Trading Practices Rules Concerning Securities Offerings

SUMMARY: The Securities and Exchange Commission (``Commission'') today

is publishing for comment a new regulation containing trading practices

rules governing securities offerings. Proposed new Regulation M would

replace Rules 10b-6, 10b-6A, 10b-7, 10b-8, and 10b-21 under the

Securities Exchange Act of 1934. Reflecting the significant

developments and innovations that have occurred in the securities

markets during recent years, the proposed regulation would create a

simpler, more flexible framework to govern the market conduct of

persons with a significant interest in the outcome of an offering. The

proposals are designed to reduce regulatory burdens on issuers,

underwriters, and other offering participants by focusing restrictions

on potentially manipulative conduct in connection with the pricing of

an offering, while retaining core investor safeguards.

DATES: The comment period will expire on June 17, 1996.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G.

Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,

N.W., Washington, D.C. 20549. Comments also may be submitted

electronically at the following E-mail address: rule [email protected].

All comment letters should refer to File No. S7-11-96; this file number

should be included on the subject line if E-mail is used. Comments

letters received will be available for public inspection and copying at

the Commission's Public Reference Room, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Electronically submitted comment letters will

be posted on the Commission's Internet web site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Any of the following attorneys in the

Office of Risk Management and Control, Division of Market Regulation,

Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop

5-1, Washington, D.C. 20549, at 202-942-0772: Nancy J. Sanow, M. Blair

Corkran, K. Susan Grafton, Carlene S. Kim, Heidi E. Pilpel, Barbara J.

Endres, John S. Markle, Lauren C. Mullen, Mark R. Pacioni, Alan J.

Reed, or Marc J. Hertzberg.

SUPPLEMENTARY INFORMATION: The Commission is proposing for comment new

Regulation M, which would be adopted under various provisions of the

Securities Act of 1933 (``Securities Act''),1 the Securities

Exchange Act of 1934 (``Exchange Act''),2 and other federal

securities statutes, and would replace Rules 10b-6, 10b-6A, 10b-7, 10b-

8, and 10b-21 (``trading practices rules'').3 Proposed Regulation

M, consisting of six rules, would set forth a new approach to

regulation of securities offerings that reflects the incentives to

affect the price of the offered security during an offering, while

acknowledging the different needs of various categories of offering

participants to conduct ordinary market activities. Regulation M would

contain separate rules for underwriters, prospective underwriters,

participating broker-dealers (``distribution participants''), and their

affiliated purchasers; and for issuers and other persons on whose

behalf a distribution is being made and their affiliated

purchasers.4

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\1\ 15 U.S.C. 77a et seq.

\2\ 15 U.S.C. 78a et seq.

\3\ 17 CFR 240.10b-6, 240.10b-6A, 240.10b-7, 240.10b-8, and

240.10b-21. The proposed rules also would make conforming and

clarifying changes to Items 502(d) and 508 of Regulation S-B and

Regulation S-K, and to Rules 10b-18 and 17a-2 under the Exchange

Act. 17 CFR 228.502(d), 229.502(d), 228.508, 229.508, 240.10b-18,

and 240.17a-2, respectively.

\4\ The term ``distribution participant,'' which is defined in

proposed Rule 100 and discussed further below, has a narrower

meaning than its use in the current trading practices rules.

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The proposed rules would retain the current prophylactic approach

to anti-manipulation regulation as the most effective means of

protecting the integrity of the market during a securities offering.

Regulation M, however, would streamline and simplify the trading

practices rules by, among other things:

Eliminating restrictions on actively-traded securities.

Reducing the period of trading restrictions for many other

securities, and focusing that period on the pricing of the offering.

Eliminating trading restrictions on derivative securities

during a distribution of an underlying security.

Narrowing substantially the restrictions on debt

securities.

Deregulating rights offerings.

Allowing routine dissemination of research reports,

transactions in baskets of securities, exercises of call options, and

transactions complying with Rule 144A under the Securities Act.5

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\5\ 17 CFR 230.144A.

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Creating a de minimis exception for transactions that are

unlikely to have market impact.

Narrowing the scope of persons subject to the rules.

Allowing greater flexibility for issuer plans and odd-lot

programs.

Expanding the scope of Nasdaq passive market making.

Creating a more flexible framework for stabilizing

transactions.

Shortening the regulated period for short sales in

connection with a public offering.

I. Introduction

A. Background

A fundamental goal of the federal securities laws is the prevention

of manipulation. Manipulation impedes the securities markets from

functioning as an independent pricing mechanism, and undermines the

integrity and fairness of those markets. Congress granted broad

rulemaking authority to the Commission to combat manipulative abuses in

whatever form they might take, including anti-fraud, prophylactic, and

general rulemaking authority. In exercising its authority, the

Commission has focused on the market activities of persons

participating in a securities offering. The Commission determined that

securities offerings present special opportunities and incentives for

manipulation, requiring specific regulatory attention. After developing

experience in administering the general anti-fraud and anti-

manipulation provisions of the Exchange Act,6 the Commission in

1955 adopted Rules 10b-6, 10b-7, and 10b-8 to govern the market

activity of persons with an interest in an offering's outcome.7

These rules are intended to protect the integrity of the offering

process by precluding activities that could influence artificially the

market for the offered security.

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\6\ Sections 9(a)(2), 10(b), and 15(c), 15 U.S.C. 78i(a)(2),

78j(b), and 78o(c).

\7\ Securities Exchange Act Release No. 5194 (July 5, 1955), 20

FR 5075.

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The trading practices rules have served their purposes well. Today,

the U.S. capital markets' unparalleled reputation for honesty and

fairness attracts not only domestic issuers, but also an increasing

number of foreign issuers that offer their securities here to gain both

broader market recognition and cost-effective financing. These rules

[[Page 17109]]

contribute to investors' high degree of confidence that the offering

price has not been influenced artificially by the conduct of offering

participants.

Since the adoption of the Commission's trading practices rules over

40 years ago, and the last substantive revisions to Rule 10b-6 in the

1980s, the markets and their participants have changed significantly.

Institutional investors, such as mutual funds and pension plans, have

become major ``buy-side'' participants in securities offerings.8

The market sophistication and bargaining power of such investors now

provide important protections against abusive conduct on the ``sell-

side'' of an offering. The secondary markets have become more

transparent and trading volume has increased substantially. Increased

transparency helps investors, analysts, and other market participants

to better observe and evaluate unusual market price movements.

Increased liquidity makes manipulation less cost-effective.

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\8\ As of December 1995, mutual funds controlled more than $2.8

trillion in assets. See Investment Company Institute Press Release

(January 25, 1996).

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Self-regulatory organizations (``SROs'') have developed

sophisticated surveillance technologies to monitor market activity on a

real-time basis. The SROs' ability to surveil trading during a

distribution serves a substantial deterrence function. The ready

availability of transaction audit trails also enhances the Commission's

and the SROs' ability to take appropriate enforcement action. As a

consequence, manipulation of the actively-traded securities of large

issuers has become more costly, and its success more uncertain.

The process of distributing securities also has evolved. Shelf-

registered offerings have become a common method of raising capital in

recent years, and equity shelf offerings are increasing.9 Instead

of engaging in formal stabilization, underwriters now routinely

``oversell'' an offering, which can result in substantial purchasing

activity in the form of short covering transactions after an offering

has been distributed. Today, rights offerings rarely are used as a

financing tool by U.S. issuers.

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\9\ In 1992, equity takedowns from shelf registrations accounted

for 3% of all underwritten offers of additional common stock, while

in 1994, equity takedowns accounted for 16% of the total value of

such underwritten offerings. See also M. Santoli, Block Trades Test

Traditions on Wall Street, Wall St. J., Feb. 9, 1996, at B12B

(``Shelf filings that cover equity have steadily become more common

in recent years, rising 18% to 110 in 1995 after climbing 26% in

1994.'')

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Equity and debt offerings and the secondary markets have become

international in scope. Many issuers' securities now are traded in

financial centers throughout the world, providing issuers with expanded

financing opportunities. U.S. investors are now active participants in

U.S. offerings of foreign issuers. Globalization also has revealed

differing, and at times conflicting, regulatory structures and offering

practices.

These developments have outpaced the current structure of anti-

manipulation regulation of securities offerings and have reduced the

need for broad prophylactic restrictions. Moreover, the Commission has

been advised by market participants that the application of the trading

practices rules in the present environment has become needlessly

complex and involves substantial compliance costs.

B. Concept Release

In April 1994, the Commission published a concept release as part

of a comprehensive reexamination of its anti-manipulation regulation of

securities offerings (``Concept Release'').\10\ The release identified

eight concepts that underlie the trading practices rules and anti-

manipulation regulation generally. The premise underlying these

concepts is that regulation should be limited to those persons,

securities offerings, and market activities that involve a readily

identifiable incentive to manipulate the market during an offering. In

considering the need for a revised regulatory approach, the Commission

requested that commenters focus on two central themes: whether certain

classes of securities, transactions, or investors need the protection

of specific rules; and whether a simpler structure for anti-

manipulation regulation would achieve the goals of providing guidance

to underwriters and their counsel, maintaining price integrity,

establishing effective deterrence and enforcement tools, and promoting

investor confidence. The Commission solicited comment on several

alternative regulatory approaches.

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\10\ Securities Exchange Act Release No. 33924 (April 19, 1994),

59 FR 21681 (``Concept Release'').

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Twenty-two comment letters were received.\11\ All commenters

appeared to accept the fundamental objectives of the trading practices

rules of preventing manipulation during a securities offering and

providing guidance to the underwriting community, principally as

expressed in the exceptions to Rule 10b-6. Many commenters questioned

the need for mechanical and complex proscriptive rules as opposed to a

simpler, more flexible approach to anti-manipulation regulation. Of the

various regulatory alternatives noted in the Concept Release,

commenters addressed three: (1) Retaining the current structure, but

relaxing restrictions; (2) more flexible stabilization regulation; and

(3) safe harbor rules.

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\11\ The comment letters and a summary of those comments which

was prepared by the staff are available for public inspection and

copying in File No. S7-14-94.

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Many commenters proposed revising the current exceptions and adding

new exceptions to the prohibitions of Rule 10b-6. Suggested approaches

varied, but the dominant themes were to: shorten the period of

restrictions; ease the application of the rules in multinational

distributions; allow issuers greater flexibility in conducting dividend

reinvestment and stock purchase plans; and narrow the scope of persons

subject to restrictions.

With respect to multinational distributions, several commenters

stated that extraterritorial application of the trading practices rules

disadvantages U.S. participants, because foreign issuers sometimes will

not engage in U.S. securities distributions that require compliance

with the rules. Some commenters proposed exceptions from the trading

practices rules for ``world-class'' issuers.

With respect to stabilization, commenters stated that the

Commission should create a flexible structure that would allow

underwriters to follow the independent market price for the offered

security. Commenters also suggested that the Commission expand and

adopt prior proposals to accommodate multinational stabilizing

transactions. The commenters were divided, however, on whether the

Commission should regulate transactions in the aftermarket of a

distribution, such as the covering of syndicate short positions and the

enforcing of penalty bids. Representatives of the underwriting industry

argued that no regulation was warranted at this time. Other commenters

asserted that certain aftermarket activity by the underwriting

syndicate, such as enforcing penalty bids, can have a manipulative

impact and can create conflicts of interest for broker-dealers.

Commenters also suggested that the restrictions on ``passive market

making'' in Rule 10b-6A be relaxed. The few commenters who addressed

Rule 10b-8 suggested that underwriters should have greater flexibility

in effecting transactions during rights offerings. Two commenters

stated that Rule 10b-21 was ineffectual because it did not cover

securities that were related to the offered security.

[[Page 17110]]

While directing the majority of their comments to specific

provisions of the trading practices rules, many commenters endorsed

recasting the rules as non-exclusive safe harbors from the anti-

manipulation provisions of the Exchange Act.\12\ In support of this

proposal, they asserted that Rule 10b-6 can have a disproportionate

effect on those offering participants who inadvertently run afoul of

the rule's prohibitions because of ``technical'' violations that do not

affect the offered security's price.

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\12\ The American Bar Association (``ABA'') and the Securities

Industry Association drafted proposed rule texts for the staff's

consideration, which are included in File No. S7-14-94.

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II. Overview of Proposed Regulation M

In light of the comments received and the recommendations of the

Commission's Task Force on Disclosure Simplification, the Commission is

proposing to replace the existing trading practices rules with new

Regulation M, consisting of individual rules covering distinct

categories of offering participants and activities.\13\ The new

regulation would continue to effectuate the goals of the existing

trading practices rules. The Commission, however, recognizes that the

current rules impose unwarranted costs on the capital raising process

because they are overly broad and unnecessarily rigid.

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\13\ See Report of the Task Force on Disclosure Simplification

77-79 (March 1996) (``Task Force Report'').

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The Commission's proposals seek to accomplish several objectives.

The proposed rules are intended to eliminate unnecessary costs and

burdens imposed on offering participants under the current rules. These

impediments would be reduced by relaxing existing restrictions in those

circumstances where either the risk of manipulation appears small or

the costs of the restrictions are disproportionate to the purposes that

they serve. For example, relaxation of restrictions seems particularly

appropriate in cases where the expense of manipulating a security would

be high or where improper trading activity would be easy to detect,

because the risk of manipulation in such situations may be far less

than in other offerings.

The proposed rules also seek to simplify and modernize the trading

practices rules. These goals are accomplished by reorganizing the

structure of the rules, reducing their complexity, and tailoring the

concepts to accommodate contemporary market activities.

Regulation M would contain rules covering the following activities

during a securities offering: (1) Activities by underwriters,

prospective underwriters, brokers, dealers, or other persons who are

participating in a distribution, and their affiliated purchasers (i.e.,

distribution participants); (2) activities by the issuer or selling

securityholder and their affiliated purchasers; (3) Nasdaq passive

market making; (4) stabilization, transactions to cover syndicate short

positions, and penalty bids; and (5) short selling in advance of a

public offering. The general anti-fraud and anti-manipulation

provisions of the federal securities laws, including Section 17(a) of

the Securities Act, and Sections 9(a), 10(b), and 15(c) of the Exchange

Act, and Rule 10b-5 thereunder, would continue to govern all activities

in connection with an offering, whether or not the provisions of

Regulation M applied.

A separate rule would contain definitional provisions. Some of

these definitions are new or revised; many are common to more than one

rule. The Commission has endeavored to use straightforward and precise

language in both the definitions and rule text.

The provisions of Regulation M that are analogous to Rule 10b-6

would be contained in Rules 101 and 102, which would cover distribution

participants, and issuers and selling securityholders, respectively.

Rules 101 and 102 would apply only during a ``restricted period'' that

would commence one or five business days before the day of the pricing

of the offered security and continue until the distribution is over.

The restricted periods would be based on the trading volume of the

offered security, rather than the price per share and public float

criteria used in Rule 10b-6. The restricted periods of Regulation M

would focus more specifically on the time of pricing. In contrast, Rule

10b-6 imposes restrictions during the entire distribution, which can

extend over a lengthy period of time, but excepts certain trading

activities prior to a two or nine business day ``cooling-off period.''

The applicable cooling-off period is keyed off of the commencement of

offers and sales. While Rule 10b-6 is intended to protect the pricing

of an offering, certain distribution methods, particularly in

connection with foreign offerings, can result in the cooling-off

periods commencing after an offering has been priced.

Rule 101 would exclude from its coverage more actively-traded

securities, many investment grade securities, and Rule 144A

transactions. Further, Rule 101 would focus on the security being

distributed and would not cover related derivative securities. It would

permit the routine dissemination of research reports, exercises of

options and other securities, and transactions in baskets of securities

involving the offered security, among other transactions. In addition,

Rule 101 would deal with ``inadvertent'' violations during the

restricted period by excusing de minimis transactions, provided that a

distribution participant had in place policies and procedures

reasonably designed to achieve compliance with the rule. The scope of

persons subject to the proposed rule would be narrowed by recognizing

``information barriers'' between the distribution participant and its

affiliates.

Rule 102 would cover issuers, selling securityholders, and related

persons. Issuers and selling securityholders would be able to engage in

market activities prior to the applicable restricted period. During the

restricted period, Rule 102 would permit bids and purchases of odd-

lots, transactions in connection with issuer plans, and exercises of

options or convertible securities by the issuer's affiliated

purchasers. This rule would not contain an exception for actively-

traded securities. The proposals also would reflect the view that the

safe harbor of Rule 10b-18 under the Exchange Act is not available

during a distribution.14

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\14\ 17 CFR 240.10b-18.

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Proposed Rule 103 would govern Nasdaq passive market making and

replace Rule 10b-6A. The new rule would extend to all Nasdaq securities

and nearly all distributions, and would permit more distribution

participants to engage in passive market making.

Proposed Rule 104 would regulate stabilizing and other activities

related to a distribution. The rule would allow underwriters to

initiate and change stabilizing bids based on the current price in the

principal market (whether U.S. or foreign), as long as the bid did not

exceed the offering price. Rule 104 also would address the fact that

underwriters engage in substantial syndicate-related market activity,

and enforce penalty bids in order to reduce volatility in the market

for the offered security. These activities are analogous to traditional

stabilizing under Rule 10b-7. The proposed rule would require

disclosure and recordkeeping with respect to these aftermarket

activities.

Proposed Rule 105 essentially would recodify Rule 10b-21 governing

short selling in connection with a public offering. To harmonize Rule

105 with the provisions of Rules 101 and 102, the period of Rule 105's

coverage would be narrowed to the five business day

[[Page 17111]]

period before pricing, rather than the period extending from the time

of filing of offering materials to the time when sales may be made.

This release requests comment, however, on the continued need for a

separate rule regulating such short selling.

The Commission believes that separate regulation of rights

offerings, as contained in Rule 10b-8, may no longer be warranted. U.S.

issuers infrequently use rights offerings to raise capital. Even when

they do, purchases of rights generally would not be an efficient way

for a distribution participant to facilitate the offering of the

underlying security. In addition, the Commission believes that many

rights offerings by foreign issuers would fall within the exception for

actively-traded securities contained in Rule 101. Therefore, the

proposals would rescind Rule 10b-8.

The proposed trading practices rules, like the current rules, would

apply to all distribution participants in a multinational offering of

securities, as well as the issuer and any selling securityholders or

affiliated purchasers, if the offering occurs at least in part in the

United States. In connection with the Concept Release, as noted above,

several commenters addressed the application of the trading practices

rules to multinational offerings. Regulation M would not distinguish

between domestic and multinational offerings subject to the

Commission's regulatory jurisdiction. Nevertheless, the proposed rules

respond to the concerns of these commenters. In particular, the

exceptions to Rule 101 for actively-traded securities, and the

exclusion of affiliates of distribution participants where the

distribution participant maintains and enforces certain information-

flow restrictions, should facilitate the ability of issuers and

underwriters to conduct multinational offerings.

Many terms and concepts in Regulation M would have the same meaning

as under the trading practices rules (e.g., the definition of

``distribution''), and current interpretations regarding such terms or

concepts would be relevant to the new rules. Exemptions granted and no-

action positions taken under the current rules no longer would be in

effect under Regulation M because the rules under which they were

issued would be rescinded. Many of these exemptions and no-action

positions, however, are proposed to be codified and, in many cases,

expanded under the new rules. Others no longer would be necessary in

view of the provisions of the new rules. The Commission believes that

the broad scope of these amendments will greatly reduce the need for

the issuance of exemptions from the proposed rules. In reviewing the

proposals, commenters are urged to consider their implications for

existing exemptions, no-action positions, and interpretations.

The new regulatory framework should relieve market participants of

unnecessary burdens and respond effectively to a changing marketplace,

while maintaining essential investor protection. The following sections

of this release describe the individual provisions of Rules 100 through

105 and discuss, where appropriate, how they would differ from current

anti-manipulation regulation and why the Commission is proposing such

changes. Comment is solicited throughout the release regarding specific

aspects of the proposals. In addition to responding to these questions,

commenters are encouraged to state how the proposed rules either would

or would not accomplish the goals of Regulation M.

III. Discussion of Proposed Regulation M and Related Amendments

A. Rule 100--Definitions

Proposed Rule 100 would set forth the definitions that apply to all

of the rules contained in Regulation M. Many of the terms in Rule 100

are defined in the trading practices rules, although the definitions of

some of these terms have been revised to reflect commenters'

suggestions. The Commission also proposes to codify terms that have

been used in interpretations, or are the subject of outstanding

Commission proposals.\15\ Other terms are new, and are integral to the

fundamental changes that are reflected by Regulation M. Individual

definitions are discussed later in this release in connection with the

particular aspects of Regulation M to which they relate.

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\15\ See Securities Exchange Act Release No. 28732 (January 3,

1991), 56 FR 814 (proposing amendments to Rule 10b-7); Securities

Exchange Act Release No. 28733 (January 3, 1991), 56 FR 820

(proposing definitional Rule 3b-10) (collectively, ``1991

Proposals''). These proposals would be withdrawn upon adoption of

Regulation M.

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Q1. Do any of the definitions need to be clarified or modified? Are

there other terms used in Regulation M that should be defined in Rule

100?

B. Rule 101--Activities by Distribution Participants

1. Overview of Rule 101

This proposed rule would include significant similarities to as

well as differences from Rule 10b-6. Rule 101, like Rule 10b-6, would

place restrictions on the activities of distribution participants and

their affiliated purchasers during the distribution period.\16\

However, while Rule 10b-6 applies during the entire distribution

period, which extends from the time the issuer determines to go forward

with the offering until all sales efforts end, the rule contains

exceptions permitting certain transactions until the commencement of

cooling-off periods. In contrast, Rule 101 would apply only during the

period commencing one or five business days immediately preceding

pricing of the offering and ending when sales efforts cease.

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\16\ The definition of ``distribution'' for purposes of Rule 101

would be identical to that contained in Rule 10b-6.

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Both Rule 101 and Rule 10b-6 cover securities that are the subject

of the distribution. Rule 101 would not apply to any security with an

average daily trading volume (``ADTV'') with a value of $1 million or

more, or to any related derivative securities. Rule 101, however, would

apply to transactions in an underlying security (i.e., a ``reference

security'') during a distribution of a derivative security.

Rule 101 and Rule 10b-6 apply to distribution participants and

their affiliated purchasers. For purposes of Rule 101, ``distribution

participant'' would refer to underwriters, prospective underwriters,

brokers, dealers, and other persons who have agreed to participate or

are participating in a distribution. Issuers and selling

securityholders and their affiliated purchasers, which also are covered

by Rule 10b-6, would be subject to proposed Rule 102. The definition of

``affiliated purchaser'' would be narrower than that contained in Rule

10b-6, and would recognize the use of information barriers to separate

distribution participants' corporate financing activities from the

trading operations of their affiliates.

Rule 101 would contain exceptions from its proscriptions for

activity that is necessary to permit the offering to proceed; to limit

adverse effects on the trading market that could result from these

prohibitions; and to allow conduct that is not likely to have a

manipulative impact.

Moreover, the Commission has simplified the language used in Rule

101, and believes that the proposed rule reflects the broader sources

of statutory authority under which Regulation M would be adopted,

including the anti-fraud provisions, the statutory authority to adopt

``means reasonably designed to prevent'' fraud and manipulation, and

the Commission's general rulemaking authority. Rule 101 explicitly

would include a prohibition against inducing

[[Page 17112]]

others to bid for as well as purchase any covered security.

2. Securities Excepted From Rule 101

a. Securities With an ADTV Value of $1,000,000 or More

Commenters on the Concept Release supported the idea of reducing

restrictions on actively-traded foreign and U.S. securities consistent

with the principles of the Commission's 1993 Statement of Policy.\17\

After considering commenters views and the Commission's experience with

the Statement of Policy, the Commission is proposing to exclude from

Rule 101 all securities with a published ADTV value of at least $1

million.18 Thus, proposed paragraph (c)(1) of Rule 101 would

eliminate the requirement of Rule 10b-6 that distribution participants

and their affiliated purchasers restrict market activities in these

securities and related securities. This action would enhance

significantly cross-border capital raising capabilities because, for

many foreign issuers, the trading practices rules have been an

impediment to offering their securities in the United States.

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\17\ See Securities Exchange Act Release No. 33137 (November 3,

1993), 58 FR 60324 (``Statement of Policy''). See also Letter

regarding Exemptions from Rules 10b-6, 10b-7, and 10b-8 During

Distributions of Certain German Securities, Securities Exchange Act

Release No. 33022 (October 6, 1993), 58 FR 53220; Letter regarding

Distributions of Certain French Securities, Securities Exchange Act

Release No. 34176 (June 7, 1994), 59 FR 31274; Letter regarding

Exemptions from Rules 10b-6, 10b-7, and 10b-8 During Distributions

of Certain United Kingdom Securities and Certain Securities Traded

on SEAQ International, Securities Exchange Act Release No. 35234

(January 11, 1995), 60 FR 4644; Letter regarding Exemptions from

Rules 10b-6, 10b-7, and 10b-8 During Distributions of Certain Dutch

Securities, Securities Exchange Act Release No. 36412 (October 19,

1995), 60 FR 55391.

\18\ A $5 million ADTV threshold was used in the Statement of

Policy as well as in the class exemptions issued thereunder to

identify very actively-traded securities. See supra note 17.

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The Commission preliminarily believes that it is reasonable to

remove prophylactic trading restrictions for securities with a minimum

ADTV value of $1 million and to rely on market mechanisms to curb

manipulative activity.\19\ While the price of any security can be

manipulated, the Commission is of the view that, as the value of

trading volume of a security increases, it becomes less likely that a

distribution participant would be able, cost-effectively, to affect the

price of the security. Actively-traded securities generally are

followed widely by the investment community, and aberrations in price

are likely to be observed and corrected quickly. Moreover, virtually

all actively-traded securities are traded on exchanges or other

organized markets with high levels of transparency and

surveillance.\20\

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\19\ See infra Section III.B.3.b. for a discussion of ADTV

generally.

\20\ The Commission expects that SROs will continue to enhance

their systems and procedures to capture improper trading during

distributions.

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If adopted, it is estimated that the $1 million value of ADTV

threshold would remove from Rule 101 equity securities of over 2,000

domestic issuers and a substantial number of foreign securities.\21\

The Commission believes that this threshold will except a large group

of securities as to which the potential for a successful manipulation

is more limited. This will make it easier for both foreign and domestic

issuers to access the U.S. capital markets, and will afford more

opportunities for U.S. investors.

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\21\ Based on transaction information for 1994, approximately

1,051 securities listed on the New York Stock Exchange, Inc.

(``NYSE''), 677 securities quoted on Nasdaq, and 30 securities

listed on the American Stock Exchange, Inc. (``AMEX'') would be

excluded from the rule. In 1994, firm commitment public offerings

were conducted for 268 of these securities. The general increase in

security prices and trading volume since year-end 1994 would

increase the number of securities likely to be excluded from the

proposed rule.

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The proposed exception would not compromise investor protection

because the general anti-fraud and anti-manipulation provisions would

continue to apply to offerings of these securities. Those provisions

would continue to prohibit distribution participants and their

affiliated purchasers from influencing a security's price as a means to

facilitate a distribution.

Q2. Is the exception for actively-traded securities appropriate? Is

the ADTV threshold of $1 million appropriate? Should the threshold be

$5 million or some other level? Commenters suggesting another threshold

should provide reasons to support their views.

Q3. Should transactions by distribution participants in actively-

traded securities be restricted for a brief period (e.g., one or two

hours) prior to pricing? Would such a restricted period be feasible to

implement?

In the case of distributions of certain actively-traded foreign

securities, the Commission has not applied Rule 10b-6 to transactions

in securities markets that have not represented a significant

proportion of activity in the security, i.e., where the trading volume

in a particular jurisdiction accounts for less than 10% of the

aggregate worldwide published trading volume in the security (``non-

significant markets'').\22\ The Commission is not proposing an

exclusion for transactions effected in non-significant markets because

the proposed exception for actively-traded securities would permit

transactions in those securities without restriction. The concept of

non-significant markets, however, may be important if a brief

restricted period were required for actively-traded securities, or for

those offerings of foreign securities that are subject to Rule 101.

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\22\ See supra note 17 (citing class exemptions).

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Q4. Should transactions effected in non-significant markets be

subject to restricted periods? How would non-significant markets be

defined (e.g., would the current test of less than 10% of aggregate

worldwide published trading volume suffice)? Commenters favoring an

exception for transactions in non-significant markets should discuss

the context where the principal market is closed for trading.

Although the Commission is not proposing to include a specific

disclosure or recordkeeping requirement for transactions in these

securities by distribution participants, as contained in exemptions

issued pursuant to the Statement of Policy, the Commission is proposing

amendments to Regulations S-B and S-K that would require disclosure of

syndicate covering transactions and penalty bids that could affect an

offered security's price.\23\

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\23\ See infra Section III.E.5.

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Q5. Should the disclosure requirements referenced in the Statement

of Policy apply to transactions in actively-traded securities excepted

from Rule 101?

b. Investment Grade Nonconvertible Securities

Paragraph (c)(2) of Rule 101 generally would incorporate the

exception contained in Rule 10b-6(a)(4)(xiii), which excepts

nonconvertible debt securities and nonconvertible preferred securities,

if the nonconvertible securities being distributed are rated investment

grade by at least one nationally recognized statistical rating

organization (``NRSRO''). This exception is based on the premise that

these securities are traded on the basis of their yields and credit

ratings, rather than the identity of the particular issuer, are largely

fungible and, therefore, are less likely to be subject to

manipulation.\24\

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\24\ Securities Exchange Release No. 19565 (March 4, 1983), 48

FR 10628, 10631-32 (``Release 34-19565'').

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Q6. Do investment grade asset-backed securities have the same

characteristics, including with respect to trading, as nonconvertible

investment grade debt securities of corporate issuers? Should

investment grade asset-backed securities be excepted from Rule 101?

[[Page 17113]]

Q7. For purposes of Rule 101, should an exception for

nonconvertible investment grade debt or preferred securities be based

on criteria other than a rating by an NRSRO?

c. Exempted Securities

The Commission proposes to exclude from Rule 101 ``exempted

securities,'' as defined in Section 3(a)(12) of the Exchange Act. Rule

10b-6 provides an exception for these exempted securities, and also

specifically excludes securities that are issued, or guaranteed as to

principal and interest, by the International Bank for Reconstruction

and Development (``IBRD''). The Commission believes that the exception

for nonconvertible investment grade debt makes it unnecessary to refer

to securities of the IBRD, or of any other entity, within the

``exempted securities'' exception.

d. Face-Amount Securities or Securities Issued by an Open-End

Management Investment Company or Unit Investment Trust

The Commission proposes to except from Rule 101 face-amount

certificates issued by a face-amount certificate company, or redeemable

securities issued by an open-end management investment company or a

unit investment trust pursuant to paragraph (c)(4) of Rule 101.

Paragraph (d) of Rule 10b-6 contains such an exception.

3. Securities and Activities Covered by the Rule

a. Restricted Periods

In the Concept Release, the Commission requested comment on whether

the Rule 10b-6 cooling-off periods, and the criteria used to determine

such periods, should be revised. Nine commenters addressed these

issues. These commenters supported shortening the cooling-off periods,

asserting that the two and nine business day periods no longer are

justified, especially in light of advances in the SROs' surveillance

systems and enhanced market transparency. A few commenters stated that

the price and public float criteria should be replaced and suggested

tests based on trading volume, market capitalization, or public float.

In Rule 10b-6, a security with a per share price of at least $5.00

and a public float of at least 400,000 shares has a cooling-off period

of two business days, while all other securities are subject to a nine

business day cooling-off period. The Commission adopted these criteria

because a security's public float provided a reasonable indication of

the depth and liquidity of the market for a security; a minimum share

price criterion was appropriate in light of the generally greater

volatility of lower priced stocks; and the criteria were easily

ascertainable.\25\ In addition, a five business day cooling-off period

applies to the exercise of standardized call options that were acquired

after the person became a distribution participant.

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\25\ See Release 34-19565, 48 FR at 10634.

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For securities covered by Rule 101 (i.e., those with a published

ADTV value of less than $1,000,000), the Commission is proposing to

replace the existing cooling-off periods with two shorter restricted

periods:

i. for a security with a published ADTV value equal to or exceeding

$100,000, the restricted period would begin on the later of one

business day prior to the determination of the price of the security to

be distributed, or such time that a person becomes a distribution

participant, and end upon the completion of such person's participation

in the distribution of a security; \26\

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\26\ The term ``business day'' would be defined in Rule 100 as a

24 hour period, determined with reference to the principal market

for the security to be distributed, that includes a complete trading

session for that market.

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ii. for all other securities, the restricted period would begin on

the later of five business days prior to the determination of the price

of the security to be distributed, or such time that a person becomes a

distribution participant, and end upon the completion of such person's

participation in the distribution.

Accordingly, the proposed trading restrictions of Rule 101 focus on

a security's ADTV value, and the period immediately before the offering

is priced. This approach differs from the cooling-off periods under

Rule 10b-6, which are based on the price and public float of a security

and begin prior to the commencement of offers and sales in the

distribution.

The Commission believes that the proposed thresholds effectively

balance maintaining depth and liquidity in the period immediately

preceding pricing and protecting the integrity of the market as an

independent pricing mechanism. Many securities now qualifying for a two

business day cooling-off period and some nine business day securities

would have this period reduced to one business day. For a large number

of securities, the nine business day period would be reduced to five

business days. The applicable period for some securities would increase

from two to five business days.\27\

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\27\ Compared with the cooling-off periods under the current

rule, for 7,477 NYSE, AMEX, and Nasdaq securities, approximately 24%

will not be subject to Rule 101, approximately 56% will have a

shorter restricted period, and approximately 20% will have a longer

restricted period (based on 1994 price and volume information).

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Q8. Would the proposed restricted periods adequately balance the

goal of maintaining market liquidity with the mandate to protect

investors from manipulation? If not, should one hour be used rather

than one business day? Should two or nine business days continue to be

used rather than one and five business days?

In some offerings, there is a lag between the time that the

securities are priced and the commencement of sales. For example, in

certain foreign offerings, the securities are priced, then there is a

subscription period for home-country residents, after which

international offers commence. Similarly, in the case of an exchange

offer or merger, the securities could be priced some time before the

exchange offer or proxy solicitation period commences. In these

offerings, as in other distributions, the Commission believes that the

restricted periods should apply one or five business days prior to the

pricing of the offering and continue until distribution activities

terminate. Thus, there could be a period of time between pricing and

the commencement of offers and sales when market activity by

distribution participants and their affiliated purchasers would be

restricted by Rule 101.

Q9. Are there circumstances when the application of the restricted

periods should be modified? For example, should there be a separate

restricted period in the case of merger transactions or exchange

offers? Commenters should describe situations where they believe that a

restricted period based on pricing may not be feasible.

b. The Use of a Test Based on ADTV

As indicated above, the basis for determining which restricted

period applies to a particular security would be different from the

test used for the cooling-off periods under Rule 10b-6. Various

measurements could be used to provide relatively certain and easily

determinable criteria for applying the appropriate restricted period

(e.g., ADTV value, the security's price, an issuer's public float). For

purposes of Regulation M, the Commission believes that the value of a

security's ADTV is the most appropriate test because it provides a more

accurate indication of

[[Page 17114]]

the depth and liquidity of the trading market for a security than its

price and public float. For example, although an issuer may have a

significant public float, the dollar value of daily trading in its

common stock may be quite low.

The Commission proposes to define ``average daily trading volume''

as the world-wide reported average daily trading volume during the

three full consecutive calendar months immediately preceding either the

date of the filing of the registration statement, or if there is no

registration statement or if the distribution involves a shelf

takedown, three full consecutive calendar months immediately preceding

the pricing. To determine the value of the ADTV, it is proposed that

the ADTV either be multiplied by the security's price (in dollars) as

of the last business day of the most recent month, or calculated by

using the actual price and volume information for each day within the

three month period, if it is available.

Q10. Does the value of a security's ADTV provide the appropriate

standard on which to base the restricted periods? Should a test based

on the issuer's public float be used instead? If so, should the

thresholds be, for example, a $150 million public float for the

actively-traded securities exception; a public float of $25-$150

million for the one business day restricted period; and a public float

of below $25 millon for the five business day restricted period?

Q11. Is information on ADTV readily available to participants in a

distribution?

Q12. Should ADTV be based on a different measuring period, e.g., 12

full calendar months, or a rolling three month (i.e., 90 day) period,

rather than three full calendar months?

c. Derivative Securities

The Concept Release stated the Commission's view that anti-

manipulation regulation of securities offerings ``should be limited to

securities whose prices may significantly affect the market's

evaluation of a security in distribution.'' \28\ Rule 10b-6(a)(4)

applies to: (1) The security being distributed, (2) any security of the

``same class and series'' as that security, and (3) ``any right to

purchase'' any such security. In the case of distributions of a

security that is ``immediately exchangeable for or convertible into''

another security, or that entitles the holder immediately to acquire

another security, Rule 10b-6(b) also prohibits purchases of the other

security.

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\28\ Concept Release, 59 FR at 21688.

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The ``right to purchase'' and ``same class and series'' concepts

appear to be both too broad and too limited. The same class and series

language has been construed broadly to encompass similar securities of

an issuer even though there is no inherent mathematical relationship

between the prices of those securities.29 This has led to some

complicated and not very clearly defined distinctions in applying the

rule to offerings of debt. On the other hand, the right to purchase

concept has been interpreted so as not to reach securities that are not

``immediately'' convertible into each other. These securities, however,

trade with a price relationship to the security in distribution because

their ultimate value is, or in the future may be, determined by the

value of the security into which they are exchangeable or

exercisable.30 The concept also does not encompass a wide variety

of securities that have been developed in recent years whose value is

or will be derived from another security, but that do not give the

holder the right to acquire that security. On the other hand, Rule 10b-

6 applies to transactions in derivative securities, such as options and

warrants, that are exchangeable or exercisable for the security in

distribution, but are not very efficient vehicles to cause a price

effect on the distribution security.

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\29\ See Concept Release, 59 FR at 21688. See also Letter

regarding Gamble-Skogmo, Inc. (January 11, 1974).

\30\ See Release 34-19565, 48 FR at 10634 n.28.

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The Commission is proposing to eliminate these two Rule 10b-6

concepts, and to apply the trading restrictions of Rule 101 to

``covered securities,'' which would include the security in

distribution and ``reference securities.'' A ``reference security''

would be defined in Rule 100 as a security whose price is or will be

used to determine, in whole or in significant part, the price of

another security that is the subject of a distribution.31

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\31\ Examples of securities that are not covered expressly by

Rule 10b-6, but would be covered by Rule 101 as reference

securities, include the underlying common stock during distributions

of ``preferred equity redemption cumulative stocks'' (``PERCS'') and

``equity-linked notes'' (``ELNS'').

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In contrast, derivative securities related to the security in

distribution would not be covered by the rule. The Commission believes

that the manipulative potential of trades in a derivative security for

the purpose of affecting the price of an underlying security is

sufficiently attenuated such that these securities should not be

covered by Regulation M. Thus, for example, bids or purchases of the

underlying common stock (i.e., the reference security) would be

restricted during a distribution of a security exercisable or

exchangeable for, or convertible into, the common stock. On the other

hand, bids or purchases of any exercisable, exchangeable, or

convertible security would not be restricted during a distribution of

the related common stock.

Many securities that under Rule 10b-6 are deemed by interpretation

to be of the same class and series as those distributed, because of the

similarities in their coupon rates, maturity dates, and other

provisions, would not be subject to Rule 101. For example, Rule 101

would not apply to bids for and purchases of nonconvertible debt or

preferred securities of the same issuer that are not identical in their

principal features to the securities being distributed. The Commission

preliminarily believes that the benefit of reducing compliance costs

and maintaining a normal trading market for these other securities

outweighs the possibility that bids for and purchases of such

securities could be used to facilitate a distribution. Rule 101 would

apply, however, to transactions in securities that differ from a

security in distribution only as to the presence or absence of voting

rights.

Q13. Commenters are invited to discuss whether derivative

securities, i.e., those that derive all or part of their value from a

security in distribution, should be covered by Regulation M.

Q14. Is there a more appropriate definition for a ``reference

security?''

Q15. Should a security that could never contribute more than 5% of

the value of another security not be deemed to be a reference security

for that security? If derivative securities are covered by the rule,

are there feasible means to identify securities with a price

relationship to a security in distribution that is sufficiently

attenuated that it should not be covered by the rule? For example,

should a derivative security that derives less than 5% of its value

from a security in distribution be excluded?

4. Distributions

a. Definition of Distribution

In the Concept Release, the Commission sought comment on whether to

continue to define the term ``distribution,'' and if so, whether the

term's definition should continue to be based on the ``magnitude of the

offering'' and the presence of ``special

[[Page 17115]]

selling efforts and selling methods.'' \32\ Commenters did not suggest

any changes to the definition or that it be eliminated from the rule.

Accordingly, the term ``distribution'' for purposes of Regulation M is

proposed to have the same meaning as in Rule 10b-6. The Concept Release

sought comment on whether certain types of offerings, specifically,

mergers and exchange offers, should continue to be deemed

distributions. Few comments, however, were received on this issue.

Thus, the Commission does not propose excluding mergers and exchange

offers from the definition of distribution.\33\

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\32\ A distribution is defined in Rule 10b-6(c)(5) as ``an

offering of securities, whether or not subject to registration under

the Securities Act of 1933, that is distinguished from ordinary

trading transactions by the magnitude of the offering and the

presence of special selling efforts and selling methods.''

\33\ The Commission is of the view that exchange offers and

mergers involving the issuance of securities, and related

shareholder election and valuation periods, should be subject to

Regulation M. See Georgia-Pacific Corporation, SEC Litigation

Release No. 3511, (May 23, 1966). See also Release 34-19565, 48 FR

at 10638 n.61.

Because the Commission is proposing to eliminate the ``right to

purchase'' concept, Rule 10b-6 restrictions on purchases of most

target company securities during an exchange offer or a merger

involving the issuance of securities would be eliminated. Rule 10b-

13 under the Exchange Act, however, would continue to prohibit any

purchases or arrangements to purchase target securities, or a

security immediately convertible into or exchangeable for those

securities, from the time of public announcement until the

expiration of a tender or exchange offer. 17 CFR 240.10b-13.

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Q16. Does the definition of distribution continue to be

appropriate?

b. Shelf Offerings

The Commission believes that it is useful to discuss the proposed

application of Rules 101 and 102 in the particular context of shelf

offerings. In 1983, the Commission permanently adopted Rule 415, which,

among other things, allows issuers and selling shareholders to register

securities for sale on a delayed or continuous basis.\34\ Since the

Commission last addressed this issue, the methods by which shelf

offerings are conducted have changed, and the use of shelf registration

has increased. For example, ``unallocated'' shelf registration

statements that register a substantial amount of securities, but do not

specify the exact amounts of particular types of securities that may be

sold, have become more common. The Commission believes that it is

appropriate to reflect these developments in the treatment of shelf

offerings for purposes of proposed Rules 101 and 102.

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\34\ 17 CFR 230.415. Securities Exchange Act Release No. 20384

(November 17, 1983), 48 FR 52889.

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Under a current Commission interpretation, ``any shelf-registered

offering that constitutes a Rule 10b-6 distribution should be

considered a single distribution for purposes of the rule.'' \35\ This

means that once an issuer, or a selling securityholder that is in a

control relationship with the issuer, determines to proceed with a

shelf registered distribution, each takedown off of the shelf is

subject to Rule 10b-6 irrespective of its individual magnitude.\36\

However, a selling securityholder that is not an affiliated purchaser

of the issuer or of any other selling securityholder is subject to the

restrictions of Rule 10b-6 only with respect to offers or sales of that

individual securityholder's securities.\37\

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\35\ Release 34-19565, 48 FR at 10631. This has been known as

the ``single distribution position.''

\36\ Id. See also Securities Exchange Act Release No. 23611

(September 11, 1986), 51 FR 33242, 33244 (``Release 34-23611'').

\37\ Release 34-23611, 51 FR at 33244.

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In addition, under Rule 10b-6, the Commission has distinguished

between broker-dealers that have arrangements, agreements, or

understandings with issuers to sell all or a portion of the securities

being distributed off the shelf (``continuing agreements''), and those

that do not. If a broker-dealer has a continuing agreement with an

issuer to sell, from time to time, securities registered on the shelf,

it is subject to the full cooling-off period prior to any offer or sale

off the shelf. If a broker-dealer does not have a continuing agreement

with an issuer, and decides to submit a bid in response to an issuer's

solicitation of interest in purchasing its securities for distribution,

the broker-dealer is subject to the applicable cooling-off period from

the time that it decides to submit the bid.\38\ If a broker-dealer

submits an unsolicited bid, it is not deemed to be a participant until

the bid has been accepted or the broker-dealer has reason to believe

that it will be accepted.\39\

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\38\ See Release 34-19565, 48 FR at 10634.

\39\ See id. at 10635. See also infra Section III.B.5.b.

discussing the revised definition of ``prospective underwriter.''

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Rather than applying the single distribution position, the

Commission would take a modified approach regarding the application of

Rule 101 to shelf distributions.\40\ Under the Commission's proposed

approach, rather than considering the entire shelf to be a single

distribution and applying the rule's restricted periods to any offers

or sales off the shelf, each takedown would be examined individually in

order to determine whether such offering constitutes a distribution,

i.e., whether it satisfies the ``magnitude'' and ``special selling

efforts and selling methods'' criteria of a distribution.\41\

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\40\ The Commission's revised interpretation regarding shelf

offerings would apply to distribution participants, issuers, and

selling securityholders, and would modify previous Commission

interpretations regarding shelfs. See Release 34-23611, 51 FR at

33244-45.

\41\ If a distribution participant (e.g., a broker-dealer) has

not entered into a continuing agreement with an issuer or selling

securityholder, and if the sales off the shelf constitute a

distribution, then the distribution participant would be required to

comply with Rule 101 from the later of the applicable restricted

period for the offered security, or the time that such person

becomes a distribution participant. This interpretation reflects the

speed with which sales off a shelf frequently occur.

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A broker-dealer participating in the offering of a shelf tranche

should determine whether it is participating in a ``distribution.'' To

determine the magnitude of the offering for purposes of Rule 101, the

broker-dealer would have to assess the amount of securities that it is,

or foreseeably will be, asked to sell.\42\ The broker-dealer also would

need to analyze the selling efforts and selling methods that it will

use. For example, where a broker-dealer sells shares on behalf of an

issuer or selling securityholder in ordinary trading transactions into

an independent market, i.e., without any special selling efforts, the

broker-dealer is not subject to Rule 10b-6.\43\ Special selling efforts

likely would be involved, however, where a broker-dealer enters into a

sales agency agreement that provides that it will receive unusual

transaction-based compensation for the sales, even if the securities

are sold in ordinary trading transactions. An issuer's identification

in a shelf registration statement of a variety of potential selling

methods that could be used to sell registered securities off a shelf

(some of which would constitute ``special selling efforts''), however,

would not, in itself, require a broker-dealer to consider itself to be

involved in a distribution unless special selling efforts or methods

were used by the broker-dealer in connection with particular sales off

the shelf.\44\

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\42\ If sales off a shelf by an issuer, or by any affiliated

purchaser of the issuer, constitute a distribution of securities,

the issuer and all issuer affiliated purchasers would be subject to

the applicable restricted period of Rule 102. Similarly, if any

shelf securityholder is selling securities off a shelf, and such

sales constitute a distribution, all other shelf securityholders who

are affiliated purchasers of the selling securityholder would be

subject to the applicable restricted period of Rule 102. See Release

34-23611, 51 FR at 33245.

\43\ See Release 34-23611, 51 FR at 33247.

\44\ Cf. Securities Exchange Act Release No. 18528 (March 3,

1982), 47 FR 11482, 11485 (``Release 34-18528''). Under current

interpretation, if a registrant, when disclosing its proposed plan

of distribution, reserves the right to utilize techniques that might

entail selling efforts or compensation of the type normally

associated with a distribution, the Commission deems special selling

efforts and selling methods to be used throughout the shelf offering

for purposes of Rule 10b-6.

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[[Page 17116]]

Q17. Should a broker-dealer that enters into a continuing agreement

regarding sales of all securities or a significant amount of the shares

on the shelf be viewed differently from one whose participation is

limited to a single takedown?

Q18. Are there other issues raised by the application of Rule 101

to shelf offerings that the Commission should address?

5. Persons Subject to the Rule

a. Distribution Participant

The term ``distribution participant'' is proposed to be defined in

Rule 100 as an underwriter, prospective underwriter, broker, dealer, or

other person who has agreed to participate or is participating in the

distribution.

Q19. Does the proposed definition of distribution participant

adequately cover those persons, other than an issuer or selling

securityholder, who have a readily identifiable incentive to manipulate

the market during an offering? 45

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\45\ See Concept Release, 59 FR at 21686.

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b. Prospective Underwriter

Commenters requested that the Commission provide greater certainty

as to when a person becomes a ``prospective underwriter'' for purposes

of Rule 10b-6.46 Commenters were concerned especially with the

application of this definition in the context of shelf-registered

distributions when a broker-dealer has submitted a bid to purchase

shelf-registered securities, but does not know whether the bid will be

accepted by the issuer or selling securityholder. This uncertainty may

exist in those circumstances where bids are submitted to the issuer or

selling securityholder by a number of broker-dealers, or where the

issuer or selling securityholder solicits a bid from a broker-dealer,

but has not indicated an intention to offer shares off the shelf or to

select that particular broker-dealer as an underwriter.

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\46\ Rule 10b-6(c)(2) defines the term as:

A person (i) who has decided to submit a bid to become an

underwriter of securities as to which the issuer or other person on

whose behalf the distribution is to be made, has issued, directly or

indirectly, an invitation for bids, or (ii) who has reached an

understanding, with the issuer or other person on whose behalf a

distribution is to be made, that he will become an underwriter,

whether or not the terms and conditions of the underwriting have

been agreed upon. 17 CFR 240.10b-6(c)(2).

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The Commission believes that the definition of ``prospective

underwriter'' should reflect the principle that anti-manipulation

regulation should apply when there exists an incentive to

manipulate.47 In the Commission's view, a person has an incentive

to manipulate, and thus becomes a prospective underwriter, when such

person knows or reasonably expects that a bid or proposal it has

submitted to the issuer or selling securityholder will be accepted,

whether or not the underwriting's terms and conditions have been agreed

upon. Moreover, a person who has received an invitation to participate

in an offering should be deemed a ``prospective underwriter'' from the

time that the person decides to participate, whether or not that

decision has been communicated to the issuer, selling securityholder,

or managing underwriter.

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\47\ See Concept Release, 59 FR at 21686. See also Release 34-

19565, 48 FR at 10634-10635.

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Accordingly, Rule 100 would define ``prospective underwriter'' as a

person who: (i) has submitted a bid to the issuer or other person on

whose behalf the distribution is to be made, which such person knows or

reasonably expects will be accepted, whether or not the terms and

conditions of the underwriting have been agreed upon; or (ii) has

reached, or reasonably expects to reach, an understanding with the

issuer or selling shareholder, or with the managing underwriter, that

such person will become an underwriter, whether or not the terms and

conditions of such person's participation have been agreed upon.

A broker-dealer would be subject to Rule 101 beginning with the

commencement of the restricted period or such later time as the broker-

dealer becomes an underwriter or prospective underwriter. If the

broker-dealer has a continuing agreement with the issuer or selling

securityholder, such firm would have advance knowledge that the

distribution will take place. Thus, the broker-dealer would be required

to observe the entire restricted period prior to the pricing of the

offered security subject to that agreement. There may be other

scenarios where a broker-dealer does not have a continuing relationship

with an issuer, but would be in a position to have advance knowledge

that a takedown off a shelf will occur and that the broker-dealer will

participate in the distribution. Such broker-dealer also would be

required to observe the entire restricted period. This position

reflects the role that such broker-dealers generally play in advising

issuers and selling shareholders regarding the timing of shelf

offerings.

Q20. Does the proposed definition of prospective underwriter

provide sufficient flexibility and certainty to persons who submit bids

to become underwriters of securities?

c. Affiliated Purchaser

Certain persons who are not themselves distribution participants

have relationships with distribution participants that raise concerns

that they may have incentives to facilitate a distribution through

manipulative means. These persons are referred to in Rule 10b-6 and in

Regulation M as ``affiliated purchasers.'' Both Rule 10b-6 and Rule 100

include within this term: (1) persons who act in concert with a

distribution participant in connection with the acquisition or

distribution of a security that is the subject of a distribution; or

(2) affiliates who control the purchase of such securities by a

distribution participant, or whose purchases are controlled by a

distribution participant, or whose purchases are under common control

with those of a distribution participant.

The Commission believes that Regulation M should reflect the

structural complexity of multi-service financial organizations, the

administrative costs incurred by such entities in complying with Rule

10b-6, and the precedents recognizing information barriers as an

element of exemptions from Rule 10b-6.48 The Commission proposes

that Rule 100 would exclude an affiliate of a distribution participant

from the coverage of Rule 101 if the distribution participant

establishes, maintains, enforces, and reviews at least annually written

policies and procedures to separate its corporate finance activities

conducted in connection with a distribution from the trading operations

of the affiliate (``information barriers'')49 and the affiliate is

a separate and distinct organizational entity from, with no officers

(or persons performing similar functions) or employees (other than

clerical, ministerial, or support

[[Page 17117]]

personnel) in common with, the distribution participant.50

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\48\ See Securities Exchange Act Release No. 36033 (July 31,

1995), 60 FR 40212; Letter regarding CS Holding, [1995] Fed. Sec. L.

Rep. (CCH) para. 77,018 (March 31, 1995) (``CS Holding Letter'').

\49\ The information barriers may be established pursuant to

separate regulatory requirements. See, e.g., 2 NYSE Guide (CCH)

para. 2098 (requiring that information barriers be established that

place substantial limits on access to, and communication of, trading

information, including strategies and positions, between a

specialist organization and an affiliated entity); Broker-Dealer

Policies and Procedures Designed to Segment the Flow and Prevent the

Misuse of Material Nonpublic Information, Report by the Division of

Market Regulation to the Securities and Exchange Commission (March

1990); Broker-Dealer Internal Control Procedures for High Yield

Securities, Report by the Division of Market Regulation to the

Securities and Exchange Commission (October 1993).

\50\ Distribution participants and their affiliates would not be

required to have separate compensation arrangements to qualify for

this exclusion. Cf. Rule 10b-6(c)(6)(i)(D)(2).

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A distribution participant would be required to obtain an

independent review at least annually of its compliance during the

preceding year with the policies and procedures governing its

information barriers, including the operation and any breaches of such

barriers, and to report on the findings of such review to its

management.51 The distribution participant's internal audit group

could perform the review if the group were independent of the corporate

financing and trading departments.52

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\51\ Consistent with Rule 17a-4(b)(4) under the Exchange Act,

registered brokers and dealers would be required to maintain and

preserve the review for a period of not less than three years, the

first two years in an accessible place. 17 CFR 240.17a-4(b)(4).

\52\ See CS Holding Letter, supra note 48.

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Q21. Would this proposed definition appropriately narrow the types

of affiliates that should be deemed ``affiliated purchasers''?

Q22. Is it appropriate to rely on information barriers to exclude

certain affiliates of distribution participants from the restrictions

of Rule 101?

Q23. Can information barriers be established effectively within the

same organizational entity so as to preclude opportunities to

manipulate the price of a security that is the subject of a

distribution?

Q24. Should the independent annual review be conducted by an

external reviewer (such as an accounting firm)?

Q25. The requirement under Rule 10b-6 of no common employees, other

than clerical, ministerial, or support personnel, would be retained;

however, the requirement of separate employee compensation arrangements

would be discontinued. Should the separate employee compensation

requirement be retained? Should shared employees or officers be

permitted?

Q26. How would this definition affect the operations of

distribution participants? Do they now conduct their corporate finance

activities in separate and distinct organizational entities from their

trading operations?

Q27. How would this definition affect investment advisers and other

non-broker-dealer fiduciaries?

Q28. How would this definition affect non-U.S. distribution

participants and their affiliates, including non-U.S. entities that are

permitted to engage in both commercial and investment banking

activities (e.g., universal banks)?

6. Activities Excepted From Rule 101: Paragraph (b)

a. Generally

As with Rule 10b-6, the Commission believes that certain activities

should be excepted from the prohibitions of proposed Rule 101 because

of the need to facilitate orderly distributions of securities, or to

limit potential disruptions in the trading market, or because the

activity has little manipulative potential. The exceptions to Rule 10b-

6 are prefaced with a proviso that such activities are not prohibited

if not ``engaged in for the purpose of creating actual, or apparent,

active trading in or raising the price of any such security.'' The

Commission does not propose to include this proviso in Rule 101 because

it adds an element of complexity that does not appear to be warranted

in light of the new structure of Rule 101. Activities permitted by Rule

101 would remain subject to the general anti-fraud and anti-

manipulation protections of the Securities Act and Exchange Act.

b. Exception 1--Research

Rule 10b-6 and Rule 101 prohibit any person participating in a

distribution from inducing others to purchase securities covered by the

rule. To reflect recent amendments to Securities Act Rule 139,53

and to codify and expand the staff's interpretations regarding

research, Rule 101 would permit written information, opinions, or

recommendations that satisfy Rule 138 or 139 under the Securities Act

to be published or disseminated in the ordinary course of its business

by a distribution participant during the restricted period.54 The

proposed exception is intended to harmonize treatment of research under

Securities Act and Exchange Act rules.

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\53\ Securities Act Release No. 7132 (February 1, 1995), 60 FR

6965.

\54\ 17 CFR 230.138 and 230.139. The Commission's staff has

taken the position that certain research reports are not prohibited

inducements if they are issued by a broker-dealer in the ordinary

course of business and satisfy Rule 138 or Rule 139(b) under the

Securities Act, or satisfy Rule 139(a) and do not contain a

recommendation or earnings forecast more favorable than that

previously disseminated by the firm. See Securities Exchange Act

Release No. 21332 (September 19, 1984), 49 FR 37569, 37572 n.25. The

current interpretive limitations on more favorable earnings

forecasts or recommendations in research reports would not be

included in exception 1.

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Although research distributed in the ordinary course of business

that complies with Rule 138 or 139 would be excepted from Rule 101,

research transmitted by sales personnel to customers who normally would

not receive it in the ordinary course of business can constitute a

solicitation to purchase.55 This directed research, or execution

of orders resulting from directed research, would not be permissible

during the Rule 101 restricted period.

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\55\ Distribution participants also must consider the broker-

dealer registration requirements of Section 15(a) of the Exchange

Act and the rules thereunder in connection with continuous

distributions of research reports to investors. 15 U.S.C. 78o(a).

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Q29. Should the circulation of offering materials and other

publications outside of the United States be excepted from Rule 101, as

some commenters have suggested?

c. Exception 2--Transactions Complying With Certain Other Rules

Rule 101 would provide an exception for transactions complying with

Rules 103 or 104 of Regulation M (governing passive market making and

stabilization). This proposed exception incorporates paragraphs

(a)(4)(xiv) and (a)(4)(viii), respectively, of Rule 10b-6.

d. Exception 3--Odd-Lot Transactions

The Commission proposes to expand the exception for odd-lot

transactions contained in Rule 10b-6(a)(4) to permit distribution

participants to bid for and purchase odd-lots during the restricted

period.

e. Exception 4--Exercises of Securities

The Commission proposes an exception to permit the exercise of call

options and other securities to acquire a covered security. Many

securities having associated standardized options would not be subject

to Rule 101 because of the proposed exception for actively-traded

securities, and other securities underlying standardized call options

generally would be subject to the proposed one business day cooling-off

period. These changes, coupled with the unpredictability of the timing

or the extent of any purchases by parties who are exercised against,

would reduce significantly the likelihood that the exercise of call

options would be used to facilitate a distribution. Therefore, the

Commission proposes to eliminate the five business day cooling-off

period contained in Rule 10b-6 for the exercise of standardized call

options. Under proposed exception 4, distribution participants would be

permitted to exercise call options during the restricted period,

regardless of when the options were acquired.

The Commission also proposes to except exercises of options or

warrants, rights received in connection with a rights offering, or

rights or conversion privileges set forth in the instrument

[[Page 17118]]

governing a security to acquire any security directly from an issuer.

This would include exercises by distribution participants of rights

acquired during a distribution through rights. Consistent with

exception (vii) of Rule 10b-6, this provision of Rule 101 is intended

to permit exercises or conversions of securities that do not entail any

significant market impact or manipulative potential, and thus do not

involve the concerns at which the anti-manipulation regulation of

securities distributions is directed.

Q30. Would any activity permitted by this exception raise

manipulative concerns because of a significant market impact?

f. Exception 5--Unsolicited Brokerage Transactions

The Commission proposes to include in Rule 101 the exception for

brokerage transactions not involving solicitation of the customer's

order that is contained in Rule 10b-6(a)(4)(v)(A).

g. Exception 6--Basket Transactions

Commenters recommended that the Commission adopt some form of

relief for transactions effected as part of a basket strategy if the

basket is not used for manipulation. Basket trading involves

contemporaneous transactions in groups of securities that often are

related to a standardized index. The Commission has granted Rule 10b-6

relief for standardized basket transactions subject to certain

conditions, including those relating to the number of securities to be

purchased, the weighting of the distribution security in the basket,

and the timing of the basket transaction.56 Several commenters

supported expanding and streamlining the treatment of basket

transactions in view of the increasing importance of such transactions

to institutional investors, and the need of broker-dealers to provide

liquidity to these investors.

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\56\ See Letter regarding Basket Trading During Distributions,

[1991] Fed. Sec. L. Rep. (CCH) para. 79,752 (August 6, 1991).

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The Commission is proposing to include an exception for purchases

of covered securities made in connection with a basket transaction.

This exception would be available with respect to both index-related

baskets and baskets unrelated to any standardized index.57

Proposed paragraph (b)(6) of Rule 101 would apply to transactions in

covered securities when: (1) the aggregate dollar value of any bids or

purchases of the security in distribution constitutes 5% or less of the

total dollar value of the basket being purchased; and (2) the basket

contains at least 20 stocks. The basket transaction also would have to

be a bona fide transaction effected in the ordinary course of business

(i.e., the decision to include the security in distribution in the

basket must be independent of the existence of the distribution). The

5% and 20 stock criteria are intended to provide an objective

indication of the bona fide nature of a basket transaction and to limit

the exception to those basket transactions where the security in

distribution represents a small portion of the basket, such that use of

the basket transaction to facilitate a distribution would not be

economical. These criteria also would provide flexibility for basket

transactions.

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\57\ As a practical matter, a high percentage of the securities

involved in basket transactions would be covered by the proposed

exception for actively-traded securities.

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The exception also would permit bids and purchases for the purpose

of adjusting an existing basket position related to a standardized

index when made in the ordinary course of business to the extent

necessary to reflect a change in the composition of the index. For

example, a basket could be adjusted to reflect substitutions of

securities in a standardized index.

Q31. In view of the exception for actively-traded securities, is

this exception necessary?

Q32. Should the exception be unavailable in the last hour of

trading before the pricing of an offering because basket transactions

can involve significant amounts of stock and may have an impact on the

security's price? If a last-hour restriction were imposed in this

exception, would a further relaxation of the 5% and 20 stock parameters

be justified?

h. Exception 7--De Minimis Transactions

Several commenters cited the consequences of ``insignificant''

violations of Rule 10b-6 by a distribution participant, particularly

bids for, or small trades in, covered securities effected during the

cooling-off period. These violations have resulted in the distribution

participant dropping out of an underwriting syndicate, or the

postponement of the offering.

In the past, at a distribution participant's request, the

Commission's staff has taken informal no-action positions with regard

to the occurrence of such violations in cases where the transactions

were represented to be inadvertent and appeared to have had no market

impact. Frequently, these transgressions occurred because of a failure

to follow policies and procedures established by the firm to comply

with Rule 10b-6. Based on the inadvertent nature of many of these

violations and the lack of market impact, coupled with the impact of

such violations on distribution participants and offerings, some

commenters recommended that the Commission consider a safe harbor

approach for such activity that was not undertaken with a manipulative

purpose.

To address these concerns, the Commission is proposing an exception

to Rule 101 for certain de minimis transactions. A de minimis

transaction would be defined as a bid that was not accepted, or one or

more purchases that in the aggregate total less than 1% of the

security's ADTV. Because this proposed exception is intended to cover

``inadvertent'' violations, and not bids or purchases wilfully made in

violation of the rule, it would be available only when the firm had

established and enforced policies and procedures reasonably designed to

achieve compliance with Rule 101. Inadvertence also would be evidenced

by prompt cessation of the activity upon its discovery.58

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\58\ A firm's reliance on this exception on repeated occasions

would raise questions about the adequacy and effectiveness of the

firm's procedures. Therefore, upon the occurrence of any violation,

a broker-dealer would be expected to review its policies and

procedures and modify them as appropriate to prevent future

violations.

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Q33. Would this exception address the problems experienced with

respect to ``inadvertent'' violations under Rule 10b-6?

Q34. Is 1% of the security's ADTV the appropriate level to be

considered de minimis?

Q35. Would an alternative exception containing the 1% ADTV

threshold, but permitting bids and purchases whether or not in

violation of procedures, be preferable? In view of the increased

latitude that would be provided by this alternative, the Commission

believes that it may be necessary to make the exception unavailable for

transactions effected during the last hour of trading prior to pricing

the offering.

i. Exception 8--Transactions in Connection with the Distribution

A variety of transfers, allocations, and reallocations of

securities are necessary in the course of conducting a distribution.

These transactions should not be effected in a manner that may affect

the price of, or give an appearance of trading activity in, covered

securities. The Commission proposes exception 8 to permit non-publicly

reported transactions among distribution participants to allocate and

reallocate

[[Page 17119]]

securities among syndicate members in connection with a distribution,

and non-publicly reported purchases of securities from the issuer or

selling securityholders necessary to conduct the distribution.

Exception 8 is consistent with the objective of exception (i) of Rule

10b-6, which permits transactions in connection with a distribution

that are effected otherwise than on a securities exchange with the

issuer or other person or persons on whose behalf such distribution is

being made, or among underwriters, prospective underwriters, brokers,

dealers, or other persons who have agreed to participate or are

participating in such distribution. It reflects, however, the fact that

many over-the-counter (``OTC'') transactions today are as transparent

as exchange transactions. Therefore, the proposed exception would apply

only to transactions among distribution participants, issuers, or

selling securityholders that are effected otherwise than on or through

the facilities of a securities exchange or an inter-dealer quotation

system (e.g., Nasdaq). Exception 8 also would permit offers and sales

of, and the solicitation of offers to buy, the securities being

distributed, including securities acquired in stabilizing transactions,

which are permitted under exception (vi) of Rule 10b-6.

j. Exception 9--Distributions of Rule 144A Securities

Several commenters recommended expanding Rule 10b-6(i) which

excepts distributions of Rule 144A-eligible foreign securities if the

securities are sold solely to qualified institutional buyers (``QIBs'')

in transactions exempt from registration under the Securities Act

(``Rule 144A distributions'').59 After considering the comments

received, the Commission proposes to expand this exception in proposed

Rule 101 to include Rule 144A distributions of domestic issuers'

securities. In light of the characteristics of transactions involving

Rule 144A securities (e.g., eligible securities are not listed on a

U.S. exchange or quoted on Nasdaq, and Rule 144A transactions are

limited to QIBs), the Commission has determined not to distinguish

between Rule 144A distributions of foreign and domestic securities. The

exception also would apply to a distribution of Rule 144A-eligible

securities to non-U.S. persons, within the meaning of paragraphs (o)(2)

and (o)(7) of Regulation S under the Securities Act, that is made

concurrently with a Rule 144A distribution to QIBs.60

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\59\ See 17 CFR 230.144A.

\60\ 17 CFR 230.902(o)(2) and 230.902(o)(7). This would codify

the position taken in Letter regarding Regulation S Transactions

during Distributions of Foreign Securities to Qualified

Institutional Buyers, [1993-1994] Fed. Sec. L. Rep. (CCH) para.

76,851 (February 22, 1994), as modified by Letter regarding

Regulation S Transactions during Distributions of Foreign Securities

to Qualified Institutional Buyers (March 9, 1995).

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The Commission notes that an exception from proposed Rule 101 based

on the category of persons to whom the securities are distributed may

be viewed as a departure from the anti-manipulation purposes of

Regulation M, because no class of investors, including large

institutions, is immune to injury from securities fraud or

manipulation.61 However, based on the ability of QIBs to obtain,

consider, and analyze market information, the Commission believes that

it may be appropriate to reduce the scope of Rule 101's prophylactic

protections for such market participants. Although some commenters

recommended expanding the exception to include offerings of Rule 144A-

eligible securities to institutional accredited investors in addition

to QIBs, the Commission is not adopting that recommendation because it

encompasses a much broader category of investors, all of whom may not

have comparable characteristics.

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\61\ Cf. BT Securities Corporation, Securities Exchange Act

Release No. 35136 (December 22, 1994); In re Scientific Control

Corp. Sec. Litig., 71 F.R.D. 491, 512 (S.D.N.Y. 1976) (both

sophisticated and unsophisticated investors are entitled to

protection from the disclosure and anti-fraud provisions of the

securities laws).

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Q36. Is it appropriate to except certain distributions of

securities from Rule 101 based in part on the class of persons to whom

the securities are offered (e.g., QIBs)?

Q37. In light of the new exception for actively-traded securities,

which will except many distributions of Rule 144A-eligible foreign

securities from the rule, does an exception expressly covering Rule

144A distributions continue to be necessary or appropriate?

Q38. Do QIBs favor this exception and agree with its rationale?

7. Rule 10b-6 Exceptions That Are Not Included in Proposed Rule 101

a. Unsolicited Privately Negotiated Purchases

Rule 10b-6(a)(4)(ii) permits unsolicited privately negotiated

purchases, each involving at least a block of securities, that are not

effected from or through a broker or dealer. This exception was adopted

in response to industry concerns regarding the need to permit issuers

and distribution participants to purchase blocks of securities

``overhanging'' the market during a distribution.\62\

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\62\ In 1983, the Commission deleted the requirement that

transactions effected in reliance on the exception not be made on an

exchange in recognition of the fact that both third market and

exchange transactions in reported securities are reported to the

consolidated transaction reporting system (``consolidated system'').

Release 34-19565, 48 FR at 10634. See also Release 34-18528, 47 FR

at 11489.

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The staff's experience is that this provision is very seldom

utilized, and does not appear to be necessary to facilitate orderly

distributions. Therefore, and in light of the shortened restricted

periods and the proposed exception for unsolicited brokerage

transactions, the Commission is not proposing an exception from the

rule for privately negotiated, unsolicited purchases of securities.

Q39. Does an exception for unsolicited privately negotiated

purchases continue to be necessary? If so, should there be any

requirements as to the size of the purchases (e.g., a block) or whether

the purchases were unsolicited? Should such an exception be available

for purchases by a broker-dealer?

b. Sinking Fund Obligations

Rule 10b-6(a)(4)(iii) provides an exception to permit an issuer to

satisfy its mandatory sinking fund obligations that become due within

12 months from the date of purchase (i.e., those that are current).\63\

The Commission is of the view that this exception no longer appears to

be necessary and thus does not propose to include within Rule 101 an

exception for purchases to satisfy sinking fund or similar obligations.

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\63\ A sinking fund is a capital reserve set aside annually from

current earnings to provide funds to retire a particular bond issue

or debt security, in whole or in part, prior to the security's

maturity date. See Release 34-18528, 47 FR at 11490 n.44.

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Q40. Is there any reason to retain this exception?

c. Rights Offerings

The Commission is of the view that Rule 10b-8 contains overly rigid

and complex restrictions on purchases of rights and, unlike the other

trading practices rules, regulates sales of the offered security. These

restrictions may no longer be necessary. Rights offerings today

generally are conducted in a manner designed not to trigger Rule 10b-

8's restrictions on purchases of rights. The Commission proposes to

rescind Rule 10b-8 to conform with Regulation M's treatment of

derivative securities. Therefore, bids and purchases of rights would

not be covered by Rule 101. Bids and

[[Page 17120]]

purchases of the security that is the subject of the rights offering,

however, would be restricted by Rule 101.

Q41. Should the Commission continue to regulate rights offerings

through a separate rule?

Q42. Recently, a number of closed-end funds have conducted rights

offerings. Do rights offerings by closed-end funds present any special

manipulative concerns that should be addressed by Regulation M?

8. Exemptive Authority

The Commission proposes to include within Rule 101 the authority to

grant exemptions from Rule 101. This provision is similar to paragraph

(j) of Rule 10b-6.

C. Rule 102--Activities by Issuers and Selling Securityholders

1. Generally

The Commission is proposing new Rule 102, which would govern the

activities of issuers, selling securityholders (i.e., any person other

than an issuer on whose behalf a distribution is being made), and their

affiliated purchasers in connection with a distribution of securities.

Rule 102 would make it unlawful for such persons to bid for, purchase,

or to attempt to induce any person to bid for or purchase any security

that is the subject of such distribution and any reference security for

such security during the applicable restricted period.

Q43. Commenters should discuss whether an exception from the

definition of ``affiliated purchaser'' should be available to

affiliates of an issuer or selling securityholder who establishes,

maintains, and enforces written policies and procedures regarding

information barriers in compliance with Rule 100. Under what

circumstances would issuers or selling securityholders establish

information barriers?

Q44. Should the rule provide more guidance as to how the

``affiliated purchaser'' concept would apply where a distribution

participant (subject to Rule 101) is an affiliate of an issuer or

selling securityholder?

2. Excepted Securities

An issuer or selling shareholder may have a substantial incentive

to raise improperly the price of offered securities. Also, issuer and

shareholder transactions are not as readily identifiable from a

surveillance perspective as those of distribution participants. Thus,

the Commission preliminarily believes that it may not be appropriate to

extend the exception for actively-traded securities, or the exception

for investment grade debt and investment grade preferred securities

provided in Rule 101, to issuers, selling securityholders, or their

affiliated purchasers.

The Commission does propose, however, to provide an exception from

Rule 102 for ``exempted securities,'' as defined in Section 3(a)(12) of

the Exchange Act, and face-amount securities or securities issued by an

open-end management investment company or unit investment trust.

Q45. Should issuers be provided with an exception for actively-

traded securities? If so, are any new procedures necessary to assist

the exchanges or the NASD with surveillance of issuer transactions in

such securities?

Q46. Do issuers, selling securityholders, or their affiliated

purchasers rely on the exception for investment grade debt securities

in Rule 10b-6? If so, under what circumstances?

3. Excepted Activities

a. Generally

The Commission is proposing fewer exceptions from the restrictions

of Rule 102 than it is proposing in connection with Rule 101. Rule 102

differs from Rule 101 because of the view that issuers and selling

securityholders have a direct and immediate stake in the proceeds of

offerings, and do not engage in the same types of market activities as

broker-dealers. Moreover, SRO surveillance mechanisms can detect more

quickly, i.e., on a real-time basis, the market activities of their

member firms that are distribution participants, while transactions by

issuers and their affiliated purchasers are not as readily

identifiable.

b. Exception 1--Odd-Lot Transactions

As with Rule 101, the Commission proposes to except from Rule 102

bids for or purchases of securities in odd lots. Among other things,

paragraph (b)(1) would permit issuers to conduct odd-lot tender offers

during the restricted period.

c. Exception 2--Transactions Complying With Rule 23c-3 of the

Investment Company Act of 1940

Paragraph (b)(2) of Rule 102 would provide an exception for

repurchases of equity securities pursuant to Rule 23c-3 under the

Investment Company Act of 1940.\64\

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\64\ Rule 23c-3 under the Investment Company Act of 1940, 17 CFR

270.23c-3, permits periodic repurchases of common stock by issuers

that are registered closed-end investment companies as well as

business development companies.

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d. Exception 3--Exercises of Securities

The Commission proposes to except from Rule 102 exercises of call

options and other securities and exercises of any right or conversion

privilege set forth in the instrument governing a security, which

provides for purchasing a security directly from the issuer, including

rights issued in a rights offering. This provision is intended to

permit affiliated purchasers of issuers to exercise rights in

connection with convertible, exchangeable, or exercisable securities,

including options received in connection with employee benefit plans.

e. Exception 4--Transactions in Connection With the Distribution

Rule 102 would provide an exception for offers to sell or the

solicitation of offers to buy the securities being distributed. This

exception, which comports with Rule 10b-6(a)(4)(vi), would permit an

issuer or selling securityholder to conduct the offering on its own

behalf.

Q47. What is the impact on issuers of not providing for other

transactional exceptions, such as the exception for unsolicited

privately negotiated purchases or stabilizing transactions? Do issuers

or selling securityholders rely on other exceptions in Rule 10b-6? If

so, how often and for what purpose? Persons urging additional

exceptions for issuers should provide reasons why they are warranted.

4. Plans

The Concept Release solicited comment on whether issuer plans

should be distinguished from other types of distributions of

securities, and whether plans should be distinguished based on the

nature of the participants, e.g., when the plan is available only to

certain groups having a relationship to the issuer. Rule 10b-6(e)

excludes from the rule's coverage any distribution of securities by an

issuer or a subsidiary of the issuer to employees or securityholders of

the issuer or its subsidiaries, or to a trustee or other person

acquiring such securities for the account of such employees or

securityholders pursuant to a ``plan,'' as defined in Rule 10b-

6(c)(4).\65\

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\65\ ``Plan'' is defined as ``any bonus, profit-sharing,

pension, retirement, thrift, savings, incentive, stock purchase,

stock ownership, stock appreciation, stock option, dividend

reinvestment or similar plan for employees or shareholders of an

issuer or its subsidiaries.'' (emphasis supplied).

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Many issuers, however, no longer limit participation in their plans

to securityholders or employees. Issuers have extended plan

participation to, among others, retirees, outside directors,

[[Page 17121]]

agents, consultants, suppliers, franchisees, independent contractors,

and family members of such persons, as well as credit card holders and

other customers. Moreover, some plans permit prospective investors to

participate by making an initial cash payment, rather than requiring

prior share ownership. Issuer plans that allow participation by persons

other than their employees or securityholders, or those of their

subsidiaries, do not qualify for the exception.

The Division of Market Regulation, acting pursuant to delegated

authority, in 1994 granted a class exemption from Rule 10b-6 that

facilitates investors' access to plans by permitting investors to

obtain their first share of an issuer's securities directly from the

issuer, and expands the availability of these programs to persons other

than the issuer's employees and securityholders.\66\ Many issuers have

relied on this exemption in implementing dividend reinvestment and

stock purchase plans. The staff also recently has provided no-action

relief from Rule 10b-6 for securities purchase and sale service

programs offered by bank-registered transfer agents.\67\ These actions

appear to have addressed most of the concerns of the ten commenters who

discussed plans. Therefore, the Commission proposes to simplify the

treatment of plans under Rule 102 by codifying this relief and further

reducing the restrictions on plan transactions.

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\66\ See Securities Exchange Act Release No. 35041 (December 1,

1994), 59 FR 63393 (``1994 STA Letter''), as modified by Letter

Regarding Dividend Reinvestment and Stock Purchase Plans, [1995]

Fed. Sec. L. Rep. (CCH) para. 77,110 (May 12, 1995). The 1994 STA

Letter also provided the staff's views on Sections 15(a) and 17A of

the Exchange Act, 15 U.S.C. 78o(a) and 78q-1, respectively.

\67\ See Letter Regarding First Chicago Trust Company of New

York, [1994] Fed. Sec. L. Rep. (CCH) para. 76,939 (December 1,

1994); Letter Regarding Bank-Sponsored Investor Services Programs,

[1995] Fed. Sec. L. Rep. (CCH) para. 77,122 (September 14, 1995)

(``Bank-Sponsored Programs Letter''). These letters also took no-

action positions with regard to Section 5 of the Securities Act, and

Sections 13(e), 14(d), and 14(e) of, and Rule 10b-13 under, the

Exchange Act, 15 U.S.C. 77e, 78m(e), 78n(d), and 78n(e), and, in the

case of the Bank-Sponsored Programs Letter, Section 15(a) of the

Exchange Act.

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For purposes of Rule 102, plans would be divided into three

different groups: (1) plans that are available only to employees and

shareholders; (2) plans that are available to persons other than

employees and shareholders where securities for the plan are purchased

from a source other than the issuer or an affiliated purchaser, i.e.,

in the open market or in privately negotiated transactions, by an agent

independent of the issuer; and (3) plans that are available to persons

other than employees and shareholders where securities for the plan are

purchased directly from the issuer or an affiliated purchaser (``direct

issuance plans'').68

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\68\ As provided by paragraph (g) of Rule 10b-6, the Commission

proposes to exclude from Rule 102 any bids or purchases of a

security made or effected by or for a plan by an ``agent independent

of the issuer.'' See infra note 70 (discussing the definition of

``agent independent of the issuer'').

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The Commission proposes to exclude from Rule 102 any distribution

pursuant to a plan by or on behalf of an issuer or a subsidiary of an

issuer, when such distribution is made solely to employees or

shareholders of the issuer or its subsidiaries, or to a trustee or

other person acquiring such securities for the accounts of such person.

This provision remains essentially unchanged from Rule 10b-6(e). For

purposes of this exception, however, the term ``employee'' would have

the same meaning as contained in Form S-8 of the Securities Act

relating to employee benefit plans.69 Thus, distributions by plans

that allow directors, general partners, insurance agents, former

employees, consultants, and certain advisors to participate in their

plans are proposed to be excepted from Rule 102. This reflects the view

that persons that are not employees of an issuer or a subsidiary of an

issuer may have a relationship with an issuer that is sufficiently

similar to that of an employee such that it is appropriate to treat

such persons in the same manner as employees for purposes of this

exception. Further, this will provide consistency between the

Securities Act and the Exchange Act regarding the types of issuer

sponsored programs that are considered to be plans.

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\69\ 17 CFR 239.16b. The definition of plan would be expanded to

include plans within the meaning of paragraph (c)(4) of Rule 10b-6

as well as dividend or interest reinvestment plans or employee

benefit plans, as defined in Rule 405 of Regulation C. 17 CFR

230.405.

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Second, the Commission proposes to except all distributions

involving plans that include persons other than employees or

shareholders where purchases for the plan are made from sources other

than the issuer or an affiliated purchaser (i.e., in the open market or

in privately negotiated transactions) by an agent independent of the

issuer. The Commission believes that when an agent independent of the

issuer effects plan transactions, the issuer's opportunity to engage in

improper conduct is reduced greatly. The Commission proposes to include

the definition of ``agent independent of the issuer'' in Rule 100,

rather than referring to the definition of that term presently in Rule

10b-18(a)(6) under the Exchange Act. 70 Except with respect to the

issuer's ability to change its determination once every three months

regarding the source of shares to fund a plan, an agent would not be

considered independent if the issuer directs the agent as to the source

of shares, or the timing of purchases of shares (e.g., a requirement

that shares to fund the plan must be purchased on the plan's investment

date). The issuer, however, may establish general conditions for the

operation of the plan, including, for example, requirements with

respect to the return of uninvested funds to plan participants, and

requirements that optional cash payments be invested within 35 days of

receipt.71

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\70\ 17 CFR 240.10b-18(a)(6). The definition of ``agent

independent of the issuer'' would be substantially the same as under

paragraph (a)(6) of Rule 10b-18. It also is proposed that Rule 10b-

18 be amended to refer to the definition in proposed Rule 100.

\71\ See 1994 STA Letter, supra note 66 (modifying Letter

regarding Lucky Stores Inc., [1974-1975] Fed. Sec. L. Rep. (CCH)

para. 79,903 (June 5, 1974)).

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Third, the Commission proposes that a direct issuance plan (i.e., a

plan that is open to persons other than employees or securityholders,

and where shares are purchased from the issuer or an affiliated

purchaser) would be subject to Rule 102 when offers and sales of

securities pursuant to the plan constitute a ``distribution'' within

the meaning of Rule 100. Thus, the ``magnitude'' and ``special selling

efforts and selling methods'' tests would be applied to offers and

sales under such plan to determine whether a distribution exists. In

determining the magnitude of an offering of plan shares, an issuer

would need to consider the amount of securities it distributes through

the plan directly and indirectly (e.g., by broker-dealers who obtain

securities from the issuer as participants in a plan by virtue of being

securityholders and then distribute the shares to the public). In

determining whether special selling efforts or selling methods are

involved, for purposes of a plan, selling efforts consistent with the

solicitation activities permitted in the 1994 STA Letter would be

presumed not to involve special selling efforts and selling methods for

purposes of determining the existence of a distribution. The treatment

of direct issuance plans under Regulation M recognizes that these plans

potentially can be capital raising transactions analogous to the types

distributions that historically have been subject to Rule 10b-6.

These proposed changes are intended to reduce significantly and, in

most cases, eliminate the rule's application to

[[Page 17122]]

issuer plans. Of course, issuers that employ their plans for

manipulative purposes would continue to be subject to the anti-fraud

and anti-manipulation provisions of the federal securities laws.72

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\72\ In addition, to avoid broker-dealer registration under

Section 15(a) of the Exchange Act, an issuer operating a plan must

limit its activities in accordance with the conditions set forth in

the 1994 STA Letter. For example, the issuer may perform only purely

clerical and ministerial functions, including forwarding cash and

securities to an independent broker-dealer or bank, in connection

with the plan.

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Q48. Do these proposals strike the appropriate balance? Are any

manipulative incentives raised by plan distributions?

Q49. Is it appropriate to distinguish plans available only to

employees and securityholders from other plans for purposes of this

rule? Is it appropriate to distinguish direct issuance plans from other

plans for purposes of this rule?

5. Exemptive Authority

The Commission proposes to include within Rule 101 the authority to

grant exemptions from Rule 101. This provision is similar to paragraph

(j) of Rule 10b-6.

6. Rule 10b-18

Rule 10b-18 provides that the issuer and its affiliated purchasers

will not incur liability under the anti-manipulation provisions of

Sections 9(a)(2) or 10(b) of the Exchange Act or Rule 10b-5 thereunder,

if purchases of the issuer's common stock are effected in compliance

with the conditions contained in that rule relating to the time, price,

volume, and manner of purchases of the issuer's common stock.73

The Commission does not believe that a safe harbor should be available

in circumstances that raise reasonably identifiable manipulative

incentives. Accordingly, in light of the special incentives that an

issuer and its affiliated purchasers may have in facilitating sales of

the issuer's securities that are the subject of a distribution, the

Commission is proposing to revise the definition of a ``Rule 10b-18

purchase'' to clarify that the safe harbor is not available during a

distribution of the issuer's common stock that is subject to Rule 102,

or during a distribution for which such stock is a reference

security.74 Under the proposals, the Rule 10b-18 safe harbor would

be unavailable during the entire course of the distribution, and not

only during the applicable restricted period. The proposed amendment

would codify an informal staff interpretation and more clearly define

the parameters of the Rule 10b-18 safe harbor.

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\73\ 17 CFR 240.10b-18.

\74\ See 17 CFR 240.10b-18(a)(3). The Commission notes that

although the Rule 10b-18 safe harbor would not be available, this

does not mean that such purchases necessarily would violate Sections

9(a)(2) or 10(b), or Rule 10b-5.

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As noted earlier in the discussion of the treatment of shelf

offerings as distributions for purposes of Regulation M, the Commission

is of the view that generally each takedown off a shelf should be

examined individually to determine whether it constitutes a

distribution for purposes of Rule 100. Accordingly, if the issuer

determines to go forward with a distribution of common stock pursuant

to a shelf registration statement, the Rule 10b-18 safe harbor would be

unavailable from the time of that determination until sales pursuant to

the takedown are completed.

Q50. Will the proposed revision to the definition of ``Rule 10b-18

purchase'' have any significant impact on issuers' repurchase programs?

Commenters that believe that there will be an impact should describe

how such programs will be affected.

D. Rule 103--Passive Market Making

1. Discussion of Rule 103

Proposed Rule 103 would replace Rule 10b-6A, which was adopted in

1993.75 Rule 103 would permit ``passive market making'' in

connection with the distribution of securities quoted on Nasdaq during

the restricted periods of Regulation M, when proposed Rule 101

otherwise would prohibit such transactions. The purpose of the proposed

rule (and Rule 10b-6A) is to alleviate special liquidity problems that

may exist in the Nasdaq market during the restricted period, when

distribution participants or their affiliates that are Nasdaq market

makers otherwise must withdraw from the market. In general, exchange-

traded securities are not similarly affected because independent

specialists are assigned to provide depth and liquidity in listed

securities.

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\75\ Securities Exchange Act Release No. 32117 (April 8, 1993),

58 FR 19598 (``Release 34-32117'').

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Rule 103 would incorporate many provisions of Rule 10b-6A. Rule 103

generally would limit a passive market maker's bids and purchases to

the highest current independent bid, i.e., a bid of a Nasdaq market

maker that is not participating in the distribution. Additionally, the

rule would limit the amount of purchases that each passive market maker

could make and the displayed size of the bid, and contain requirements

relating to identification, notification, and disclosure of passive

market making.

Several commenters and others experienced with Rule 10b-6A have

suggested allowing Nasdaq market making in a greater number of contexts

than is permitted under the current criteria. Rule 10b-6A defines an

``eligible security'' as a Nasdaq security that: (1) is the subject of

a firm commitment, fixed price offering registered under the Securities

Act or is a related security; (2) has a minimum price of $5.00 per

share and a minimum public float of 400,000 shares; and (3) has Nasdaq

market makers that are underwriters or prospective underwriters, or

affiliated purchasers of underwriters or prospective underwriters, that

account for at least 30% of the total trading volume in such

security.76 These eligibility criteria were designed to limit the

availability of passive market making to those firm commitment

offerings of securities qualifying for the two business day cooling-off

period of Rule 10b-6, when the restrictions of that rule otherwise

would have reduced market making capacity significantly.

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\76\ See 17 CFR 240.10b-6A(b)(3).

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The Commission believes that eliminating the rule's eligibility

criteria, thereby permitting passive market making in a greater number

of contexts, is consistent with the purposes of Regulation M. Rule 103

would eliminate almost all of the eligibility criteria contained in

Rule 10b-6A(b)(3). The Commission no longer considers it necessary to

restrict passive market making to the class of offerings where the

potential liquidity loss may be substantial. Under the proposals,

however, best efforts and at the market offerings would remain

ineligible for passive market making.77

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\77\ The Commission previously has noted that the NASD

surveillance system does not easily accommodate at the market

offerings. Release 34-32117, 58 FR at 19600. The Commission notes

that the NASD's surveillance of passive market making is an

essential consideration in the proposal to expand the contexts in

which passive market making would be permitted.

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Rule 103 also would extend the period when passive market making is

permitted, and increase the number of eligible securities. Rule 10b-6A

restricts passive market making to the two business day cooling-off

period, and prohibits passive market making upon the commencement of

offers and sales or when stabilization commences. The new rule would

permit passive market making throughout the applicable restricted

period, but would continue to prohibit passive market making when

stabilization is being conducted. Under the proposals, all Nasdaq

securities would qualify for passive market

[[Page 17123]]

making. The rule also would permit passive market making in Nasdaq

reference securities (e.g., the underlying common stock during a

distribution of a convertible security).

In addition, passive market makers could bid for one round lot of

securities if their initial or remaining net purchasing capacity is

between one and 99 shares. This provision would permit more syndicate

members to be passive market makers and also would respond to

commenters who suggested greater flexibility for passive market making.

To provide flexibility in the operation of passive market making, a

market maker is not required to lower its quotation to reflect lower

independent bids until it purchases an amount equal to five times the

maximum order size for the particular security, as provided for under

the NASD's rules for the Small Order Execution System (``SOES''). In

order to account for possible changes to Nasdaq operations, the

Commission proposes to allow a passive market maker to purchase an

amount that equals or exceeds two times the minimum quotation size for

the security as determined by the NASD, before it is required to lower

its quotations to reflect lowered independent bids.78 Moreover,

passive market makers facilitating the execution of customer orders

would be able to make bids or purchases at a price above the

independent price where necessary to comply with any Commission or NASD

rule relating to the execution of customer orders.79

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\78\ See, e.g., Securities Exchange Act Release No. 36548

(December 1, 1995), 60 FR 63092.

\79\ See Letter regarding Obligations of Passive Market Makers

that Hold Customer Limit Orders, [1995] Fed. Sec. L. Rep. (CCH)

para. 77,040 (July 19, 1995).

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Q51. Are the proposals to delete the requirements of the definition

of ``eligible security'' in Rule 10b-6A appropriate? Is it appropriate

to extend passive market making to Nasdaq securities with an ADTV value

under $100,000?

Q52. Would the provision permitting passive market making for at

least one round lot of a security assist Nasdaq market makers whose

trading volumes are insufficient to qualify for passive market making?

Is some other minimum purchase limitation appropriate, e.g., two round

lots or five round lots?

2. Postponement of Further Changes

The Commission is not proposing to make other revisions to passive

market making regulation at this time because proposed Rule 101 would

eliminate the need for passive market making for many actively-traded

Nasdaq securities and would allow passive market making in many more

contexts than permitted currently. Moreover, the Commission is aware

that there have been a significant number of failures to comply with

basic requirements of passive market making (i.e., bid and purchase

prices have exceeded the highest independent bid, and purchases have

exceeded the rule's net purchase limitation). These incidents, along

with the expansion of passive market making to cover more offerings and

securities, suggest that it would be appropriate for the Commission to

continue to monitor passive market making before proposing further

changes. The Commission, however, intends to review passive market

making under Rule 103, if adopted, and will consider other appropriate

modifications.

Q53. In view of the compliance difficulties associated with Rule

10b-6A, are there any structural changes that could help to eliminate

these problems, other than revisions to the rule's price and volume

limitations?

Q54. Net purchases by a passive market maker are limited to 30% of

its Nasdaq ADTV. Is this 30% Nasdaq ADTV limitation adequate to allow

passive market making, particularly in light of the elimination of the

provisions for SOES transactions, or should this threshold be revised,

e.g., by permitting net purchases of 50% of a market maker's Nasdaq

ADTV?

E. Rule 104--Stabilization and Other Syndicate Activities

1. Background

The Commission is proposing new Rule 104 to govern stabilization.

It would create a more flexible framework for managing the distribution

process and eliminate much of the complexity in the operation of Rule

10b-7.80 The Commission believes that stabilization should

continue to be regulated because it is market activity during an

offering that is intended to influence a security's price.81

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\80\ In addition to comments responding to the Concept Release,

the proposed new rule is based on comments received in response to

the 1991 Proposals. See supra note 15. The 1991 Proposals chiefly

were intended to accommodate the increasing internationalization of

securities markets and would be superseded by Regulation M.

Therefore, they would be withdrawn if Regulation M is adopted.

\81\ See Section 9(a)(6) of the Exchange Act, 15 U.S.C.

78i(a)(6); Concept Release, 59 FR at 21689. See also the

Commission's 1940 policy statement on stabilizing, Securities

Exchange Act Release No. 2446 (March 18, 1940).

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Rule 104 would reflect the significant changes that have occurred

in underwriting methods since Rule 10b-7 was adopted. For example,

underwriters have developed highly effective means of quickly placing

and controlling an offering through the book-building and allocation

processes. Stabilization pursuant to Rule 10b-7 has become less common,

perhaps in part because of the rule's limitations on increasing

stabilizing bids, but also because of the development of efficient

distribution methods and underwriters' concern that stabilization may

indicate that an offering is progressing poorly. Nevertheless,

underwriters continue to disclose in prospectuses that they reserve the

right to stabilize an offering, and stabilization remains an important

option in domestic and foreign contexts.

In their responses to the Concept Release, commenters recognized

the importance of regulating stabilization, but were critical of Rule

10b-7's price restrictions, which prevent underwriters from adjusting

stabilizing bids to reflect fluctuating markets and currency changes,

and of the rule's reliance on U.S. markets to govern permissible

stabilizing prices. Rule 104 reflects a fundamental shift from Rule

10b-7's structure, while codifying exemptive and no-action relief

issued by the Commission and its staff within the last decade,

particularly with respect to cross-border transactions.

2. Stabilizing Levels

The most significant proposed changes from Rule 10b-7 pertain to

permissible stabilizing price levels. The Commission believes that

these changes would afford greater flexibility to underwriters, which

is especially important in the context of multinational securities

offerings. Under Rule 10b-7, an underwriter generally must set its

stabilizing bid based on the independent market price for the security,

and cannot change that bid except in limited circumstances. In

principal markets that are exchanges, initiation of stabilizing bids is

limited by last sale prices. In other markets, independent bids are the

reference price.

Rule 104 would allow persons effecting stabilizing transactions to

establish a stabilizing bid with reference to prices in the principal

market for the security, wherever located,82 and then to maintain,

reduce, or raise that bid to follow the independent market, as long as

the bid does not exceed the highest

[[Page 17124]]

independent bid and in no case exceeds the offering price of the

security.83 These provisions would provide significant flexibility

to stabilization regulation, because they effectively would permit the

stabilizing bid to follow the independent market for the security,

limited by the offering price.

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\82\ A U.S. market that is not the principal market would no

longer control stabilizing price levels. The reference prices in the

principal market must be reported pursuant to Rule 11Aa3-1 under the

Exchange Act, 17 CFR 240.11Aa3-1, or be reported to a foreign

financial regulatory authority as defined in Section 3(a)(52) of the

Exchange Act, 15 U.S.C. 78c(a)(52).

\83\ Rule 100 would define ``independent bid'' as a bid by a

person who is not a distribution participant, issuer, selling

securityholder, or affiliated purchaser.

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When the principal market is open, stabilizing price levels would

be determined by the stabilizing bid in that market, and if there is no

stabilizing bid, by the highest independent bid price in that market.

If the principal market is closed and stabilizing has not been

initiated in any market, no stabilizing could be effected at a price in

excess of the lower of: (1) The price at which stabilizing could have

been effected in the principal market at the close thereof; or (2) the

most current reported price at which transactions in the offered

security have been effected on any exchange or inter-dealer quotation

system after the close of the principal market. After the opening of

quotations or trading in the market where stabilizing will be effected,

stabilizing could not be effected at a price higher than the highest

independent bid price for such security reported in that market at the

time such stabilizing is effected. Where an independent market for the

offered security does not exists, stabilizing would be limited only by

the offering price. Rule 104 also provides for adjustments to the

stabilizing bid when the security being stabilized goes ex-dividend,

ex-rights, or ex-distribution, or is expressed in a currency other than

the currency of the principal market and there are changes in the

exchange rate between the two currencies.84

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\84\ Rule 100 would define ``current exchange rate'' as the

current rate of exchange between two currencies, which is obtained

from at least one independent entity that provides foreign exchange

quotations and information in the ordinary course of its business.

Rule 104(g)(5) would retain Rule 10b-7's provisions that any

stabilizing price that otherwise meets the requirements of the rule

need not be adjusted to reflect special prices available to any

group or class of persons (including employees or holders of

warrants or rights). See 17 CFR 240.10b-7 (h), (i), (j)(5), and

(j)(7).

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Q55. Do the provisions regarding stabilizing price levels create an

effective framework to govern stabilizing transactions? Do the

provisions regarding stabilizing price levels present any manipulative

concerns?

3. Other Provisions Relating to Stabilization

As under Rule 10b-7, Rule 104 would provide that no person may

effect either alone or with others any stabilizing transaction to

facilitate an offering of any security in contravention of its

provisions.85 The term ``stabilizing'' would be defined in Rule

100 as the placing of any bid, or the effecting of any purchase, for

the purpose of pegging, fixing, or otherwise maintaining the price of a

security. Rule 104 would retain provisions governing priority of

independent bids, control and purpose of stabilizing, stabilizing at

prices resulting from unlawful activity, and the prohibition of

stabilization in ``at the market'' offerings. The Commission proposes

to eliminate the distinction in Rule 10b-7 between exchange-traded and

OTC securities.

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\85\ Unlike proposed Rules 101 and 102, which would apply to a

``distribution,'' Rule 104 would govern stabilizing to facilitate an

``offering,'' a term that is broader in scope.

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Rule 104 would retain the exclusion for ``excepted securities.''

The Commission also proposes to expand the exception in Rule 10b-7 for

distributions of Rule 144A-eligible foreign securities made solely to

QIBs in exempt transactions. Rule 104 would except all distributions of

Rule 144A-eligible securities to QIBs, and sales of Rule 144-eligible

securities to non-U.S. persons, within the meaning of Regulation S

under the Securities Act, that are made concurrently with Rule 144A

distributions to QIBs. This responds to commenters who argued that as a

matter of consistency, the exception for Rule 144A-eligible securities

should be extended to the domestic context.

Rule 104 would eliminate the provision pertaining to limitation of

liability. The Commission believes that lead managers now exert

considerably more control over stabilizing transactions than when Rule

10b-7 was adopted, and that a provision regarding vicarious liability

arising out of stabilizing transactions by syndicate members no longer

appears necessary.

Q56. Does Rule 104 cover all situations where underwriters believe

that stabilizing would be appropriate to facilitate an offering? Would

the rule's greater flexibility result in stabilizing by underwriters in

a greater number of instances?

Q57. In addition to ``at the market'' offerings, are there other

categories of offerings (e.g., best efforts) or securities (e.g., penny

stocks) for which stabilizing is not appropriate? Should issuers be

permitted to stabilize and, if so, under what circumstances?

Q58. Is it appropriate to except from an anti-manipulation

provision stabilization of offerings of Rule 144A-eligible securities?

Q59. Should the Commission retain the provision in Rule 10b-7(m)

regarding limitation of liability? What purpose does this paragraph

serve? If it should be retained, should it be in the same form as the

current provision?

4. Aftermarket Activities

An underwriter's interest in the success of an offering does not

necessarily end with the completion of the sales efforts and

termination of formal stabilizing activities, but can extend into the

``aftermarket'' trading in the distributed security (in general, the

period immediately following the termination of formal syndicate

activity--the so-called ``breaking of the syndicate''). Aftermarket

participation may be an expected part of the underwriting services

provided to an issuer, and the anticipated quality of such services can

influence the issuer's selection of a managing underwriter.

Underwriters also have an incentive to provide ``support'' in the

aftermarket to counterbalance pressure on the security's price from

``flipping'' and other selling activity that could adversely affect the

investors who have purchased in the offering. In addition, the managing

underwriter often purchases shares in the aftermarket period to cover a

syndicate short position.86 Accordingly, the point in time when

underwriters no longer have the purpose to ``facilitate an offering''

cannot be identified with precision.

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\86\ Underwriters frequently receive an overallotment option

(commonly referred to as the ``Green Shoe'' option), which is the

right, but not the obligation, to purchase securities from the

issuer in addition to those initially underwritten by the syndicate,

which may constitute up to 15% of the initial underwritten amount.

Because the overallotment option may be insufficient to cover the

entire syndicate short position, that portion in excess of the

overallotment option must be covered through purchases in the

secondary market.

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Furthermore, in initial public offerings the agreement among

underwriters may contain a provision authorizing the managing

underwriter to invoke a ``penalty bid.'' This is a contractual

agreement permitting the managing underwriter to reclaim the selling

concession accruing to a syndicate participant with respect to shares

that the managing underwriter purchases in the aftermarket to cover the

syndicate short position.87 One of

[[Page 17125]]

the primary objectives of a penalty bid is to encourage syndicate

participants to sell the securities to those persons who intend to hold

them rather than to engage in short-term profit-taking, i.e., to combat

flipping. Enforcement of penalty bids typically continues for as long

as 30 days.

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\87\ Penalty bids are governed by Schedule D of the NASD's By-

Laws, Part V, Section 3, NASD Manual (CCH) para. 1820.

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The Commission believes that the aftermarket activities described

above are not uncommon and may act to support the price of the offered

security in the aftermarket.88 Commenters, however, were divided

concerning whether regulation should be extended to cover such

activities. Therefore, the Commission at this time is not proposing to

extend the price limitations of Rule 104 to cover aftermarket

activities. Instead, as described in the following section, the

Commission is proposing to require disclosure of syndicate covering and

penalty bid activities, and that underwriters keep records of such

activities. Disclosure of these aftermarket activities would serve to

apprise regulators of their possible market effects, while the

recordkeeping requirements would assist the Commission in monitoring

aftermarket practices and in assessing whether further regulation is

warranted.

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\88\ See J. Shayne & L. Soderquist, Inefficiency in the Market

for Initial Public Offerings, 48 Vand. L. Rev. 965, 983-84 (May

1995).

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5. Disclosure and Recordkeeping

The Commission proposes to require more specific disclosure of

stabilization, syndicate covering transactions,89 and penalty bids

90 in order to make disclosure of these activities more

meaningful.

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\89\ Rule 100 would define ``syndicate covering transaction'' as

the placing of any bid or the effecting of any purchase on behalf of

the sole distributor or the underwriting syndicate or group to

reduce a syndicate short position.

\90\ Rule 100 would define ``penalty bid'' to mean an

arrangement that permits the managing underwriter to reclaim a

selling concession otherwise accruing to a syndicate member in

connection with an offering when the securities originally sold by

the syndicate member are purchased in syndicate covering

transactions.

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Like Rule 10b-7, paragraph (h) of Rule 104 would require any person

who places or transmits a bid that such person knows is for the purpose

of stabilizing the price of any security to notify the market on which

the transaction is effected, and to disclose the purpose of such

transaction to the person to whom the bid is placed or is transmitted

(e.g., the specialist or the executing broker-dealer). The NASD

requires persons intending to initiate stabilization to provide it with

prior notification.91 Stabilizing bids are then identified by a

symbol on the Nasdaq quotation display. In this way, the person engaged

in stabilization satisfies the requirement to inform the market and the

recipients of the purpose of a bid by notifying the NASD. The

exchanges, however, do not have this procedure. To fulfill the proposed

requirements for stabilizing transactions on an exchange, underwriters

would have to notify the exchange and provide disclosure separately to

recipients of the bid. In the Commission's view, contemporaneous

disclosure of the fact that stabilizing is occurring is beneficial to

the market and its participants.

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\91\ See Schedule D of the NASD's By-laws, Part V, Section 3(c),

NASD Manual (CCH) para. 1820.

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Rule 104 also would require any person effecting a syndicate

covering transaction, or placing or transmitting a penalty bid, to

disclose that fact to the SRO that has direct oversight authority over

the market on which the syndicate covering transaction is effected, or

the penalty bid is placed. This information would be helpful to the

exchanges and Nasdaq in carrying out their surveillance

responsibilities.

The stabilizing legend required by Rule 10b-7(k), and Item 502(d)

of Regulations S-B and S-K,92 would be replaced by a brief legend

identifying activity that may affect the offered security's price and

directing investors to a discussion in the ``plan of distribution''

section of the prospectus. Item 508 of Regulations S-B and S-K,93

governing the plan of distribution disclosure, would be revised to

require a brief description of any prospective stabilizing and

aftermarket activities, including syndicate covering transactions and

the imposition of a penalty bid, and their potential effects on the

market price. The objective of these proposals is to augment the

language found in the stabilizing legend with more meaningful

information regarding stabilizing and related activities.94

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\92\ See 17 CFR 228.502(d) and 229.502(d).

\93\ See 17 CFR 228.508 and 229.508.

\94\ Once a ``plain English'' prospectus is implemented, a

stabilizing legend may no longer be required on the inside front

cover of the prospectus. See Task Force Report at 17-18, supra note

13.

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Q60. Is regulation of aftermarket transactions warranted? For

example, should syndicate covering transactions be subject to the price

level restrictions of Rule 104? Should penalty bids be prohibited as

some commenters have suggested?

Q61. Would there be any difficulty in disclosing to the SRO the

fact that syndicate covering transactions are occurring or that a

penalty bid is in place?

Proposed amendments to Rule 17a-2 under the Exchange Act would

require managing underwriters to keep records of syndicate covering

transactions and penalty bids, in addition to stabilizing information.

Records would reflect the name and class of securities, and the price,

the date, and the time for each syndicate covering transaction. The

records also would reflect the dates that any penalty bid was in

effect, information relating to transactions against which penalty bids

were assessed, and the date the bid was terminated. The information

would be required to be maintained in a separate file, for a period of

three years, the first two years in an easily accessible place. The

Commission believes that this recordkeeping requirement will impose

little, if any, additional burden on underwriters, because underwriters

already are required to keep detailed syndicate account records.95

Records of such transactions would provide the Commission with an

empirical basis for determining whether additional regulation is

warranted.

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\95\ See NASD Rules of Fair Practice, Art. III, Sec. 21, NASD

Manual (CCH) para. 2171. See also NASD Rules of Fair Practice, Art.

III, Sec. 44, NASD Manual (CCH) para. 2200D.

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In addition to registered offerings for which a registration

statement or a Form 1-A 96 is filed, Rule 17a-2 applies to any

other offering if the total proceeds exceed $1,500,000. This threshold

is proposed to be increased to $5,000,000 in Rule 17a-2. The Commission

believes that raising this threshold would make the rule less

burdensome for smaller offerings, and would be consistent with other

Securities Act and Exchange Act initiatives.97

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\96\ 17 CFR 249.1a.

\97\ See, e.g., Securities Exchange Act Release No. 35895 (June

27, 1995), 60 FR 35642.

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Q62. Is the expansion of Rule 17a-2 to include recordkeeping of

syndicate covering transactions and penalty bids appropriate and what,

if any, burdens would be imposed by these new requirements?

Q63. Should offerings with proceeds of $5,000,000 or less be exempt

from Rule 17a-2?

F. Rule 105--Short Sales In Connection With An Offering

The Commission adopted Rule 10b-21 in 1988 to address the practice

of manipulative short sales prior to a public offering by short sellers

who cover their short positions by purchasing securities in the

offering. Manipulative short sales could result in a lower offering

price, and thus reduce

[[Page 17126]]

proceeds to the issuer. Rule 10b-21 addresses this practice by

prohibiting the covering from the offering of any short sales made

during the period beginning at the time a registration statement or

Form 1-A is filed and ending at the time that sales may be made

pursuant to the registration statement or Form 1-A.

The Commission is proposing Rule 105 to replace Rule 10b-21. Rule

105, like Rule 10b-21, is designed to prevent short sales from being

covered with securities obtained from an underwriter, broker, or dealer

who is participating in the offering. Rule 105 would differ from Rule

10b-21 because it would cover only those short sales effected in the

period commencing five business days prior to the pricing of an

offering and ending with such pricing. Reducing the period of the

rule's applicability is consistent with the structure of Rules 101 and

102, which provide for shorter restricted periods, and reflects the

Commission's belief that such period should be sufficient to dissipate

the effects of any manipulative short selling on the price of the

offered security.

Commenters expressed divided views on the efficacy of Rule 10b-21.

Some believe that the rule impedes legitimate short selling activity.

Others maintain that the rule would be more effective if it also

covered activity in derivative securities. Since the adoption of Rule

10b-21, several additional regulatory measures have been implemented

that may lessen the effects of short selling in connection with an

offering. These initiatives, which include permitting passive market

making during offerings of Nasdaq securities and implementing a short

sale rule for the Nasdaq market,98 may reduce the need for Rule

105. Short selling to depress an offering price would continue to be

covered by the general anti-manipulation provisions of the Securities

Act and the Exchange Act.

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\98\ NASD Rules of Fair Practice, Art. III, Sec. 48, NASD Manual

(CCH) para. 2200H.

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Q64. Does a special regulation dealing with short selling in

connection with an offering continue to be necessary or appropriate?

Q65. Should the prohibitions of Rule 105 extend to short sales of

derivative securities? Commenters should discuss how this proposal

would be consistent with Rule 101, which would not cover bids or

purchases of derivative securities.

Q66. Would the five business day restricted period present

compliance difficulties?

Q67. Should the restricted period of Rule 105 parallel the one or

five business day restricted periods of Rule 101, which depend on the

security's ADTV?

Q68. Should offerings of actively-traded securities (i.e.,

securities having an ADTV value of at least $1 million) be excluded

from Rule 105, as in Rule 101?

IV. Safe Harbor Alternative

Many commenters endorsed recasting the rules as non-exclusive safe

harbors from the statutory anti-manipulation provisions of the Exchange

Act.99 They argued that Rule 10b-6 can have a disproportionate

impact on those distribution participants and affiliated purchasers who

inadvertently run afoul of the rule's prohibitions but do not affect

the offered security's price.

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\99\ Commenters cited Rule 10b-18 as a relevant example of a

safe harbor provision. See supra Section III.C.6. discussing Rule

10b-18.

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The Commission believes that a prophylactic approach to market

activities of persons interested in a distribution continues to serve

an important role in maintaining the integrity of the capital markets.

In the Commission's view, the framework of proposed Regulation M

preserves the Commission's strong interest in protecting investors from

manipulated offerings, while providing flexibility, clarity, and

guidance to offering participants.

The Commission has stated that the ``exceptions [to Rule 10b-6] are

not, and never have been, safe harbors,'' and that a lack of improper

motive when relying on the rule's exceptions always has been

required.100 A safe harbor from manipulation charges is

inappropriate in contexts where it is reasonable to infer that

manipulative incentives are present, such as during securities

distributions. Also, requiring the Commission to demonstrate the

existence of a purpose on the part of persons engaged in any market

activity, for example, to ``facilitate the distribution'' of an offered

security,101 would conflict with the goal of precluding improper

market activity prior to pricing of offerings. The inclusion of a

``purpose'' element effectively would make enforcement of such a

provision an after-the-fact remedy that would in many respects overlap

Rule 10b-5. Moreover, it is likely that safe harbor rules would be

inappropriate for some securities offerings, such as those involving

penny stocks, and may be inconsistent with the Commission's express

statutory authority to promulgate rules governing the ``pegging,

fixing, or stabilizing'' of the price of certain securities.102

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\100\ See Securities Exchange Act Release No. 24003 (January 16,

1987), 52 FR 2994, 2998.

\101\ This is a component of the ABA draft proposal.

\102\ See Section 9(a)(6) of the Exchange Act.

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It is important to note, moreover, that commenters advocated a safe

harbor approach in the context of the current rules. As proposed,

several categories of offerings, persons, and activities that are

subject to the trading practices rules would not be subject to the

prophylactic prohibitions of Regulation M. In addition, the new rules

would create a more flexible framework for conducting market activities

during distributions. The proposed exception for de minimis violations

would address the concerns commenters had regarding the impact of Rule

10b-6 on those persons who inadvertently violated the rule through

nominal purchases, or unaccepted bids.

Although the Commission does not favor a safe harbor approach,

commenters may wish to present arguments supporting a safe harbor

framework and to submit draft rule text. Commenters are urged to

provide careful analyses of how a safe harbor approach would be

utilized and what kinds of transactions would be permitted under a safe

harbor. Would safe harbor rules be appropriate in all contexts and, if

not, would it be confusing to have a set of safe harbor and

prophylactic rules governing substantially similar conduct?

The Commission also requests comment as to whether a safe harbor

approach to anti-manipulation regulation would diminish the investor

protection goals of the Exchange Act. How would the balance between the

capital-raising role of securities offerings and the Commission's

investor protection mandate be affected if a safe harbor were extended

to the general anti-manipulation provisions?

Support for the safe harbor approach also appears to stem from

concerns regarding application of the general anti-manipulation

provisions to conduct that would be permitted under the trading

practices rules. The Commission requests comment on alternatives to a

safe harbor approach that might address uncertainty regarding the reach

of the general anti-manipulation provisions in circumstances where the

conduct in question otherwise would be permitted under Regulation M.

For example, should conduct in compliance with Regulation M be presumed

not to violate the general anti-manipulation provisions, subject, of

course, to rebuttal?

V. General Request for Comments

Any interested person wishing to submit written comments on any

aspect

[[Page 17127]]

of the proposed rules discussed in this release, as well as on other

matters that might have an impact on the proposals contained herein, is

requested to do so. In addition to the comments solicited above,

commenters are urged to provide their views on the overall structure of

proposed Regulation M and whether the format and the rules contained

herein provide a beneficial alternative to the trading practices rules.

Commenters are encouraged to submit proposed rule text and data

together with their written comments. Comments should be submitted in

triplicate to Jonathan G. Katz, Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, and should

refer to file number S7-11-96. Comments also may be submitted

electronically at the following E-mail address: [email protected].,

and should include the file number on the subject line of the E-mail.

VI. Costs and Benefits of the Proposed Amendments and Their Effects on

Competition

To assist the Commission in its evaluation of the costs and

benefits that may result from the proposed new rules, commenters are

requested to provide analyses and data relating to costs and benefits

associated with any of the proposals herein. The Commission

preliminarily believes that compliance burdens generally will be

reduced by the proposed changes. The proposals would reduce

significantly trading restrictions on issuers, underwriters, and others

with an interest in an offering from those currently in effect and,

therefore, should reduce the costs of raising capital.

In addition, Section 23(a)(2) of the Exchange Act requires the

Commission, in adopting rules under the Exchange Act, to consider the

anti-competitive effects of such rules, if any, and to balance any

impact against the regulatory benefits gained in terms of furthering

the purposes of the Exchange Act.103 The Commission preliminarily

has considered the proposed rules in light of the standards cited in

Section 23(a)(2) and believes preliminarily that, if adopted, they

would not likely impose any significant burden on competition not

necessary or appropriate in furtherance of the Exchange Act. Indeed,

the Commission believes that Regulation M may enhance the posture of

U.S. underwriters in relation to foreign broker-dealers in competing

for underwriting business in cross-border distributions. The Commission

solicits commenters' views regarding the effects of the proposed rules

on competition.

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\103\ See 15 U.S.C. 78w(a)(2).

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VII. Initial Regulatory Flexibility Analysis

The Commission has prepared an Initial Regulatory Flexibility

Analysis (``IRFA''), in accordance with the provisions of the

Regulatory Flexibility Act,104 regarding the rules contained in

proposed Regulation M and the proposed amendments to Rules 10b-18 and

17a-2 under the Exchange Act and Items 502(d) and 508 of Regulations S-

B and S-K.

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\104\ 5 U.S.C. 603.

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As discussed more fully in the analysis, some of the issuers and

broker-dealers that Regulation M would affect are small entities, as

defined by the Commission's rules. In general, Regulation M overall

would decrease costs for issuers and

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