[Federal Register: May 13, 2009 (Volume 74, Number 91)]
[Notices]
[Page 22600-22611]
[DOCID:fr13my09-95]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59880; File No. SR-FINRA-2007-009]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Proposed Rule Change and Amendment
No. 1 Thereto To Modernize and Simplify NASD Rule 2720

May 7, 2009.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on September 6, 2007, Financial Industry
Regulatory Authority, Inc. (``FINRA'') (f/k/a National Association of
Securities Dealers, Inc. (``NASD'')) filed with the Securities and
Exchange Commission (``SEC'' or ``Commission''), and amended on May 1,
2009,\3\ the proposed rule change as described in Items I, II, and III
below, which Items have been substantially prepared by FINRA. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ This Amendment No. 1 to SR-FINRA-2007-009 replaces and
supersedes the original filing submitted on September 6, 2007,
except with regard to Exhibit 2 (NASD Notice to Members 06-52 and
comments received in response to NASD Notice to Members 06-52).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    FINRA is proposing to modernize and simplify NASD Rule 2720
(Distributions of Securities of Members and Affiliates--Conflicts of
Interest) (``Rule

2720'' or ``Rule''), which governs public offerings of securities in
which a member with a conflict of interest participates, and make
corresponding changes to FINRA Rule 5110 (Corporate Financing Rule)
(``Rule 5110'').
    Amendment No. 1 to SR-FINRA-2007-009 makes certain changes to the
original filing of September 6, 2007 to address the Commission staff's
comments. The proposed rule change replaces and supersedes the proposed
rule change filed on September 6, 2007 in its entirety, except with
regard to Exhibit 2, NASD Notice to Members 06-52 and comments received
in response to NASD Notice to Members 06-52.
    The text of the proposed rule change is available on FINRA's Web
site at http://www.finra.org, at the principal office of FINRA and at
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Rule 2720 governs public offerings of securities issued by
participating members or their affiliates, public offerings in which a
member or any of its associated persons or affiliates has a conflict of
interest, and public offerings that result in a member becoming a
public company. The Rule regulates the potential conflicts of interest
that exist with respect to the pricing of such offerings and the
conduct of due diligence when a member participates in such offerings.
    In September 2006, FINRA published NASD Notice to Members 06-52
requesting comment on proposed amendments to Rule 2720 (the ``original
proposal''). FINRA received two comment letters that generally
supported the proposal and recognized the need to modernize the
Rule.\4\ However, in response to the comments received, FINRA staff
made certain revisions to the original proposal in its September 6,
2007 filing with the Commission. In order to address Commission staff's
comments, FINRA filed Amendment No. 1 to SR-FINRA-2007-009 on May 1,
2009.
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    \4\ Letter from the Securities Industry and Financial Markets
Association, dated November 1, 2006 (the ``SIFMA Letter''); and
Letter from the American Bar Association, dated December 4, 2006
(the ``ABA Letter'').
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    The proposed rule change would replace the current Rule in its
entirety with proposed Rule 2720 entitled ``Public Offerings of
Securities With Conflicts of Interest.'' Some of the more significant
amendments that FINRA is proposing in this proposed rule change are to:
(1) Exempt from the filing and qualified independent underwriter
(``QIU'') requirements public offerings of investment grade rated
securities, public offerings of securities that have a bona fide public
market, and public offerings in which the member primarily responsible
for managing the offering does not have a conflict of interest and can
meet the disciplinary history requirements for a QIU; (2) Amend the
definition of ``conflict of interest'' to include public offerings in
which at least five percent of the offering proceeds are directed to a
participating member or its affiliates; (3) Modify the Rule's
disclosure requirements to provide more prominent disclosure of
conflicts of interest in the offering documents; and (4) Amend the
Rule's provisions regarding the use of a QIU to focus on the QIU's due
diligence responsibilities and eliminate the requirement that the QIU
render a pricing opinion. In addition, the proposed rule change would
amend the QIU qualification requirements to focus on the experience of
the firm rather than its board of directors, prohibit a member from
acting as a QIU if it would receive more than five percent of the
proceeds of an offering, and lengthen from five to ten years the amount
of time that a person involved in due diligence in a supervisory
capacity must have a clean disciplinary history. These and the other
proposed amendments are discussed in greater detail below.
a. Proposed Rule 2720 Generally
    Proposed Rule 2720(a) provides that no member that has a conflict
of interest may participate in a public offering unless the offering
meets one of the exemptions set forth in paragraph (a)(1) or a QIU
participates in the offering pursuant to paragraph (a)(2).
b. Offerings Exempt From the QIU and Filing Requirements Under
Paragraph (a)(1)
    First, FINRA is proposing an exemption from the QIU and filing
requirements for public offerings in which the member primarily
responsible for managing the offering (e.g., the book-running lead
manager or lead placement agent) does not have a conflict of interest,
is not an affiliate of a member that has a conflict of interest, and
can meet the disciplinary history requirements for a QIU under proposed
paragraph (f)(12)(E).\5\ FINRA staff believes that a QIU should not be
required for such offerings because the book-running lead manager or
lead placement agent (or member acting in a similar capacity), which
does not have conflict of interest, would be expected to perform the
necessary due diligence that would otherwise be required of a QIU.\6\
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    \5\ See proposed Rule 2720(a)(1)(A).
    \6\ All syndicate members have due diligence responsibility, but
the book-runner(s) in a firm commitment offering and the lead
placement agent(s) in a best efforts offering typically hire outside
counsel to help members meet their due diligence obligations.
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    In response to comments on the original proposal,\7\ FINRA has
amended this provision to clarify that it would apply to public
offerings in which there are joint books or that are best efforts
offerings. However, where there are two or more co-lead managers or co-
lead placement agents that have equal responsibilities with regard to
due diligence, each would need to be free of conflicts of interest. Due
to the important role a book-runner or dealer-manager can be expected
to play in the due diligence process in an offering, even if that
responsibility is shared equally with other members, the Rule's QIU
provisions would apply and the offering would have to be filed for
review if any book-runner or dealer-manager has a conflict.
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    \7\ SIFMA Letter.
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    Second, FINRA is proposing an exemption from the QIU and filing
requirements for public offerings of securities that have a bona fide
public market.\8\ The current Rule exempts public offerings of
securities for which there is a ``bona fide independent market'' from
Rule 2720's QIU requirement, but not the filing requirement.\9\ The
proposed rule change

would replace the term ``bona fide independent market'' with ``bona
fide public market,'' which is defined in proposed Rule 2720(f)(3) in
accordance with the numerical standards set forth in SEC's Regulation
M.\10\ Specifically, ``bona fide public market'' is defined in the
proposal as a market for a security issued by a company that has been
reporting under the Exchange Act for at least 90 days, is current in
its reporting requirements and whose securities are listed on a
national securities exchange with an average daily trading volume of at
least $1 million, provided that the issuer's common equity securities
have a public float value of at least $150 million. One commenter
expressed strong support for the proposed definition of ``bona fide
public market.'' \11\
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    \8\ See proposed Rule 2720(a)(1)(B).
    \9\ ``Bona fide independent market'' is defined in current Rule
2720(b)(3) as a market in a security that is listed on a national
securities exchange or Nasdaq with a market price of $5 per share,
aggregate trading volume of 500,000 shares over 90 days and a public
float of 5 million shares.
    \10\ 17 CFR 242.100 to 105.
    \11\ ABA Letter.
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    Third, FINRA is proposing to exempt from the filing requirement,
and to retain the existing exemption from the QIU requirement for,
public offerings of investment grade rated securities and securities in
the same series that have equal rights and obligations as investment
grade rated securities.\12\ In response to comments on the original
proposal,\13\ FINRA has proposed to define ``investment grade rated''
in proposed Rule 2720(f)(8) to refer to securities that are rated by a
nationally recognized statistical rating organization in one of its
four highest generic rating categories. This definition is consistent
with the definition proposed by FINRA in SR-NASD-2004-022 relating to
the filing requirements and the regulation of public offerings of
securities registered with the Commission and offered by members
pursuant to Securities Act Rule 415 (the ``proposed shelf
amendments'').\14\
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    \12\ See proposed Rule 2720(a)(1)(C). Thus, proposed Rule
2720(a)(1)(C) would apply to public offerings of securities that
have not received an individual rating, but are of the same class or
series and are considered ``pari passu'' with other investment grade
rated securities issued by the same company.
    \13\ ABA Letter.
    \14\ See Exchange Act Release No. 50749 (November 29, 2004), 69
FR 70735 (December 7, 2004) (notice of filing of SR-NASD-2004-022)
and Amendment No. 5 (filed on August 31, 2007), available at http://
www.finra.org/Industry/Regulation/RuleFilings/2004/P036671.
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    The three types of public offerings enumerated in paragraphs
(a)(1)(A) through (a)(1)(C) of proposed Rule 2720 would not be subject
to the QIU requirements of the proposed Rule and, by operation of
proposed Rule 2720(d), they would not be subject to the filing
requirements of Rule 5110 (formerly NASD Rule 2710).\15\ They would be,
however, subject to the other provisions of proposed Rule 2720, e.g.,
the escrow and discretionary account requirements in paragraphs (b) and
(c) respectively, if applicable. Additionally, these public offerings
would be subject to certain disclosure requirements. Proposed Rule
2720(a)(1) would require prominent disclosure of the nature of the
conflict of interest in the prospectus, offering circular or similar
document for the public offering.
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    \15\ On September 11, 2008, the Commission approved proposed
rule change SR-FINRA-2008-039, in which FINRA proposed, among other
things, to adopt NASD Rule 2710 as Rule 5110 in the Consolidated
FINRA Rulebook. See Exchange Act Release No. 58514 (September 11,
2008), 73 FR 54190 (September 18, 2008). SR-FINRA-2008-039 was
implemented on December 15, 2008. See Regulatory Notice 08-57
(October 2008).
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    In response to the original proposal, one commenter requested
clarification regarding the ``prominent disclosure'' requirement in the
proposed Rule.\16\ Proposed Rule 2720(f)(10) provides a description of
how a member may make ``prominent disclosure'' for purposes of
paragraphs (a)(1) and (a)(2)(B). Specifically, a member could make the
notation ``(Conflicts of Interest)'' following the listing of the Plan
of Distribution in the Table of Contents section required in Item 502
of SEC Regulation S-K, and provide such disclosures in the Plan of
Distribution section required in Item 508 and any Prospectus Summary
section required in Item 503 of SEC Regulation S-K. For offering
documents not subject to SEC Regulation S-K, ``prominent disclosure''
could be made by providing disclosure on the front page of the offering
document that a conflict exists, with a cross-reference to the
discussion within the offering document and in the summary of the
offering document if one is included. These methods of disclosure would
be considered a non-exclusive safe harbor for effecting ``prominent
disclosure,'' and FINRA would consider alternative--but equally
prominent--disclosures on a case-by-case basis.
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    \16\ ABA Letter.
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c. Offerings in Which a QIU Must Participate Under Paragraph (a)(2)
    If a member with a conflict of interest participates in a public
offering that does not meet the conditions of proposed Rule 2720(a)(1),
then proposed Rule 2720(a)(2)(A) would require that a QIU participate
in the preparation of the registration statement and the prospectus,
offering circular or similar document and exercise the usual standards
of ``due diligence'' with respect thereto.\17\
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    \17\ The requisite qualifications of a QIU are set forth in the
definition of ``qualified independent underwriter'' in proposed Rule
2720(f)(12), which is discussed in greater detail below.
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    Like proposed Rule 2720(a)(1), proposed Rule 2720(a)(2)(B) would
require ``prominent disclosure,'' as defined in proposed Rule
2720(f)(10), in the prospectus, offering circular or similar document
of the nature of the conflict of interest. In addition, proposed Rule
2720(a)(2)(B) would require disclosure of the name of the member acting
as QIU and a brief statement regarding the role and responsibilities of
the QIU. The disclosure requirements contained in current Rule 2720(d)
require that, among other things, the offering documents expressly
state that the member acting as QIU (if one is required for the
offering) is assuming its responsibilities in pricing the offering and
conducting due diligence. In response to commenters' concerns that such
a statement potentially could give rise to liability on the part of the
QIU,\18\ FINRA is proposing to replace this disclosure requirement with
a more general statement about the role and responsibilities of a QIU.
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    \18\ ABA Letter; SIFMA Letter.
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    A public offering in which a QIU participates pursuant to proposed
paragraph (a)(2) would continue to be subject to the filing
requirements of Rule 5110.\19\ Additionally, as in the Rule currently,
a public offering in which a QIU participates would be required to meet
proposed Rule 2720's escrow and discretionary account requirements, if
applicable.
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    \19\ See proposed Rule 2720(d).
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    Current Rule 2720 requires that a QIU provide an opinion that the
price at which equity securities are offered to the public is no
higher, or the yield for debt securities is no lower, than that
recommended by the QIU. The proposed rule change would eliminate the
requirement that a QIU provide a pricing opinion. FINRA staff is
unaware of instances where QIUs have made recommendations that were
inconsistent with pricing decisions by the book-running lead manager or
lead placement agent. In addition, FINRA staff believes that QIU
pricing opinions in at-the-market offerings are of little to no value.
Both commenters expressed strong support for eliminating the QIU
pricing requirement.\20\
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    \20\ ABA Letter; SIFMA Letter.

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d. Escrow of Proceeds; Net Capital Computation
    Proposed Rule 2720(b)(1) would require that all proceeds from a
public 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 the member in any manner until the member has complied with the net
capital requirements set forth in paragraph (b)(2). This proposed
provision mirrors current Rule 2720(e).\21\
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    \21\ Members are reminded that additional escrow account
maintenance and payment requirements may be applicable under
Exchange Act Rule 15c2-4.
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    The net capital requirements set forth in proposed Rule 2720(b)(2)
mirror current Rule 2720(e)(2), except that FINRA is proposing to
replace the reference to Exchange Act Rule 15c3-1(f) with a reference
in proposed Rule 2720(b)(2) to the alternative standard for calculating
net capital under Exchange Act Rule 15c3-1(a)(1)(ii).
    In addition, proposed Rule 2720(b)(3) provides that any member
offering its securities pursuant to this Rule 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 paragraph (b)(1). This provision mirrors current Rule
2720(d)(1).
e. Disclosure
    Current Rule 2720(d)(1) requires disclosure in the registration
statement or offering circular regarding the date the offering will be
completed and the terms upon which proceeds will be released from the
escrow account. Current Rule 2720(d)(2) requires disclosure: (1) That
the offering is being made pursuant to Rule 2720; (2) Relating to the
member's status in the offering; and (3) Relating to the QIU (if one is
required).
    The proposed rule change would delete current paragraph (d) of Rule
2720. As discussed above, the proposal would move the disclosure
requirements in current paragraph (d)(1) to proposed paragraph (b)(3)
and establish separate disclosure requirements for public offerings in
which a QIU participates (proposed Rule 2720(a)(2)(B)) and public
offerings in which a QIU does not participate (proposed Rule
2720(a)(1)).
f. Discretionary Accounts
    Proposed Rule 2720(c) provides that, notwithstanding NASD Rule 2510
(Discretionary Accounts), no member that has a conflict of interest
would be permitted to sell to a discretionary account any security with
respect to which the conflict exists, unless the member has received
specific written approval of the transaction from the account holder
and retains documentation of the approval in its records. This
provision differs from current Rule 2720(l), which also places
limitations on sales to discretionary accounts, in that proposed Rule
2720(c) would only apply to the sale of securities by the member with
the conflict of interest. Current Rule 2720(l) limits discretionary
sales by all firms participating in the offering, even those that do
not have a conflict of interest. One commenter expressed support for
limiting this provision to the member that has a conflict.\22\
Additionally, FINRA notes that the ``specific written approval''
requirement in this provision can be satisfied by an e-mail from the
customer.
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    \22\ ABA Letter.
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g. Application of Rule 5110
    As noted above, proposed Rule 2720(d) provides that any public
offering subject to the QIU requirements of paragraph (a)(2) would be
subject to Rule 5110, whether or not the offering would otherwise be
exempted from Rule 5110's filing or other requirements. Rule 5110
generally requires members to file with FINRA public offerings for
review of the proposed underwriting terms and arrangements. Rule 5110
contains certain exemptions from the filing requirements for, among
others, public offerings of the securities of seasoned issuers \23\ and
offerings of investment grade debt. However, pursuant to current Rule
2720(m), these exemptions are inapplicable to public offerings that
fall within the scope of Rule 2720. Thus, for example, while a public
offering of the securities of a seasoned issuer is normally exempt from
filing under Rule 5110, if a member participating in the offering has a
conflict of interest with the seasoned issuer, it must be filed and
comply with Rule 5110. The proposed rule change would narrow this
filing requirement to apply only to those public offerings that fall
within the scope of proposed Rule 2720(a)(2).
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    \23\ The ``seasoned issuer'' filing exemption in Rule
5110(b)(7)(C) currently exempts offerings registered on Forms S-3
and F-3 by issuers that meet the standards for those Forms prior to
October 21, 1992 (i.e., a three-year reporting history and either
$150 million float or $100 million float and annual trading volume
of three million shares). The proposed shelf amendments (see supra
note 14) would preserve the current filing requirements and amend
the Rule to specifically describe the pre-October 21, 1992
standards.
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    In response to comments on the original proposal,\24\ FINRA is
proposing to amend current Rule 5110(b)(7), which lists offerings that
are exempt from the Rule 5110 filing requirements, to specify that
documents and information related to the public offerings listed in
Rule 5110(b)(7) are not required to be filed with FINRA for review,
unless the public offering is subject to the QIU requirements of Rule
2720(a)(2). This would clarify that if a public offering listed in Rule
5110(b)(7) is subject to Rule 2720(a)(1), such offering would not be
subject to the filing requirements of Rule 5110.
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    \24\ SIFMA Letter.
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h. Requests for Exemption From Rule 2720
    Proposed Rule 2720(e) provides that pursuant to the Rule 9600
Series, FINRA could 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 the proposed Rule that it would deem appropriate. This provision
mirrors existing Rule 2720(o).
i. Definition of ``Affiliate''
    Proposed Rule 2720(f)(1) defines the term ``affiliate'' as an
entity that controls, is controlled by or is under common control with
a member. While current Rule 2720(b)(1) incorporates the ``control''
standard in the definition of affiliate, FINRA is proposing instead to
adopt a separate definition of ``control,'' which is discussed below.
    In response to comments on the original proposal,\25\ FINRA has
narrowed the proposed definition of ``affiliate'' to apply only where
an entity controls, is controlled by or is under common control with a
member. As originally proposed, the definition would have applied where
an entity was under common control with another entity that controls,
was controlled by or was under common control with a member.
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    \25\ ABA Letter.
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j. Definition of ``Beneficial Ownership''
    Proposed Rule 2720(f)(2) defines ``beneficial ownership'' as the
right to the economic benefits of a security. This provision mirrors
the definition contained in current Rule 2720(b)(2). In NASD Notice to
Members 06-52, FINRA requested comment on whether Rule 2720 should
incorporate the definition of ``beneficial ownership'' found in

Exchange Act Rule 13d-3. That definition includes the right to dispose
and vote the securities, which would apply to many investment funds. In
response to comments suggesting that the definition should be confined
to economic interests in which the member can profit directly,\26\
FINRA is proposing to retain the current definition of ``beneficial
ownership.''
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    \26\ Id.
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k. Definition of ``Common Equity''
    Proposed Rule 2720(f)(4) defines ``common equity'' as the total
number of shares of common stock outstanding without regard to class,
whether voting or non-voting, convertible or non-convertible,
exchangeable or non-exchangeable, redeemable or non-redeemable, as
reflected on the consolidated financial statements of the company. This
definition mirrors current Rule 2720(b)(5).
l. Definition of ``Conflict of Interest''
    Proposed Rule 2720(f)(5) would define ``conflict of interest'' to
mean if, at the time of a member's participation in an entity's public
offering, any of four conditions applies. The proposed Rule would
operate much as it does currently. However, the proposed rule change
would relocate many of the current Rule's substantive concepts to the
definition of ``conflict of interest.''
    First, pursuant to proposed Rule 2720(f)(5)(A), a conflict of
interest would exist if the securities are to be issued by the member.
    Second, pursuant to proposed Rule 2720(f)(5)(B), a conflict of
interest would exist if the issuer controls, is controlled by or is
under common control with the member or the member's associated
persons. ``Control'' is defined in proposed Rule 2720(f)(6) and is
discussed below.
    Third, pursuant to proposed Rule 2720(f)(5)(C), a conflict of
interest would exist where at least five percent of the net offering
proceeds, not including underwriting compensation, are intended to be
either used to reduce or retire the balance of a loan or credit
facility extended by the member, its affiliates, and its associated
persons (in the aggregate) or otherwise directed to the member, its
affiliates, and associated persons (in the aggregate). In response to
comments on the original proposal,\27\ FINRA has amended the proposed
definition to clarify that the proceeds are net of underwriting
compensation.
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    \27\ SIFMA Letter.
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    Currently, Rule 5110(h) requires public offerings in which ten
percent or more of the offering proceeds (not including the
underwriting discount) will be paid to participating members to comply
with Rule 2720's QIU requirements. Pursuant to this proposed rule
change, FINRA is proposing to delete Rule 5110(h) and move the proceeds
requirement to Rule 2720 by defining ``conflict of interest'' to
include a member's participation in a public offering where proceeds
are directed to the member. Although the threshold for proceeds
directed to a member is being lowered from ten percent to five percent,
the new threshold would apply to each participating member individually
(including the member's affiliates and its associated persons), not on
an aggregate basis for all participating members, as is currently the
case. Thus, for example, a conflict of interest would exist where a
member received five percent of the proceeds, but not where two
unaffiliated members each received three percent of the proceeds.
    Fourth, pursuant to proposed Rule 2720(f)(5)(D), a conflict of
interest would exist if, as a result of the public offering and any
transactions contemplated at the time of the public offering, the
member will be an affiliate of the issuer, the member will become
publicly owned, or the issuer will become a member or form a broker-
dealer subsidiary.
    In response to comments on the original proposal,\28\ FINRA is
clarifying that for purposes of Rule 2720, ``participation in a public
offering'' has the same meaning as in Rule 5110. Rule 5110(a)(5)
provides that ``participation or participating in a public offering''
means:
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    \28\ Id.

    Participation in the preparation of the offering or other
documents, participation in the distribution of the offering on an
underwritten, non-underwritten, or any other basis, furnishing of
customer and/or broker lists for solicitation, or participation in
any advisory or consulting capacity to the issuer related to the
offering, but not the preparation of an appraisal in a savings and
loan conversion or a bank offering or the preparation of a fairness
opinion pursuant to [Exchange Act] Rule 13e-3.\29\
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    \29\ Rule 5110(a)(5). Pursuant to the proposed shelf amendments
(see supra note 14), this definition in former NASD Rule 2710 (which
has since been moved to the Consolidated FINRA Rulebook as Rule
5110) would be amended to specify participation in the distribution
of the offering on an ``underwritten, non-underwritten, principal,
agency or any other basis'' and to include ``participation in a
shelf takedown.''
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m. Definition of ``Control''
    As noted above, under the current Rule, the control standard is
incorporated in the definition of ``affiliate.'' The proposal would
define ``control'' as any of: (1) Beneficial ownership of ten percent
or more of the outstanding common equity of an entity, including any
right to receive such securities within 60 days of the member's
participation in the public offering; \30\ (2) The right to ten percent
or more of the distributable profits or losses of an entity that is a
partnership, including any right to receive an interest in such
distributable profits or losses within 60 days of the member's
participation in the public offering; \31\ (3) Beneficial ownership of
ten percent or more of the outstanding subordinated debt of an entity,
including any right to receive such subordinated debt within 60 days of
the member's participation in the public offering; \32\ (4) Beneficial
ownership of ten percent or more of the outstanding preferred equity of
an entity, including any right to receive such preferred equity within
60 days of the member's participation in the public offering; \33\ or
(5) The power to direct or cause the direction of the management or
policies of an entity.\34\ FINRA believes it is important in
subparagraph (i) to include entities other than corporations in order
to expressly include conflicts that may arise in connection with the
offerings of, for example, trusts.
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    \30\ Proposed Rule 2720(f)(6)(A)(i). The term ``beneficial
ownership'' is defined in proposed paragraph (f)(2). In response to
a comment by Commission staff, FINRA is clarifying that the use of
the term ``beneficial ownership'' in proposed paragraph (f)(6) is a
more narrow interpretation of the term as compared to the definition
in proposed paragraph (f)(2), owing to the numerical thresholds
imposed by proposed paragraph (f)(6).
    \31\ Proposed Rule 2720(f)(6)(A)(ii).
    \32\ Proposed Rule 2720(f)(6)(A)(iii).
    \33\ Proposed Rule 2720(f)(6)(A)(iv).
    \34\ Proposed Rule 2720(f)(6)(A)(v).
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    FINRA had originally proposed that the definition of control would
eliminate ownership of subordinated debt and preferred equity as a
basis for a conflict of interest.\35\ However, in response to comments
from Commission staff, FINRA is now proposing to include beneficial
ownership of ten percent or more of the outstanding common equity
(which is defined expressly to include non-voting stock), subordinated
debt or preferred equity in the proposed definition of control. Thus,
for example, ``control'' could derive from the restrictive covenants
typically found in debt indentures, preferred rights to dividends given
to holders of non-voting common or preferred stock or special voting
rights given to certain classes of (generally) non-voting stock. FINRA
is specifically requesting comment on whether such

forms of ownership give rise to a conflict of interest and should be
included in the proposed Rule.
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    \35\ See current Rule 2720(b)(7)(A) and (C).
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    The proposed definition of control includes not only shares
beneficially owned by a participating member, but also the right to
receive such securities within 60 days of the member's participation in
the public offering. In its original filing of September 6, 2007, FINRA
proposed that for purposes of this provision, 60 days would be from the
effective date of the offering. However, in Amendment No. 1, FINRA
revised the proposed rule text to provide that the relevant time frame
is ``within 60 days of the member's participation in the public
offering.'' \36\ This would ensure that the Rule properly applies to
takedowns from an effective shelf registration. FINRA believes that the
determination of control should be when the member participates in an
offering, not the date that a registration statement for the offering
is declared effective.
---------------------------------------------------------------------------

    \36\ For purposes of Rule 2720, ``participation in a public
offering'' has the same meaning as in Rule 5110(a)(5). See supra for
further discussion of the definition of the term ``participation in
a public offering.''
---------------------------------------------------------------------------

    Thus, under the proposed rule change, warrants or rights for voting
securities that are exercisable within 60 days of the member's
participation in the public offering would be included in the
calculation of voting securities when determining whether control
exists. In response to comments on the original proposal, FINRA is
clarifying that in calculating the percentage beneficial ownership, it
is appropriate to include the potential ownership of shares in both the
numerator and denominator.\37\ FINRA does not believe, however, that
this calculation should include securities that could be received by
all investors. Rather, the calculation would be limited to warrants or
rights that are exercisable within 60 days and received by the
participating member only and would not include warrants or rights held
by other investors.
---------------------------------------------------------------------------

    \37\ See ABA Letter (requesting that FINRA clarify whether the
amount of securities to be received by a member and any other person
within 60 days of the offering will be included in the denominator
in order to calculate the member's total ownership interest in the
issuer's securities).
---------------------------------------------------------------------------

n. Definition of ``Entity''
    Currently, Rule 2720 does not contain a definition of ``entity.''
Pursuant to proposed Rule 2720(f)(7), an ``entity'' would be defined,
for purposes of the definitions of affiliate, conflict of interest and
control under the Rule, as ``a company, corporation, partnership,
trust, sole proprietorship, association or organized group of
persons.''
    The proposed definition would expressly exclude: (1) An investment
company registered under the Investment Company Act of 1940; \38\ (2) A
``separate account'' as defined in Section 2(a)(37) of the Investment
Company Act of 1940; \39\ (3) A ``real estate investment trust'' as
defined in Section 856 of the Internal Revenue Code; \40\ and (4) A
``direct participation program'' as defined in NASD Rule 2810.\41\
These exclusions are substantially similar to the exemptions from the
``conflict of interest'' provisions contained in current Rule
2720(b)(7)(D). In response to comments on the original proposal,\42\
FINRA revised the proposed definition of ``conflict of interest'' to
apply only to a public offering of an ``entity.''
---------------------------------------------------------------------------

    \38\ Proposed Rule 2720(f)(7)(B)(i).
    \39\ Proposed Rule 2720(f)(7)(B)(ii).
    \40\ Proposed Rule 2720(f)(7)(B)(iii).
    \41\ Proposed Rule 2720(f)(7)(B)(iv).
    \42\ SIFMA Letter.
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o. Definition of ``Preferred Equity''
    Proposed Rule 2720(f)(9) defines the term ``preferred equity'' as
the aggregate capital invested by all persons in the preferred
securities outstanding without regard to class, whether voting or non-
voting, convertible or non-convertible, exchangeable or non-
exchangeable, redeemable or non-redeemable, as reflected on the
consolidated financial statements of the company. This definition
mirrors current Rule 2720(b)(12).
p. Definition of ``Public Offering''
    Proposed Rule 2720(f)(11) is substantively similar to the
definition of ``public offering'' in current Rule 2720(b)(14) and would
define the term as any primary or secondary offering of securities made
pursuant to a registration statement or offering circular including
exchange offers, rights offerings, offerings made pursuant to a merger
or acquisition and all other securities offerings of any kind
whatsoever. The proposed definition excludes from its scope any
offering made pursuant to an exemption from registration under Sections
4(1), 4(2) or 4(6) of the Securities Act of 1933 (``Securities
Act''),\43\ Securities Act Rule 504, if the securities are ``restricted
securities'' under Securities Act Rule 144(a)(3), Securities Act Rule
505, or Securities Act Rule 506, and Securities Act Rule 144A or
Regulation S. FINRA currently does not interpret an offering made
pursuant to Regulation S to be within the scope of a ``public
offering'' under this Rule and as such, is proposing also to exclude
these offerings from the definition. Additionally, in response to
comments on the original proposal,\44\ FINRA has amended the proposed
definition of ``public offering'' to expressly exclude exempted
securities as defined in Section 3(a)(12) of the Exchange Act,\45\ as
in the current Rule.
---------------------------------------------------------------------------

    \43\ 15 U.S.C. 77d(1), (2), and (6).
    \44\ ABA Letter.
    \45\ 15 U.S.C. 78c(a)(12).
---------------------------------------------------------------------------

    One commenter suggested that the proposed Rule should provide an
express exclusion for offerings made pursuant to SEC Rule 144A.\46\
FINRA agrees and has added an express exclusion for offerings under SEC
Rule 144A. FINRA also notes that it currently does not interpret an
offering made pursuant to SEC Rule 144A to be within the scope of
either Rule 5110 or Rule 2720.
---------------------------------------------------------------------------

    \46\ ABA Letter.
---------------------------------------------------------------------------

q. Definition of ``Qualified Independent Underwriter''
    Proposed Rule 2720(f)(12) defines the term ``qualified independent
underwriter'' as a member that meets the certain conditions. First, the
member must not have a conflict of interest and must not be an
affiliate of any member that has a conflict of interest.\47\ The Rule
currently does not disqualify or prohibit a QIU from receiving proceeds
from an offering. The proposed rule change would prohibit a QIU from
receiving more than five percent of the offering proceeds because the
receipt of such proceeds would disqualify a member from acting as a QIU
because it would fall within the proposed definition of ``conflict of
interest.''
---------------------------------------------------------------------------

    \47\ Proposed Rule 2720(f)(12)(A).
---------------------------------------------------------------------------

    The second condition for being considered a QIU in the proposed
Rule is the member cannot beneficially own, as of the date of the
member's participation in the public offering, more than five percent
of the class of securities that would give rise to a conflict of
interest, including any right to receive any such securities
exercisable within 60 days.\48\ Current Rule 2720(b)(15)(E) prohibits a
member from acting as a QIU if it is an affiliate of the issuer or if
it beneficially owns at least five percent of the equity, subordinated
debt or partnership interest of the issuer. The proposed rule change
would maintain these prohibitions.
---------------------------------------------------------------------------

    \48\ Proposed Rule 2720(f)(12)(B).
---------------------------------------------------------------------------

    Third, the member must have agreed, in acting as a QIU, to
undertake the legal responsibilities and liabilities of an underwriter
under the Securities Act,

specifically including those inherent in Section 11 thereof.\49\ The
proposed provision mirrors current Rule 2720(b)(15)(F).
---------------------------------------------------------------------------

    \49\ Proposed Rule 2720(f)(12)(C).
---------------------------------------------------------------------------

    Fourth, the member must have served as underwriter in at least
three public offerings of a similar size and type during the three-year
period immediately preceding the filing of the registration statement
or the date of first sale in an offering for which there is no
registration statement.\50\ This requirement will be deemed satisfied
if, during the past three years, the member, with respect to a proposed
public offering of debt securities, has acted as sole underwriter or
book-running lead or co-manager of at least three public offerings of
debt securities each with gross proceeds of not less than 25% of the
anticipated gross proceeds of the proposed offering. With respect to a
proposed public offering of equity securities, this requirement will be
deemed satisfied if, during the past three years, the member has acted
as sole underwriter or book-running lead or co-manager of at least
three public offerings of equity securities (or of securities
convertible into equity securities), each with gross proceeds of not
less than 50% of the anticipated gross proceeds of the proposed
offering. FINRA is specifically requesting comment on whether the 50%
threshold should be lowered if an equity offering is particularly large
(e.g., over $1 billion). The proposed requirements are similar those
set forth in current Rule 2720(b)(15)(C). The proposal would, however,
shorten the relevant period from five to three years and would impose,
as discussed above, the requirement that a QIU must have acted as a
managing underwriter in at least three similar offerings during that
time.
---------------------------------------------------------------------------

    \50\ Proposed Rule 2720(f)(12)(D).
---------------------------------------------------------------------------

    Additionally, Rule 2720(b)(15)(B) currently permits a member to
serve as a QIU only if the member is a sole proprietorship and the sole
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, or is a corporation or
partnership and a majority of its board of directors or general
partners has been similarly engaged in the investment banking or
securities business. The proposed rule change would eliminate the
requirement regarding board or partner experience, since FINRA staff
believes that the experience of the firm is more relevant.
    The final condition for being considered a QIU in the proposed Rule
is that the member's associated persons in a supervisory capacity who
are responsible for organizing, structuring or performing due diligence
with respect to corporate public offerings of securities cannot have
certain criminal or disciplinary histories.\51\ These associated
persons cannot have been convicted within ten years prior to the filing
of the registration statement or the preparation of an offering
circular in an offering without a registration statement of a violation
of the anti-fraud provisions of the Federal or State securities laws,
or any rules or regulations promulgated thereunder, in connection with
a registered or unregistered offering of securities. These associated
persons also cannot be subject to any order, judgment, or decree of any
court of competent jurisdiction entered within ten years prior to the
filing of the registration statement, or the preparation of an offering
circular in an offering without a registration statement, permanently
enjoining or restraining such person from engaging in or continuing any
conduct or practice in violation of the anti-fraud provisions of the
Federal or State securities laws, or any rules or regulations
promulgated thereunder in connection with a registered or unregistered
offering of securities. Finally, these associated persons cannot have
been suspended or barred from association with any member by an order
or decision of the Commission, any State, FINRA or any other self-
regulatory organization within ten years prior to the filing of the
registration statement, or the preparation of an offering circular in
an offering without a registration statement, for any conduct or
practice in violation of the anti-fraud provisions of the Federal or
State securities laws, or any rules, or regulations promulgated
thereunder, or the anti-fraud rules of any self-regulatory organization
in connection with a registered or unregistered offering of securities.
The Rule currently prohibits an associated person's involvement in the
due diligence process in a supervisory capacity if that person has been
subject to certain criminal and disciplinary actions pertaining to the
offering of securities within five years prior to the filing of the
registration statement. The proposed rule change, as described above,
would lengthen this period from five to ten years.
---------------------------------------------------------------------------

    \51\ See proposed Rule 2720(f)(12)(E).
---------------------------------------------------------------------------

r. Definition of ``Registration Statement''
    Proposed Rule 2720(f)(13) defines the term ``registration
statement'' as a registration statement as defined by Section 2(a)(8)
of the Securities Act,\52\ notification on Form 1A filed with the
Commission pursuant to the provisions of Securities Act Rule 252, 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. This
definition mirrors current Rule 2720(b)(16), except for technical
changes to correct the references in the current Rule to Securities Act
Section 2(8) and Securities Act Rule 255.
---------------------------------------------------------------------------

    \52\ 15 U.S.C. 77b(a)(8).
---------------------------------------------------------------------------

s. Definition of ``Subordinated Debt''
    Proposed Rule 2720(f)(14) defines ``subordinated debt'' to include
debt of an issuer which is expressly subordinate in right of payment to
(or with a claim on assets subordinate to) any existing or future debt
of such issuer or all debt that is specified as subordinated at the
time of issuance. Subordinated debt shall not include short-term debt
with maturity at issuance of less than one year and secured debt and
bank debt not specified as subordinated debt at the time of issuance.
This definition mirrors current Rule 2720(b)(18).
t. Deleted Definitions
    Proposed Rule 2720 does not contain definitions of the following
terms that appear in current Rule 2720: ``company,'' ``effective
date,'' ``immediate family,'' ``parent,'' ``person,'' ``public
director,'' and ``settlement.'' In response to comments on the original
proposal,\53\ FINRA is proposing to adopt the current definitions of
``company,'' ``effective date,'' ``immediate family,'' and ``person''
as new paragraphs (a)(11) through (14) of Rule 5110 because they are
used in that rule. Proposed Rule 2720(f) provides that the definitions
in Rule 5110 are incorporated by reference in Rule 2720.
---------------------------------------------------------------------------

    \53\ ABA Letter.
---------------------------------------------------------------------------

u. Corporate Governance and Periodic Reporting
    Rule 2720 currently includes certain provisions that do not apply
to the public offering itself and instead require the issuer to adopt
corporate governance policies relating to an audit committee, public
directors, and to issue periodic reports to shareholders.\54\ With the
enactment of the Sarbanes-Oxley Act of 2002 and recent SEC rulemaking
and interpretive actions, FINRA believes that issuers' periodic
reporting requirements under the Exchange Act

have been enhanced and listing standard changes intended to improve
corporate governance and enhance the role of audit committees have been
adopted. Accordingly, at this time, FINRA believes that separate Rule
2720 requirements for corporate governance and periodic reporting are
unnecessary. One commenter expressed support for eliminating these
provisions from Rule 2720.\55\
---------------------------------------------------------------------------

    \54\ See current Rule 2720(f), (g), and (h).
    \55\ ABA Letter.
---------------------------------------------------------------------------

v. Intrastate Offerings
    Rule 2720(j) currently requires any member offering its securities
pursuant to the intrastate offering exemption under the Securities Act
to include in the offering documents information required in a release
that the Commission published in 1972. The proposed amendments would
delete this requirement from Rule 2720. FINRA believes that disclosure
requirements for unregistered offerings should be addressed in a more
comprehensive manner by the Commission, the states, or FINRA, and not
imposed under the narrow scope of Rule 2720 or limited to intrastate
offerings. One commenter suggested that FINRA should not adopt
disclosure requirements for intrastate offerings because such offerings
are subject to the disclosure requirements of the State where the
securities are offered.\56\
---------------------------------------------------------------------------

    \56\ Id.
---------------------------------------------------------------------------

x. Suitability
    Rule 2720(k) currently requires that every member underwriting an
issue of its own securities, or securities of an affiliate or company
with which it has a conflict of interest, that recommends to a customer
the purchase of a security of such issue must have reasonable grounds
to believe that the recommendation is suitable for the customer. FINRA
is not proposing a similar provision in new Rule 2720 because NASD Rule
2310 already addresses a member's obligations relating to suitability.
    FINRA will announce the implementation date of the proposed rule
change in a Regulatory Notice to be published no later than 60 days
following Commission approval. The implementation date will be 30 days
following publication of the Regulatory Notice announcing Commission
approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\57\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. FINRA believes that the proposed rule change will
simplify and modernize Rule 2720, thereby providing greater clarity
regarding members' obligations and enhancing the regulation of public
offerings in which members have a conflict of interest.
---------------------------------------------------------------------------

    \57\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others

    The proposed rule change was published for comment in NASD Notice
to Members 06-52 (September 2006). Two comments were received in
response to the Notice. A copy of the Notice is attached as Exhibit 2a.
A list of the comment letters received in response to the Notice is
attached as Exhibit 2b. Copies of the comment letters received in
response to the Notice are attached as Exhibit 2c. Those comments that
have not already been addressed herein are discussed below.\58\
---------------------------------------------------------------------------

    \58\ In addition, FINRA has incorporated some of the commenters'
non-substantive comments without specifically addressing them
herein, e.g., comments regarding inconsistent use of the terms
``entity,'' ``company'' and ``issuer.'' See ABA Letter.
---------------------------------------------------------------------------

Comments on the Scope of Proposed Rule 2720
    Both commenters suggested revising proposed Rule 2720(a)(1) to
include additional categories of public offerings that would be exempt
from the QIU and filing requirements by operation of proposed Rule
2720(d). As discussed in greater detail below, FINRA does not agree
that the exemptions should be expanded further. FINRA notes that, as
proposed, the Rule would significantly reduce the number of public
offerings that must be filed and reviewed by FINRA staff. A public
offering (that is not an offering of investment grade rated securities
or securities with a bona fide public market) will be subject to the
QIU and filing requirements under Rule 2720 only if a member with
primary responsibility for managing the offering has a conflict of
interest. As such, FINRA does not believe that it would be appropriate
to further expand the automatic exemptions under the Rule, as suggested
by the commenters.
    Specifically, the commenters suggested that paragraph (a)(1) of the
proposed Rule should include ``well-known seasoned issuers'' or
``WKSIs.'' \59\ The commenters contend that such a change would be
consistent with the proposed shelf amendments, which proposes exempt
all WKSI shelf offerings from the filing requirements of the
predecessor to Rule 5110.\60\ FINRA does not agree. FINRA believes that
if a participating member has a conflict of interest, the offering
should be subject to the QIU and filing requirements, irrespective of
whether the issuer involved is a WKSI. Today, a WKSI that is not
required to file under Rule 5110 would nonetheless be required to
obtain a QIU if it were to receive ten percent of the offering
proceeds.\61\ In addition, FINRA does not agree that application of
Rule 2720 to WKSIs would slow the offering process.\62\ Currently, all
WKSI filings are reviewed and cleared on the same day they are received
by FINRA's Corporate Financing Department. In connection with the
proposed shelf amendments, FINRA is developing upgrades to the
COBRADesk electronic filing system that will implement a new same-day
automatic review and clearance process for most shelf offerings and all
WKSI shelf offerings.\63\
---------------------------------------------------------------------------

    \59\ ABA Letter; SIFMA Letter. See also Securities Act Rule 405
(defining WKSI); Exchange Act Release No. 52056 (July 19, 2005), 70
FR 44722 (August 3, 2005) (adopting the WKSI definition).
    \60\ ABA Letter; SIFMA Letter. The proposed shelf amendments
were proposed to amend NASD Rule 2710, which has since been moved to
the Consolidated FINRA Rulebook as Rule 5110. See supra note 15.
    \61\ See Rule 5110(h) and current Rule 2720(m).
    \62\ SIFMA Letter.
    \63\ See supra note 14.
---------------------------------------------------------------------------

    Similarly, one commenter suggested that public offerings by issuers
with investment grade rated debt, which are currently exempted by Rule
5110(b)(7)(A), should be included in proposed Rule 2720(a)(1).\64\
FINRA does not agree. The proposed rule change is designed to focus on
the particular public offering in which a member has a conflict of
interest. FINRA believes that while it is appropriate to exempt certain
public offerings from the Rule, it would be inappropriate to exempt an
entire class of issuers such as WKSIs or all issuers with investment
grade rated debt. The relevant inquiry is whether the member has a
conflict of interest with respect to that offering of that security;
the characteristics of the issuer should not be determinative. As such,
FINRA also does not agree with the commenter that proposed paragraphs

(a)(1)(B) and (C) should be amended to refer to the issuer of the
securities, instead of the securities being offered.\65\
---------------------------------------------------------------------------

    \64\ SIFMA Letter.
    \65\ Id.
---------------------------------------------------------------------------

    One commenter suggested that the exception under proposed Rule
2720(a)(1)(B) should be available for public offerings of warrants,
options, convertible debt and convertible preferred securities that are
exercisable for or convertible into equity securities that meet the
standard of having a bona fide public market.\66\ FINRA does not
believe that such an exemption would be appropriate because the
characteristics of the derivative will not always be the same as the
underlying security. The existence of a bona fide public market in the
underlying equity security does not necessarily extend to an offering
of a derivative on that security.
---------------------------------------------------------------------------

    \66\ ABA Letter.
---------------------------------------------------------------------------

    One commenter also suggested that there should be an exception for
offerings by banks and other financial institutions that are the
parents or affiliates of FINRA members of medium-term notes or similar
securities, the return of which is linked to the performance of a
particular stock, asset or index.\67\ While an offering of these
securities that are rated investment grade would be exempted under the
proposed Rule, FINRA believes that an offering of such securities rated
below investment grade should continue to be subject to the filing and
QIU requirements. FINRA believes that an exemption for offerings of
structured products rated below investment grade would be inconsistent
with concerns expressed by FINRA about these securities.\68\ However,
to avoid potential unintended consequences of the proposed Rule, FINRA
is specifically requesting comment on whether certain other types of
securities that are registered on a shelf registration statement or
automatic shelf registration statement should be eligible for the
exemption from the filing and QIU requirements.
---------------------------------------------------------------------------

    \67\ Id.
    \68\ See NASD Notice to Members 05-59 (September 2005). The
Notice stated that FINRA is concerned that when members sell
structured products, they may not be fulfilling their sales practice
obligations, including the requirement to perform a reasonable-basis
and customer-specific suitability determination. The Notice also
raised specific concerns about member sales practice obligations
when selling these instruments to retail customers. The Notice added
that structured products have been increasingly targeted at retail
investors and that FINRA is concerned about the manner in which such
products are marketed and the types of investors purchasing such
products.
---------------------------------------------------------------------------

    Both commenters suggested that the reorganizations, mergers and
acquisition transactions that are currently exempted by Rule 2720(a)(3)
should be exempted under proposed Rule 2720(a)(1).\69\ FINRA believes
that unless a reorganization, merger or acquisition would otherwise
meet the proposed Rule 2720(a)(1) exemptions, it should be subject to
the QIU and filing requirements. The Rule currently applies to these
transactions if the member or its parent issues shares or the
transaction results in the public ownership of a member. Thus, there is
not currently a blanket exemption for reorganizations, mergers and
acquisitions.
---------------------------------------------------------------------------

    \69\ ABA Letter; SIFMA Letter.
---------------------------------------------------------------------------

    One commenter also suggested that the proposed Rule should exempt
all offerings by government entities.\70\ FINRA has proposed to exclude
certain government entities from the filing requirements of Rule 5110
pursuant to the proposed shelf amendments.\71\ However, FINRA does not
agree that all such offerings should be excluded under Rule 2720. If a
member has a conflict of interest with a government entity (e.g., the
member will receive at least five percent of the net proceeds of the
public offering) and the public offering does not otherwise meet the
Rule 2720(a)(1) exemptions, FINRA believes that the offering documents
should be filed and reviewed by FINRA staff.
---------------------------------------------------------------------------

    \70\ SIFMA Letter.
    \71\ See supra note 14.
---------------------------------------------------------------------------

    One commenter suggested that offerings of securities exempt from
registration with the Commission under Section 3(a)(4) of the
Securities Act of 1933 should be exempt under proposed Rule 2720(a)(1),
noting that such offerings currently are exempted from the conflict of
interest provisions of Rule 2720.\72\ While FINRA is not aware of
member conflicts with non-profit or charitable organizations, in the
unlikely event that such a conflict does exist, FINRA believes that the
offering should be filed and reviewed by FINRA staff.
---------------------------------------------------------------------------

    \72\ SIFMA Letter.
---------------------------------------------------------------------------

    This same commenter also suggested that proposed Rule 2720(a)(1)
should exclude offerings conducted pursuant to the multi-jurisdictional
disclosure system because they are already subject to regulation under
the Canadian system.\73\ FINRA does not agree that it should remove
itself from public offerings in which a FINRA member with a conflict of
interest is participating, even if such offerings also are subject to
regulation under the Canadian system.
---------------------------------------------------------------------------

    \73\ Id.
---------------------------------------------------------------------------

    Finally, with respect to proposed Rule 2720(a)(1)(A), one commenter
suggested amending the provision to apply to any book-running manager,
including co- or joint book-running managers, such that a QIU would not
be required if any of the joint book-runners could meet the
requirements of the Rule.\74\ FINRA does not agree that the provision
should be expanded in this way. FINRA understands that in some joint
book offerings, members have been designated as a joint book-runner or
co-lead manager in return for assistance with the road show or other
services critical to marketing the offering. In some cases, the member
designated as a co-lead would not be in the position of supervising due
diligence for the offering or may not be involved in the due diligence
at all. FINRA staff does not believe that including a book-runner or
lead placement agent without a conflict of interest eliminates the
conflict that exists with respect to the remaining book-runner(s) or
lead placement agent(s). Therefore, amending the proposed provision as
the commenter suggests would not fulfill the objective of ensuring
independent due diligence by a member free of conflicts.
---------------------------------------------------------------------------

    \74\ Id.
---------------------------------------------------------------------------

Comments on Proposed QIU Requirements
    One commenter suggested that the references to ``due diligence''
and ``usual standards of due diligence'' should be eliminated from the
Rule, expressing concern that such references could raise the due
diligence defense to the level of a regulatory requirement.\75\ The
requirement that a QIU exercise the usual standards of due diligence
has been in the Rule for 20 years and FINRA believes that it is an
appropriate regulatory requirement.\76\ However, as discussed above, in
response to comments, as well as similar concerns expressed by FINRA's
Corporate Financing Committee, FINRA has eliminated the proposal to
require that the offering documents include a statement that the QIU
has assumed responsibilities for conducting due diligence.
---------------------------------------------------------------------------

    \75\ Id.
    \76\ See, e.g., current Rule 2720(c)(3)(A) and (d)(2).
---------------------------------------------------------------------------

    The commenters also suggested that offerings in which a QIU
participates should be exempt from the filing requirements of Rule
5110.\77\ FINRA does not believe that the participation of a QIU in an
offering sufficiently mitigates the conflicts of interest such that
FINRA review is no longer necessary. Additionally, pursuant to current
Rule 2720(m), the Rule 5110

filing requirements apply to all public offerings subject to Rule 2720,
including public offerings in which a QIU has participated. Thus, the
proposed rule change would not expand the current filing requirements.
---------------------------------------------------------------------------

    \77\ ABA Letter; SIFMA Letter.
---------------------------------------------------------------------------

Comments on the Proposed Discretionary Accounts Provision
    One commenter \78\ suggested that the Rule should be revised to
incorporate the advance authorization procedure in FINRA's Corporate
Financing Department's exemption letter to Goldman Sachs (the ``Goldman
Letter'').\79\ The Goldman Letter applies to public offerings of
straight debt securities, structured notes and straight preferred stock
issued by Goldman or its affiliates and permits the firm to use an
advance authorization procedure in lieu of the requirement in Rule 2720
for prior specific written approval. Specifically, the firm could
obtain an advance written letter of consent from certain customers with
discretionary accounts and oral authorization by the customer prior to
execution of the transaction. FINRA does not believe that Rule 2720
should expressly incorporate the advance authorization procedure set
forth in the Goldman Letter. As discussed above, the written
authorization requirements of this provision can be satisfied by e-
mail, which today may often prove quicker and easier than obtaining
oral authorization.
---------------------------------------------------------------------------

    \78\ ABA Letter.
    \79\ See letter to Judith G. Belash, Esq., Goldman, Sachs & Co.,
from Joseph Price, NASD, Corporate Financing Department, dated June
14, 1999, available at http://www.finra.org/Industry/Regulation/
Guidance/ExemptiveLetters/P002617.
---------------------------------------------------------------------------

    Additionally, this commenter suggested that public offerings in
which proceeds are being directed to a member should be exempted from
the discretionary account provision.\80\ FINRA does not agree. FINRA
believes that the receipt of offering proceeds by members and their
affiliates gives rise to conflicts that are of equal concern in the
context of sales to a discretionary account.
---------------------------------------------------------------------------

    \80\ ABA Letter.
---------------------------------------------------------------------------

Comments on the Proposed Definition of ``Affiliate''
    One commenter suggested that the definition of ``affiliate'' should
be structured similar to the current definition as a control standard
and a presumption of control as a result of management or share
ownership.\81\ FINRA recognizes that there are other ways to define
``affiliate.'' However, this commenter has not demonstrated that its
recommended approach is better than the approach FINRA is proposing.
---------------------------------------------------------------------------

    \81\ Id.
---------------------------------------------------------------------------

Comments on the Proposed Definition of ``Bona Fide Public Market''
    The commenters suggested that the definition of ``bona fide public
market'' should be amended to apply to equity securities of foreign
issuers that meet the ``actively traded'' standards of Regulation M and
are designated offshore securities markets under Rule 902(b).\82\ Upon
further consideration, FINRA is not proposing to amend the definition
along these lines. Because securities with a bona fide public market
are not subject to the QIU or filing requirements, amending the
definition to apply to securities traded on a foreign market would make
this exemption too broad.
---------------------------------------------------------------------------

    \82\ Id.; SIFMA Letter.
---------------------------------------------------------------------------

    One commenter also suggested that the definition should be amended
to clarify that the issuer--and not the particular security--must have
a bona fide public market.\83\ FINRA does not agree. As discussed
above, the focus of this Rule is on the securities being offered and
not the characteristics of the issuer.
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    \83\ SIFMA Letter.
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Comments on the Proposed Definition of ``Conflict of Interest''
    The commenters suggested that there should be no filing requirement
for public offerings in which the conflict of interest derives from the
member's receipt of proceeds.\84\ One commenter asserted that ``NASD
has historically deemed a conflict of interest based on the receipt of
offering proceeds by participating members to be a less significant
conflict than one that is based on the ownership of an issuer's
securities or management control.'' \85\ FINRA does not agree and
believes that the conflict deriving from a member's receipt of proceeds
warrants review and filing of the offering documents. Indeed, FINRA's
Corporate Financing Committee has identified conflicts resulting from
proceeds being directed to a member as one of the most important
conflicts in public offerings today. Pursuant to the proposed rule
change, all public offerings in which a QIU is involved--including
those for which a QIU is required because proceeds are being directed
to a member or its affiliate--must be filed and reviewed by FINRA
staff.
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    \84\ ABA Letter; SIFMA Letter.
    \85\ ABA Letter.
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    Additionally, both commenters assert that the five percent
threshold for a member's receipt of offering proceeds is too low.\86\
FINRA does not agree and believes that in recognition of the
significance of proceeds-related conflicts, it is appropriate to lower
the threshold from ten percent to five percent.
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    \86\ ABA Letter; SIFMA Letter.
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    One commenter suggested that the proposed definition of ``conflict
of interest'' should exclude transactions by which the issuer will
become a member or form a broker-dealer subsidiary.\87\ This commenter
also suggested that the definition be revised to exclude
reorganizations and restructurings if no material change in the
ownership of the issuer or participating member is taking place.\88\
FINRA does not agree that merely because the corporate governance
provisions have been deleted from the Rule, a member's participation in
such offerings no longer creates a conflict of interest. FINRA believes
that these offerings should be subject to the Rule.
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    \87\ SIFMA Letter.
    \88\ Id.
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    This commenter also suggested that the old formulation in which
conflicts of interest existed under specific circumstances, rather than
as a result of a member's participation in public offerings where
certain conditions apply, should be retained because it was easier for
members to argue that no conflict actually exists.\89\ FINRA does not
agree and believes that the proposed definition of ``conflicts of
interest'' is preferable in that it clearly delineates the scope of the
Rule.
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    \89\ Id.
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    The commenters suggested that the definition should not apply to
arms length forward sales contracts and other derivatives where the
proceeds are used by the issuer to purchase the securities to hedge
risk in the transactions.\90\ FINRA is requesting further comment on
this issue and specifically how use of the proceeds by the issuer to
buy derivatives or other hedging transactions is substantially
different from other uses of proceeds contemplated by the Rule (e.g.,
to retire debt).
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    \90\ ABA Letter; SIFMA Letter.
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Comments on the Proposed Definition of ``Control''
    One commenter suggested that ``control'' should not be a defined
term because an entity that is in a control relationship is an
affiliate and thus, the control concept should remain in the definition
of ``affiliate.'' \91\ As previously noted, FINRA recognizes that there
are other ways to approach the definitions

and standards set forth in this Rule. However, FINRA does not believe
that the approach the commenter has proposed is preferable to that
outlined above.
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    \91\ ABA Letter.
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Comments on the Proposed Definition of ``Entity''
    One commenter suggested that the proposed definition of ``entity''
be amended to include groups of persons only if they are organized to
conduct business under the laws of a jurisdiction.\92\ FINRA does not
agree and believes that more flexibility is needed given that FINRA is
not proposing to define ``beneficial ownership'' in accordance with
Exchange Act Rule 13d-3.
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    \92\ Id.
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Comments on the Proposed Definition of ``Public Offering''
    One commenter reiterated its concern, also expressed in response to
FINRA's proposed shelf amendments, that Rules 5110 and 2720, and NASD
Rule 2810, should not be extended to any sale of securities (even one
share) from a registration statement or offering circular, including a
takedown of securities from a shelf registration statement that does
not meet the standard of being a ``distribution'' for purposes of
Regulation M.\93\ The appropriate filing requirements for shelf
takedowns are addressed in FINRA's response to comments on the proposed
shelf amendments.
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    \93\ Id.
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Comments on the Proposed Definition of ``QIU''
    One commenter suggested that the disciplinary history lookback
period should not be extended from five years to ten.\94\ FINRA
believes that a longer lookback period is consistent with the goal of
ensuring that a QIU will provide the necessary investor protection in
public offerings where a member has a conflict of interest.
Additionally, FINRA notes that a ten-year lookback is consistent with
the period used to determine whether a person is subject to a statutory
disqualification.
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    \94\ Id.
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    One commenter suggested that ownership of five percent or more of
the issuer's securities is too low a threshold for purposes of
disqualification as a QIU and should be increased to ten percent in
proposed Rule 2720(f)(12)(B).\95\ FINRA believes that the five percent
threshold is not too low and in fact considered lowering it to three
percent.
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    \95\ SIFMA Letter.
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    This commenter also believes that the term ``5% of the class of
securities that would give rise to a conflict of interest'' contained
in proposed Rule 2720(f)(12)(B) improperly suggests that the member's
conflict of interest is with the issuer's securities rather than with
the issuer and should be replaced with ``5% of the issuer's total
equity securities.'' \96\ FINRA does not agree. Because the proposed
Rule addresses conflicts resulting from the receipt of offering
proceeds by the member, the five percent standard is appropriately
limited to the class of securities offered.
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    \96\ Id.
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    One commenter suggested that the Rule should permit a prospective
QIU to demonstrate on a case-by-case basis that it has acquired
experience within the previous years involving the pricing and due
diligence functions.\97\ FINRA believes that such an approach would be
unmanageable and that a bright-line test is necessary.
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    \97\ Id.
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    One commenter suggested that FINRA should eliminate the requirement
that FINRA members wishing to act as a QIU must qualify on an annual
basis.\98\ This commenter stated that when a participating member acts
as a QIU, that member represents by way of prospectus disclosure that
it is qualified to act and the commenter believes that FINRA should not
require proof in each case. FINRA notes that there is no annual
qualification requirement contained in the current or proposed Rule.
Rather, to streamline the QIU process, FINRA's Corporate Financing
Department permits members to provide information establishing that
they meet the QIU qualification requirements in advance of
participating in a particular public offering and to update this
information annually. In the course of its review of information in
connection with a public offering requiring a QIU, FINRA staff
routinely asks for information that establishes that a member
identified as a QIU is qualified to participate in that capacity. If a
member has already provided this information within the last 12 months
or has done an annual update, the member will not need to provide the
information in connection with that particular offering.
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    \98\ Id.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action

    Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number SR-FINRA-2007-009 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2007-009. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments,
all written statements with respect to the proposed rule change that
are filed with the Commission, and all written communications relating
to the proposed rule change between the Commission and any person,
other than those that may be withheld from the public in accordance
with the provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Room, 100 F Street,
NE., Washington, DC 20549, on official business days between the hours
of 10 a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of FINRA. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly. All

submissions should refer to File Number SR-FINRA-2007-009 and should be
submitted on or before June 3, 2009.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\99\
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    \99\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-11081 Filed 5-12-09; 8:45 am]

BILLING CODE 8010-01-P