent as those persons associated with broker/dealers with a more comprehensive securities business. It should be noted, however, that the amendment applies only to a person associated with such a limited broker/dealer, and not to the broker/ dealer itself. The NASD does not believe that it is appropriate for any NASD member to purchase a hot-issue security for its own account, regardless of the scope of its securities business.

Issuer-Directed Securities

Previously, an employee of an issuer, who also was restricted under the Interpretation, had to receive permission from the NASD Board of Governors to purchase hot-issue securities of its employer, if the employee did not have the requisite investment history with the NASD member making the securities distribution.

The NASD concluded that it was inequitable to impose such restrictions on employees of issuers who are in most cases tangentially restricted under the Interpretation, in connection with their purchase of securities issued by their employer. Issuer-directed share programs are viewed as a valuable tool in employee development and retention, and the NASD does not believe that the objectives of the Interpretation are furthered by imposing essentially the same restrictions on such purchases as those not involving an employer/ employee relationship. Thus, the amendment to the Issuer Directed Securities section of the Interpretation will allow employees of issuers to purchase hot-issue securities of the employer under the same terms and conditions as persons associated with NASD members are permitted to purchase securities issued by the member, pursuant to an exemption provided in Section 13 of Schedule E to the NASD By-Laws.

Under the changes to the issuer-directed provision of the Interpretation, the employee will still be restricted if the restricted person directly or indirectly materially supports the employee. If permission is granted by the Board of Governors, the employee is allowed to purchase the securities of the employer without meeting the investment history requirement, but the amount purchased would still have to meet the insubstantial and not disproportionate tests described above.

Cancellation Provision

The NASD determined to clarify in the Interpretation that it will not be a violation if an NASD member makes an allocation of a hot issue to a restricted person or account, so long as the member canceled the trade and reallocated the security at the public offering price to a unrestricted account, prior to the end of the first business day after the date on which secondary market trading begins. The NASD believes that the clarification will remedy any concerns caused by inadvertent violations of the Interpretation that are corrected by the NASD member making the distribution.

To help members meet their responsibilities under this cancellation provision, the NASD will provide notification on the Nasdaq News Frame of the name of those new issues that the NASD has determined to have traded at a premium in the secondary market and therefore will be subject to regulatory review by the NASD under its Free-Riding Interpretation. This notification on the News Frame will take place by no later than after the close of business on the first day of trading and will continue to be displayed on the next business day as well. This will allow members adequate time to cancel trades made to restricted accounts and to reallocate those shares.

Members are reminded that cancellation and reallocation may raise issues under Rule 10b-6. Members are directed to the SEC Release approving these rule changes where this issue is discussed.

Other Considerations

The amendments to the Interpretation clarify the NASD's position that unregistered investment advisors (persons who manage hedge funds, investment partnerships or corporations, investment clubs, or similar entities) are considered Paragraph 4 restricted persons. The amendments also make clear that if investment partnerships and corporations accept investment funds from other investment entities, the investing entities must provide the partnership or corporation with documentation and assurances as outlined in the Rule that restricted persons, if any, are not participating in the purchase of hot issues. The NASD would also point out that shares purchased in the hot-issue account for investment partnerships and corporations must remain in that account until they are sold.

Questions regarding this Notice should be directed to the NASD Office of General Counsel at (202) 728-8294.

Text Of Amendments To The NASD's Free-Riding And Withholding Interpretation Under Article III, Section 1 Of The NASD Rules Of Fair Practice

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

Introduction

The following Interpretation of Article III, Section 1 of the Association's Rules of Fair Practice is adopted by the Board of Governors of the Association pursuant to the provisions of Article VII, Section 3(a) of the Association's By-Laws and Article I, Section 3 of the Rules of Fair Practice.

This Interpretation is based upon the premise that members have an obligation to make a bona fide public distribution at the public offering price of securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins (a "hot issue") regardless of whether such securities are acquired by the member as an underwriter, as a selling group member, or from a member participating in the distribution as an underwriter or a selling group member, or otherwise. The failure to make a bona fide public distribution when there is a demand for an issue can be a factor in artificially raising the price. Thus, the failure to do so, especially when the member may have information relating to the demand for the securities or other factors not generally known to the public, is inconsistent with high standards of commercial honor and just and equitable principles of trade and leads to an impairment of public confidence in the fairness of the investment banking and securities business. Such conduct is, therefore, in violation of Article III, Section 1 of the Association's Rules of Fair Practice and this Interpretation thereof which establishes guidelines in respect to such activity.

As in the case of any other Interpretation issued by the Board of Governors of the Association, the implementation thereof is a function of the District Business Conduct Committees and the Board of Governors. Thus, the Interpretation will be applied to a given factual situation by individuals active in the investment banking and securities business who are serving on these committees or on the Board. They will construe this Interpretation to effectuate its overall purpose to assure a public distribution of securities for which there is a public demand.

The Board of Governors has determined that it shall not be considered a violation of this Interpretation if a member which makes an allocation to a restricted person or account of an offering that trades at a premium in the secondary market, cancels the trade for such restricted person or account, prior to the end of the first business day following the date on which secondary market trading commences and reallocates such security at the public offering price to a non-restricted person or account.

Interpretation

Except as provided herein, it shall be inconsistent with high standards of commercial honor and just and equitable principles of trade and a violation of Article III, Section 1 of the Association's Rules of Fair Practice for a member, or a person associated with a member, to fail to make a bona fide public distribution at the public offering price of securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins regardless of whether such securities are acquired by the member as an underwriter, a selling group member or from a member participating in the distribution as an underwriter or selling group member, or otherwise. Therefore, it shall be a violation of Article III, Section 1 for a member, or a person associated with a member, to:

1. Continue to hold any of the securities so acquired in any of the member's accounts;
2. Sell any of the securities to any officer, director, general partner, employee or agent of the member or of any other broker/dealer, or to a person associated with the member or with any other broker/dealer, or to a member of the immediate family of any such person; provided however, that:
(a)This prohibition shall not apply to a person in a limited registration category as that term is defined below;
(b)The prohibition shall not apply to sales to a member of the immediate family of a person associated with a member who is not supported directly or indirectly to a material extent by such person if the sale is by a broker/ dealer other than that employing the restricted person and the restricted person has no ability to control the allocation of the hot issue.
3. Sell any of the securities to a person who is a finder in respect to the public offering or to any person acting in a fiduciary capacity to the managing underwriter, including, among others, attorneys, accountants and financial consultants, or to [a member of the immediate family of any such person;] any other person who is supported directly or indirectly, to a material extent, by any person specified in this paragraph.
4. Sell any securities to any senior officer of a bank, savings and loan institution, insurance company, [registered] investment company, [registered] investment advisory firm or any other institutional type account (including, but not limited to, hedge funds, investment partnerships, investment corporations, or investment clubs), domestic or foreign, or to any person in the securities department of, or to any employee or any other person who may influence or whose activities directly or indirectly involve or are related to the function of buying or selling securities for any bank, savings and loan institution, insurance company, [registered] investment company, [registered] investment advisory firm, or other institutional type account, domestic or foreign, or to [a member of the immediate family of any such person;] any other person who is supported directly or indirectly, to a material extent, by any person specified in this paragraph.
5. Sell any securities to any account in which any person specified under paragraphs (1), (2), (3) or (4) hereof has a beneficial interest;

Provided, however, a member may sell part of its securities acquired as described above to:
(a) persons enumerated in paragraphs (3) or (4) hereof; and
(b) members of the immediate family of persons enumerated in paragraph (2) hereof provided that such person enumerated in paragraph (2) does not contribute directly or indirectly to the support of such member of the immediate family; and
(c) any account in which any person specified under paragraph (3) or (4) or subparagraph (b) of this paragraph has a beneficial interest; if the member is prepared to demonstrate that the securities were sold to such persons in accordance with their normal investment practice [with the member], that the aggregate of the securities so sold is insubstantial and not disproportionate in amount as compared to sales to members of the public and that the amount sold to any one of such persons is insubstantial in amount.
6. Sell any of the securities, at or above the public offering price, to any other broker/dealer; provided, however, a member may sell all or part of the securities acquired as described above to another member broker/dealer upon receipt from the latter in writing assurance that such purchase would be made to fill orders for bona fide public customers, other than those enumerated in paragraphs (1), (2), (3), (4) or above, at the public offering price as an accommodation to them and without compensation for such.
7. Sell any of the securities to any domestic bank, domestic branch of a foreign bank, trust company or other conduit for an undisclosed principal unless:
(a) An affirmative inquiry is made of such bank, trust company or other conduit as to whether the ultimate purchasers would be persons enumerated in paragraphs (1) through (5) hereof and receives satisfactory assurance that the ultimate purchases would not be such persons, and that the securities would not be sold in a manner inconsistent with the provisions of paragraph (6) hereof; otherwise, there shall be a rebuttable presumption that the ultimate purchasers were persons enumerated in paragraphs (1) through (5) hereof or that the securities were sold in a manner inconsistent with the provisions of paragraph (6) hereof;
(b) A recording is made on the order ticket, or its equivalent, or on some other supporting document, of the name of the person to whom the inquiry was made at the bank, trust company or other conduit as well as the substance of what was said by that person and what was done as a result thereof;
(c) The order ticket, or its equivalent, is initialed by a registered principal of the member; and
(d) Normal supervisory procedures of the member provide for a close follow-up and review of all transactions entered into with the referred to domestic bank, trust companies or other conduits for undisclosed principals to assure that the ultimate recipients of securities so sold are not persons enumerated in paragraphs (1) through (6) hereof.
8. Sell any of the securities to a foreign broker/dealer or bank unless:
(a) In the case of a foreign broker/dealer or bank which is participating in the distribution as an underwriter, the agreement among underwriters contains a provision which obligates the said foreign broker/dealer or bank not to sell any of the securities which it receives as a participant in the distribution to persons enumerated in paragraphs (1) through (5) above, or in a manner inconsistent with the provisions of paragraph (6) hereof; or
(b) In the case of sales to a foreign broker/dealer or bank which is not participating in the distribution as an underwriter, the selling member:
(i) makes an affirmative inquiry of such foreign broker/dealer or bank as to whether the ultimate purchasers would be persons enumerated in paragraphs (1) through (5) hereof and receives satisfactory assurance that the ultimate purchasers of the securities so purchased would not be such persons, and that the securities would not be sold in a manner inconsistent with the provisions of paragraph (6) hereof;
(ii) a recording is made on the order ticket, or its equivalent, or upon some other supporting document, of the name of the person to whom the inquiry was made at the foreign broker/dealer or bank as well as the substance of what was said by that person and what was done as a result thereof; and
(iii) the order ticket, or its equivalent, is initialed by a registered principal of the member.

The obligations imposed upon members in their dealings with foreign broker/dealers or banks by this paragraph 8(b) can be fulfilled by having the foreign broker/dealer or bank to which sales falling within the scope of this Interpretation are made execute Form FR-1, or a reasonable facsimile thereof. This form, which gives a blanket assurance from the foreign broker/dealer or bank that no sales will be made in contravention of the provisions of this Interpretation, can be obtained at any District Office of the Association or at the Executive Office. The acceptance of an executed Form FR-1, or other written assurance, by a member must in all instances be made in good faith. Thus, if a member knows or should have known of facts which are inconsistent with the representations received, such will not operate to satisfy the obligations imposed upon him by this paragraph.

Scope and Intent of Interpretation

In addition to the obvious scope and intent of the above provisions, the intent of the Board of Governors in the following specific situations is outlined for the guidance of members.

Limited Business Broker/Dealer

The restrictions placed on associated persons pursuant to Paragraph 2 of the Interpretations shall not apply to persons associated with NASD members engaged solely in the purchase or sale of either investment company/variable contracts securities or direct participation program securities.

Issuer Directed Securities

This Interpretation shall apply to securities which are part of a public offering notwithstanding that some or all of those securities are specifically directed by the issuer to accounts which are included within the scope of paragraphs (3) through (8) above. Therefore, if a person within the scope of those paragraphs to whom securities were directed did not have the required [an] investment history [with the member or registered representative from whom they were to be purchased], the member would not be permitted to sell him such securities. Also, the "disproportionate" and "insubstantial" tests would apply as in all other situations. Thus, the directing of a substantial number of securities to any one person would be prohibited as would the directing of securities to such accounts in amounts which would be disproportionate as compared to sales to members of the public. If such issuer-directed securities are sold to the issuer's employees or directors or potential employees or directors resulting from an intended merger, acquisition, or other business combination, such securities may be sold without limitation as to amount and regardless of whether such employees have an investment history as required by the Interpretation; provided, however, that in the case of an offering of securities for which a bona fide independent market does not exist, such securities shall not be sold, transferred, assigned, pledged, or hypothecated for a period of three months following the effective date of the offering. This Interpretation shall also apply to securities which are part of a public offering notwithstanding that some of those securities are specifically directed by the issuer on a non-underwritten basis. In such cases, the managing underwriter of the offering shall be responsible for insuring compliance with this Interpretation in respect to those securities.

Notwithstanding the above, sales of issuer directed securities may be made to non-employee/director restricted persons without the required investment history after receiving permission from the Board of Governors. Permission will be given only if there is a demonstration of valid business reasons for such sales (such as sales to distributors and suppliers [or key employees], who are in each case incidentally restricted persons), and the member seeking permission is prepared to demonstrate that the aggregate amount of securities so sold is insubstantial and not disproportionate as compared to sales to members of the public, and that the amount sold to any one of such persons is insubstantial in amount; provided, however, that such securities shall not be sold, transferred, assigned, pledged, or hypothecated for a period of three months following the effective date of the offering.

Stand-By Purchasers

Securities purchased pursuant to a stand-by arrangement shall not be subject to the provisions of the Interpretation if the following conditions are met:

1.The stand-by agreement is disclosed in the prospectus.
2.The stand-by arrangement is the subject of a formal written agreement.
3.The managing underwriter represents in writing that it was unable to find any other purchasers for the securities.
4.The securities purchased shall be restricted from sale or transfer for a period of three months.

Investment Partnerships and Corporations

A member may not sell [securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins ("hot issue"),] a hot issue to the account of any investment partnership or corporation, domestic or foreign (except companies registered under the Investment Company Act of 1940) including but not limited to, hedge funds, investment clubs, and other like accounts unless the member complies with either of the following alternatives:

(A) prior to the execution of the transaction, the member has received from the account a current list of the names and business connections of all persons having any beneficial interest in the account, and if such information discloses that any person [enumerated in paragraphs (1) through (4) hereof] restricted under this Interpretation has a beneficial interest in such account, any sale of securities to such account must be consistent with the provisions of this Interpretation, or
(B) prior to the execution of the transaction, the member has obtained a copy of a written representation [current opinion] from counsel admitted to practice law before the highest court of any state or the account's independent certified public accountant stating that such counsel or accountant reasonably believes that no person with a beneficial interest in the account is a restricted person under this Interpretation and stating that, in providing such [opinion] representation, counsel or accountant:
(1) has reviewed and is familiar with this Interpretation;
(2) has reviewed a current list of all persons with a beneficial interest in the account supplied by the account manager;
(3) has reviewed information sup-plied by the account manager with respect to each person with a beneficial interest in the account, including the identity, the nature of employment, and any other business connections of such persons; and
(4) has requested and reviewed other documents and other pertinent information and made inquiries of the account manager and received responses thereto, if counsel or the accountant determines that such further review and inquiry are necessary and relevant to determine the correct status of such persons under the Interpretation.

The member shall maintain a copy of the names and business connections of all persons having any beneficial interest in the account or a copy of the current [opinion of counsel] written representation in its files for at least three years following the member's last sale of a new issue to the account, depending upon which of the above requirements the member elects to follow. For purposes of this section, a list or [opinion] written representation shall be deemed to be current if it is based upon the status of the account as of a date not more than 18 months prior to the date of the transaction.

Beneficial Interest

The term beneficial interest means not only ownership interests, but every type of direct financial interest of any persons enumerated in paragraphs (1) through (4) hereof in such account [, including, without limitation, management fees based on the performance of the account].

Provided, however, that no restricted person shall be deemed to have a beneficial interest in an account receiving a hot issue as a result of ownership of an interest in an investment partnership or corporation, or similar type account ("investment entity"), if the following conditions are met.

1. The investment entity establishes a separate brokerage account, with a separate identification number, for its new-issue purchases. At the end of each fiscal year, the general partner, or similarly situated party, will certify in writing to its independent certified public accountants that: (a) all hot issues purchased by the investment entity were placed in this new-issue account; and (b) that the participants in the new-issue account are not restricted persons under this Interpretation.
2. Prior to the execution of the initial hot-issue transaction, the investment entity's accountant or attorney will provide a written representation that complies with paragraph B of the section of this Interpretation entitled "Investment Partnerships and Corporations."
3, As part of its audit procedure for the investment entity, the independent certified public accountant will confirm in writing to the investment entity that all allocations for the new-issue account were made in accordance with the provisions of the applicable investment entity agreement that restricts participation in hot-issue purchases.
4. The investment entity will maintain in its files copies of the certifications, representations, and confirmations referred to in paragraphs (1) - (3) above for at least three years following the last purchase of a hot issue for the new-issue account.
5. The investment entity will accept investment funds from other investment entities if such other accounts provide the same documentation and assurances described in paragraphs (1) - (4) above that restricted persons will not participate in the purchase of hot issues.
6. The certifications and documents required in paragraphs (1) - (3) above shall be provided to the member holding such account at such time as these certifications and documents are filed with the investment entity and its independent certified public accountant and, the member shall make such documentation available to the NASD upon request.

Venture Capital Investors

This Interpretation shall not prohibit the sale of hot issues in an initial public offering to a person restricted under the Interpretation or to an account in which such restricted person has a beneficial interest (a "Venture Capital Investor") if the following conditions are met:

1.The Venture Capital Investor has held an ownership interest in the company issuing the hot issue securities for a period of one year prior to the effective date of the public offering;
2.The acquisition of the hot issue securities in the public offering does not increase the percentage equity ownership of the Venture Capital Investor in the company above that held three months prior to the filing of the registration statement in connection with the offering;
3.The Venture Capital Investor received no special terms in connection with the purchase; and
4.The securities purchased shall be restricted from sale or transfer for a period of three months following the conclusion of the offering.

Violations by Recipient

In those cases where a member or person associated with a member has been the recipient of securities of a public offering to the extent that such violated the Interpretation, the member or person associated with a member shall be deemed to be in violation of Article III, Section 1 of the Rules of Fair Practice and this Interpretation as well as the member who sold the securities since their responsibility in relation to the public distribution is equally as great as that of the member selling them. In those cases where a member or a person associated with a member has caused, directly or indirectly, the distribution of securities to a person falling within the restrictive provisions of this Interpretation the member or person associated with a member shall also be deemed to be in violation of Article III, Section 1 of the Rules of Fair Practice and this Interpretation. Receipt by a member or a person associated with a member of securities of a hot issue which is being distributed by an issuer itself without the assistance of an underwriter and/or selling group is also intended to be subject to the provisions of this Interpretation.

Violations by Registered Representative Executing Transaction

The obligation which members have to make a bona fide public distribution at the public offering price of securities of a hot issue is also an obligation of every person associated with a member who causes a transaction to be executed. Therefore, where sales are made by such persons in a manner inconsistent with the provisions of this Interpretation, such persons associated with a member will be considered equally culpable with the member for the violations found taking into consideration the facts and circumstances of the particular case under consideration.

Disclosure

The fact that a disclosure is made in the prospectus or offering circular that a sale of securities would be made in a manner inconsistent with this Interpretation does not take the matter out of its scope. In sum, therefore, disclosure does not affect the proscriptions of this Interpretation.

Explanation of Terms

The following explanation of terms is provided for the assistance of members. Other words which are defined in the By-Laws and Rules of Fair Practice shall, unless the context otherwise requires, have the meaning as defined therein.

Associated Person

A person associated with a member or any other broker/dealer, as defined in Article I, paragraph (m) of the NASD's By-Laws, shall not include a person whose association with the member is limited to a passive ownership interest in the member of ten percent or less, and who does not receive hot issues from the member in which he or she has the ownership interest; and that such member is not in a position to direct hot issues to such person.

Public Offering

The term public offering shall mean 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), 4(2) or 4(6) of the Securities Act of 1933, as amended, or pursuant to Rule 504 (unless considered a public offering in the states where offered), Rule 505 or Rule 506 adopted under the Securities Act of 1933, as amended [all distributions of securities whether underwritten or not; whether registered, unregistered or exempt from registration under the Securities Act of 1933, and whether they are primary or secondary distributions, including intrastate distributions and Regulation A issues, which sell at an immediate premium, in the secondary market]. It shall not mean exempted securities as defined in Section 3(a)(12) of the Securities Exchange Act of 1934.

Immediate Family

The term immediate family shall include parents, mother-in-law or father-in-law, husband or wife, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-law, and children. In addition, the term shall include any other person who is supported, directly or indirectly, to a material extent by the member, person associated with the member or other person specified in paragraph[s] (2)[, (3), or (4)] above.

Normal Investment Practice

Normal investment practice shall mean the history of investment of a restricted person in an account or accounts maintained by the restricted person. [maintained with the member making the allocation. In cases where an account was previously maintained with another member, but serviced by the same registered representative as the one currently servicing the account for the member making the allocation, such earlier investment activity may be included in the restricted person's investment history.]

Usually the previous one-year period of securities activity is the basis for determining the adequacy of a restricted person's investment history. Where warranted, however, a longer or shorter period may be reviewed. It is the responsibility of the registered representative effecting the allocation, as well as the member, to demonstrate that the restricted person's investment history justifies the allocation of hot issues. Copies of customer account statements or other records maintained by the registered representative or the member may be utilized to demonstrate prior investment activity. In analyzing a restricted person's investment history the Association believes the following factors should be considered:

(1) The frequency of transactions in the account or accounts during that period of time. Relevant in this respect are the nature and size of investments.
(2) A comparison of the dollar amount of previous transactions with the dollar amount of the hot issue purchase. If a restricted person purchases $1,000 of a hot issue and his account revealed a series of purchases and sales in $100 amounts, the $1,000 purchase would not appear to be consistent with the restricted person's normal investment practice.
(3) The practice of purchasing mainly hot issues would not constitute a normal investment practice. The Association does, however, consider as contributing to the establishment of a normal investment practice, the purchase of new issues which are not hot issues as well as secondary market transactions.

Disproportionate

In respect to the determination of what constitutes a disproportionate allocation, the Association uses a guideline of 10% of the member's participation in the issue, however acquired. It should be noted, however, that the 10% factor is merely a guideline and is one of a number of factors which are considered in reaching determinations of violations of the Interpretation on the basis of disproportionate allocations. These other factors include, among other things:

the size of the participation;

the offering price of the issue;

the amount of securities sold to restricted accounts; and,

the price of the securities in the after market.

It should be noted that disciplinary action has been taken against members for violations of the Interpretation where the allocations made to restricted accounts were less than 10% of the member's participation. The 10% guideline is applied as to the aggregate of the allocations.

Notwithstanding the above, a normal unit of trading (100 shares or 10 bonds) will in most cases not be considered a disproportionate allocation regardless of the amount of the member's participation. This means that if the aggregate number of shares of a member's participation which is allocated to restricted accounts does not exceed a normal unit of trading, such allocation will in most cases not be considered disproportionate. For example, if a member receives 500 shares of a hot issue, he may allocate 100 shares to a restricted account even though such allocation represents 20% of that member's participation. Of course, all of the remaining shares would have to be allocated to unrestricted accounts and all other provisions of the Interpretation would have to be satisfied. Specifically, the allocation would have to be consistent with the normal investment practice of the account to which it was allocated and the member would not be permitted to sell to restricted persons who were totally prohibited from receiving hot issues.

Insubstantiality

This requirement is separate and distinct from the requirements relating to disproportionate allocations and normal investment practice. In addition, this term applies both to the aggregate of the securities sold to restricted accounts and to each individual allocation. In other words, there could be a substantial allocation to an individual account in violation of the Interpretation and yet be no violation on that ground as to the total number of shares allocated to all accounts. The determination of whether an allocation to a restricted account or accounts is substantial is based upon, among other things, the number of shares allocated and/or the dollar amount of the purchase.

SALES BY ISSUERS IN CONVERSION OFFERINGS

Definitions

(a) For purposes of this Subsection, the following terms shall have the meanings stated:
(1) "Conversion offering" shall mean any offering of securities made as part of a plan by which a savings and loan association or other organization converts from a mutual to a stock form of ownership.
(2) "Eligible purchaser" shall mean a person who is eligible to purchase securities pursuant to the rules of the Federal Home Loan Bank Board or other governmental agency or instrumentality having authority to regulate conversion offerings.

Conditions for Exemption

(b) This Interpretation shall not apply to a sale of securities by the issuer on a non-underwritten basis to any person who would otherwise be prohibited or restricted from purchasing a hot issue security if all of the conditions of this Subsection (b) are satisfied.

Sales to Members, Associated Persons of Members and Certain Related Persons

(1) If the purchaser is a member, person associated with a member, member of the immediate family of any such person to whose support such person contributes, directly or indirectly, or an account in which a member or person associated with a member has a beneficial interest:
(A) the purchaser shall be an eligible purchaser;
(B) the securities purchased shall be restricted from sale or transfer for a period of [150 days] three months following the conclusion of the offering; and
(C) the fact of purchase shall be reported in writing to the member where the person is associated within one day of payment.

Sales to Other Restricted Persons

(2) If the purchaser is not a person specified in Subsection (b)(1) above, and is [the purchaser shall be] an eligible purchaser pursuant to Subsection (a)(2), the conditions of Subsection (b)(1) shall not apply to such purchaser.