Interpretive Letter to Dennis C. Hensley, Sidley Austin Brown and Wood LLP

November 13, 2002

Dennis C. Hensley
Sidley Austin Brown and Wood LLP
875 Third Avenue
New York, New York 10022

Dear Mr. Hensley:

This letter is in response to your letter dated June 25, 2002, and our subsequent conversation that day, in which you request that NASD clarify if repurchases of TRACE-eligible debt securities that are made by or on behalf of an issuer in the open market are required to be reported under the Rule 6200 Series, the Transaction Reporting and Compliance Engine rules (“TRACE Rules”), or are not required to be reported under the exception set forth in Rule 6230(e)(3).

Background

The TRACE initiative began on July 1, 2002. At that time, secondary market transactions in a large group of corporate debt securities defined as “TRACE-eligible securities" began to be reported for the first time. Generally, Rule 6230 requires a member that is a party to a transaction in a TRACE-eligible security to report the transaction. However, a member is not required to report a transaction in a TRACE-eligible security if one of three limited exceptions to reporting applies as provided in Rule 6230(e).

You state that a member should not be required to report a transaction in a TRACE-eligible security that is part of an “open market issuer repurchase” under the exception in Rule 6230(e)(3). This section provides that a transaction shall not be reported ”where the buyer and the seller have agreed to trade at a price substantially unrelated to the current market for the TRACE-eligible security (e.g., to allow the seller to make a gift).” You state that issuers engaged in a repurchase program of debt securities, unlike those engaged in a repurchase program of equity securities, are not subject to the restrictions and safe-harbor provisions of SEC Rule 10b-18,¹ and therefore may repurchase their debt securities “at prices unrelated to the current market price and in amounts vastly different than normal trading volumes.” You also state that an issuer’s motivation to repurchase the securities may differ from an investor’s motivation to buy and hold the securities, which is a factor affecting pricing. The issuer’s motivations may include the issuer’s desire to realize significant savings on interest rates or to reduce debt/equity ratios or the issuer’s need to meet contractual obligations to pursue corporate strategies. You assert that, as a result of the issuer’s motivations, transactions done pursuant to an issuer repurchase program may be executed at “prices higher than the current market price.” You argue that the reporting of such information should not be required because, if disseminated, such information would be misleading to investors in such securities and similar securities in two ways: (1) issuer repurchase price levels may not reflect current market prices and may be unrelated to normal supply and demand forces; and (2) issuer repurchases usually are executed as block transactions, but, in any event, tend to exceed normal trading volumes.

Analysis

The TRACE Rules are drafted broadly to require an NASD member that is a party to almost any transaction in a TRACE-eligible security to report the transaction. For example, Rule 6230 requires a member that acts as either a buyer or seller to report the transaction (“dual side” reporting). In addition, whether acting as a principal or an agent, the member must report. The Rule also requires a member to report transactions that occur before or after the TRACE system hours, and during a weekend or on a holiday. Rule 6230(d)(4)(A) provides that a transaction that is not executed at a price that reflects the current market price must be reported, but specially marked, using the modifier, “special price.”² In summary, if a member engages in a transaction in a TRACE-eligible security, there are few exceptions to the requirement to report.

However, a member is not required to report a transaction in a TRACE-eligible security if one of three limited exceptions to reporting under Rule 6230(e) applies. Rule 6230(e)(3) provides that a transaction shall not be reported “where the buyer and the seller have agreed to trade at a price substantially unrelated to the current market for the TRACE-eligible security (e.g., to allow the seller to make a gift).”³ NASD construes Rule 6230(e)(3) narrowly. Generally, Rule 6230(e)(3) applies to unique or singular transactions with no commercial intent. Transactions having an investment, commercial, or trading purpose, are not subject to this exception because generally the price established in these transactions reflects current market pricing. That such pricing may prove anomalous in terms of the overall trading characteristics of a particular security neither nullifies nor renders meaningless the trading intent of the parties or the occurrence of the transaction in the marketplace.

When considering if a member is excepted from reporting a transaction, NASD interprets the general requirement to report in Rule 6230 broadly in furtherance of the underlying policy goals of TRACE, and, as stated above, the exception in Rule 6230(e)(3) narrowly. Accordingly, based on the information you have provided, it is NASD staff’s position that a member would not be in compliance with Rule 6230 if the member failed to report the open market issuer repurchase transactions in reliance on Rule 6230(e)(3) for the following reasons. Generally, in such purchases and sales, market participants negotiate the price and other terms of the transaction (or multiple transactions) based on investment, commercial or trading considerations, and execute the transaction in furtherance of investment, commercial, or trading purposes. Even where an issuer, or a market participant on behalf of an issuer, determines to price and purchase a significant amount of a debt security, the price established for the transaction is determined with substantial reference to the current market price of the security and current market conditions. This would appear to be likely regardless of the issuer’s ultimate motivation. By requiring the reporting of transactions that reflect current market pricing, NASD is able to collect pricing information, and transaction and volume information, and when appropriate, disseminate such information.⁴ If the exception in Rule 6230(e)(3) were interpreted to except such transactions from reporting, NASD’s surveillance of the debt markets may be hampered by incomplete information relating to significant trading activity. In addition, if such transactions were subject to dissemination, the market would be deprived of significant, relevant, current price information.⁵

I hope this letter is responsive to your inquiry. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the Board of Governors of NASD. This letter responds only to the issues that you have raised based on the facts you have described, and does not address any other rule or interpretation of the NASD, or all the possible regulatory and legal issues involved.

Very truly yours,

Sharon K. Zackula
Assistant General Counsel

1 17 C.F.R. 240.10b-18 (2001).

2 If a transaction is reported, it also may be disseminated, provided it is subject to dissemination under Rule 6250.

3 If a transaction is not reported, the transaction information also would not be available to be disseminated.

4 There may be circumstances in which a member reports a transaction done pursuant to an issuer open market repurchase and appropriately appends the “special price” modifier described in Rule 6230(d)(4)(A). In most cases, however, it appears that such issuer repurchase transactions establish pricing in the current market for that security.

5 It should be noted that the staff does not believe that volume, if disseminated, would be misleading. The amount of securities purchased in such programs, if disseminated, would reflect the current supply and demand for such securities in the market. In addition, the actual volume of large transactions currently is not disseminated. Instead, a large transaction is disseminated as “$5 million plus” if it is a transfer of more than $5 million (par value) of an Investment Grade security and “$1 million plus” if it is a transfer of more than $1 million (par value) of a Non-Investment Grade security.