Anti-manipulation Rules Concerning Securities Offerings

SUMMARY: The Commission is adopting new Regulation M governing the

activities of underwriters, issuers, selling security holders, and

others in connection with offerings of securities. Regulation M is

intended to preclude manipulative conduct by persons with an interest

in the outcome of an offering. Regulation M significantly eases

regulatory burdens on offering participants by eliminating the trading

restrictions for underwriters of actively-traded securities; reducing

the scope of coverage for other securities; reducing restrictions on

issuer plans; providing a more flexible framework for stabilizing

transactions; and deregulating rights offerings. Consisting of five new

rules, plus a new definitional rule, Regulation M replaces Rules 10b-6,

10b-6A, 10b-7, 10b-8, and 10b-21 (``trading practices rules'') under

the Securities Exchange Act of 1934 (``Exchange Act''), which are being

rescinded. In addition, related amendments are being made to Items

502(d) and 508 of Regulations S-B and S-K, and to Rules 10b-18 and 17a-

2 under the Exchange Act. Conforming changes to various rules under the

Securities Act of 1933 (``Securities Act'') and the Exchange Act are

being made to reflect the repeal of the trading practices rules and the

adoption of Regulation M.

EFFECTIVE DATE: March 4, 1997. The requirement of Sec. 242.104(i) and

the amendments to Sec. 240.17a-2 are effective on April 1, 1997.

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, Carlene S. Kim, Heidi E. Pilpel, Barbara J. Endres, Irene A.

Halpin, Marc J. Hertzberg, Denise M. Landers, Lauren C. Mullen, Mark R.

Pacioni, Alan J. Reed, or Margaret A. Smith.

SUPPLEMENTARY INFORMATION:

I. Introduction and Summary of New Regulation M

A fundamental goal of the federal securities laws is the prevention

of manipulation. Manipulation impedes the securities markets from

functioning as independent pricing mechanisms, and undermines the

integrity and fairness of those markets. Congress granted the

Commission broad rulemaking authority to combat manipulative abuses in

whatever form they might take. In exercising its authority, the

Commission has focused on the market activities of persons

participating in a securities offering, and determined that securities

offerings present special opportunities and incentives for manipulation

that require specific regulatory attention.

On April 11, 1996, the Commission published for comment a release

(``Proposing Release'') proposing Regulation M, and Rules 100 through

105 thereunder, to govern the activities of issuers, underwriters, and

other persons participating in a securities offering,1 and to

replace Rules 10b-6, 10b-6A, 10b-7, 10b-8, and 10b-21 2 under the

Exchange Act.3 The Commission received 39 comment letters from 36

commenters in response to the Proposing Release.4 The commenters

generally expressed strong support for proposed Regulation M, although

several expressed concerns with specific provisions, and some suggested

alternative approaches for addressing particular issues. The Commission

is adopting Regulation M substantially as proposed, but with some

modifications to clarify provisions or to reflect commenters' views.

The new regulation represents the most significant changes to the

Commission's anti-manipulation regulation of securities offerings since

the adoption of the trading practices rules over 40 years ago.5

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\1\ Securities Exchange Act Release No. 37094 (April 11, 1996),

61 FR 17108.

\2\ 17 CFR 240.10b-6, 240.10b-6A, 240.10b-7, 240.10b-8, and

240.10b-21.

\3\ 15 U.S.C. 78a et seq.

\4\ A summary of comments has been prepared by the staff of the

Division of Market Regulation. The summary is included, along with

the comment letters, in Public File No. S7-11-96, which is available

for inspection and copying in the Commission's Public Reference

Room, 450 Fifth Street, N.W., Washington, D.C. 20549.

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

20 FR 5075.

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Regulation M is the culmination of a comprehensive review by the

Commission of its anti-manipulation regulation of securities

offerings.6 This review was prompted by ongoing developments and

innovations in the securities industry, including: increasing

institutionalization of the markets, advances in technology and

communications media, enhanced surveillance capabilities, continuing

globalization of the securities markets, and new offering techniques.

These developments have outpaced the existing structure of anti-

manipulation regulation of securities offerings and reduced the need

for broad prophylactic restrictions. Moreover, the Commission was

informed by market participants that the application of the trading

practices rules had become needlessly complex and involved substantial

compliance costs.

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\6\ See Securities Exchange Act Release No. 33924 (April 19,

1994), 59 FR 21681 (``Concept Release'').

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Regulation M exemplifies the Commission's efforts to relax

restrictions in cases where either the risk of manipulation is small or

the costs of the restrictions are disproportionate to the purposes they

serve. The new regulation continues the anti-manipulation objectives of

the trading practices rules, but reflects developments in the

securities industry, allows greater flexibility for market participants

to engage in activities that enhance competition in the marketplace,

and incorporates the recommendations of the Commission's Task Force on

Disclosure Simplification for a more streamlined approach to regulating

manipulative conduct during offerings.7 Three of the principal

elements that underlie the Commission's decision to provide greater

flexibility for market activities during offerings are: securities

market transparency, surveillance capabilities of the self-regulatory

organizations (``SROs''), and continuing application of 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 Rules 10b-5 and 15c1-2

thereunder,8 to all activities in connection with an offering,

whether or not the provisions of Regulation M apply.9 Like the

former trading practices rules, Regulation M proscribes certain

activities that offering participants could use to manipulate the price

of an offered security. Although some

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commenters requested that the rules under Regulation M be formulated as

non-exclusive safe harbors from the anti-manipulation provisions of the

Exchange Act, the Commission continues to believe that a prophylactic

approach to anti-manipulation regulation is the most effective means 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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\7\ Report of the Task Force on Disclosure Simplification, 77-79

(March 1996) (``Task Force Report'').

\8\ 15 U.S.C. 77q(a); 15 U.S.C. 78i(a), 78j(b), and 78o(c); and

17 CFR 240.10b-5 and 240.15c1-2.

\9\ See Proposing Release, 61 FR at 17109. Similarly, Regulation

M and the interpretations thereof do not affect the application of

the registration and prospectus delivery requirements of the

Securities Act to offers and sales of securities.

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Regulation M contains six rules covering the following activities

during a securities offering: (1) activities by underwriters or other

persons who are participating in a distribution (i.e., distribution

participants) and their affiliated purchasers; (2) activities by the

issuer or selling security holder 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.10 A separate rule under Regulation

M, Rule 100, contains 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.

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\10\ Regulation M is adopted under the Securities Act,

particularly Sections 7, 17(a), and 19(a), 15 U.S.C. 77g, 77q(a),

and 77s(a); the Exchange Act, particularly Sections 2, 3, 9(a), 10,

11A(c), 12, 13, 14, 15(c), 15(g), 17(a), 23(a), and 30, 15 U.S.C.

78b, 78c, 78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(c), 78o(g),

78q(a), 78w(a), and 78dd; and the Investment Company Act of 1940

(``Investment Company Act''), 15 U.S.C. 80a-1 et seq., particularly

Sections 23, 30, and 38, 15 U.S.C. 80a-23, 80a-29, and 80a-37.

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

contained in Rules 101 and 102, which cover distribution participants,

and issuers and selling security holders, respectively. Rules 101 and

102 apply only during a ``restricted period'' that commences one or

five business days before the day of the pricing of the offered

security and continues until the distribution is over. The restricted

periods are based on the trading volume value of the offered security

and the public float value of the issuer, rather than the price per

share and public float criteria used in Rule 10b-6, and generally are

of a shorter duration than the cooling-off periods under Rule 10b-6.

Furthermore, the restricted periods of Regulation M focus on the time

of pricing. In contrast, Rule 10b-6 imposed restrictions during the

entire distribution, which could extend over a lengthy period of time,

but excepted certain trading activities prior to a two or nine business

day ``cooling-off period.'' The applicable cooling-off period was keyed

off the commencement of offers or sales. While Rule 10b-6 was designed

to protect the pricing of an offering, certain distribution methods,

particularly in connection with foreign offerings, could result in the

cooling-off periods commencing after an offering had been priced.

Rule 101 excludes from its coverage more actively-traded

securities, nonconvertible and asset backed securities rated investment

grade, and Rule 144A transactions. Restrictions on transactions in

outstanding debt securities during a distribution of a debt security

are narrowed substantially. Further, Rule 101 focuses on the security

being distributed and does not cover bids for and purchases of related

derivative securities. It permits, among other things, the routine

dissemination of research reports, exercises of options and other

securities, and transactions in baskets of securities involving the

offered security. Also, bids for and purchases of rights during rights

offerings are deregulated. Rule 101 deals with ``inadvertent''

violations during the restricted period by excusing de minimis

transactions, provided that a distribution participant had in place

written policies and procedures reasonably designed to achieve

compliance with the regulation. Moreover, the scope of persons subject

to Rule 101 is narrowed by recognizing ``information barriers'' between

the distribution participant and its affiliates.

Rule 102 covers issuers, selling security holders, and related

persons. The rule allows issuers and selling security holders to engage

in market activities prior to the applicable restricted period. It also

gives issuers greater flexibility in conducting their dividend

reinvestment and stock purchase plans and odd-lot repurchase programs.

During the restricted period, Rule 102 permits 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, and transactions in commodity pool or limited partnership

interests during distributions of those securities. The rule contains a

limited exception for actively-traded ``reference securities.''

Rule 103 replaces Rule 10b-6A and expands the scope of Nasdaq

passive market making. The rule covers all Nasdaq securities and nearly

all distributions, and permits more distribution participants to engage

in passive market making.

Rule 104, which replaces Rule 10b-7, regulates stabilizing and

other activities related to a distribution. The rule provides a more

flexible framework for stabilizing transactions than Rule 10b-7. Rule

104 allows 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 does not exceed the offering price. Also, by

providing for greater disclosure and recordkeeping of transactions that

can influence market prices immediately following an offering, Rule 104

addresses the fact that underwriters now engage in substantial

syndicate-related market activity, and enforce penalty bids in order to

reduce volatility in the market for the offered security.

Rule 105 recodifies 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 is

narrowed to the five business day period before pricing, rather than

the period extending from the time of filing of offering materials to

the time when sales may be made.

The Commission believes that separate regulation of rights

offerings, as contained in Rule 10b-8, no longer is warranted. Many

rights offerings, especially by foreign issuers, involve securities

that fall within the exception for actively-traded securities contained

in Rule 101. Even for less actively-traded securities, purchases of

rights generally are not an efficient way for a distribution

participant to facilitate an offering of the underlying security.

Therefore, the Commission has decided to rescind Rule 10b-8.

The new regulatory framework relieves market participants of

unnecessary burdens and responds effectively to a changing marketplace,

while maintaining essential investor protection. The following sections

of this release describe the individual provisions of Regulation M and

associated rule changes and discuss, where appropriate, how they differ

from the rules as proposed and from the former trading practices rules,

as well as reasons for these changes.

II. Discussion of Regulation M and Related Amendments

A. Rule 100--Definitions

Rule 100 sets forth the definitions applicable to all of the rules

under Regulation M. Most of the definitions are adopted as proposed;

some definitions are revised to respond to commenters' suggestions or

to add clarity to the rules. Many of these definitions are discussed

later in this release in conjunction with the specific

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provisions of Regulation M to which they relate.11

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\11\ In this release, terms defined in Rule 100 appear in

italics when discussed for the first time.

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B. Rule 101--Activities by Distribution Participants

1. Generally

Rule 101 governs the activities of persons participating in

distributions of securities, other than issuers or selling security

holders, and their affiliated purchasers. The distribution participants

subject to Rule 101 will typically be financial intermediaries that

routinely engage in market transactions for their own accounts or for

customers as part of their businesses.

In general, Rule 101 prohibits distribution participants and their

affiliated purchasers from bidding for, purchasing, or attempting to

induce any person to bid for or purchase, a covered security during a

specified period (restricted period). As with Rule 10b-6(c)(5), a

distribution of securities under Regulation M is distinguished from

ordinary trading transactions by the ``magnitude of the offering'' and

the presence of ``special selling efforts and selling methods.''

12 The restricted period for a particular distribution commences

one or five business days before the day of the pricing of the offered

security and continues until the distribution is over.13

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\12\ Rule 100 defines distribution as ``an offering of

securities, whether or not subject to registration under the

Securities Act, that is distinguished from ordinary trading

transactions by the magnitude of the offering and the presence of

special selling efforts and selling methods.''

\13\ Many of the terms and concepts discussed with respect to

Rule 101 also are relevant to Rule 102, which proscribes activities

by issuers and selling security holders and their affiliated

purchasers.

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Even during the restricted period, Rule 101 permits distribution

participants and their affiliated purchasers to engage in a variety of

activities, including the following: the routine dissemination of

research reports; exercises of options and other securities, including

rights received in connection with a rights offering; transactions in

baskets of securities involving an offered security; and certain

transactions involving Rule 144A securities of foreign and domestic

issuers. Rule 101 also excepts de minimis transactions that would

otherwise violate the rule: bids that are not accepted, and one or more

purchases that in the aggregate over the restricted period total less

than 2% of the security's average daily trading volume, provided that

the person making the unaccepted bids or purchases has maintained and

enforced written policies and procedures designed to achieve compliance

with the rule.

2. Persons Subject to Rule 101

a. Distribution Participant

A distribution participant is defined in Rule 100 as an

underwriter, prospective underwriter, broker, dealer, or other person

who has agreed to participate or is participating in a distribution.

The Commission is adopting the definition as proposed.

Several commenters expressed concern that a distribution

participant affiliated with an issuer or selling security holder (e.g.,

an underwriter that is affiliated with an issuer) would be subject to

the more restrictive provisions of Rule 102, rather than those of Rule

101, which they claimed could result in unwarranted adverse business

and market consequences.14 They recommended that such distribution

participants be permitted to rely on the provisions of Rule 101. Other

commenters recommended that any financial services affiliate of an

issuer or selling security holder, whether or not it is acting as a

distribution participant in connection with the distribution, should

have the benefit of the additional exceptions available under Rule 101.

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\14\ See infra Section II.C., discussing Rule 102.

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After considering the commenters' views, the Commission has added a

proviso to paragraph (a) of Rules 101 and 102, specifying that any

affiliated purchaser of an issuer or selling security holder that also

is acting as a distribution participant may comply with the provisions

of Rule 101, rather than Rule 102, provided that such affiliated

purchaser is not itself the issuer or selling security holder.15

Thus, during a distribution, an underwriter affiliated with the issuer

will be able to comply with the provisions of Rule 101. The Commission

is making this revision based upon its experience with Rule 10b-6, and

the fact that underwriters affiliated with the issuer are often

important market participants that are subject to SRO surveillance.

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\15\ The exception for actively-traded securities is not

available for securities that are issued by a distribution

participant or an affiliate of the distribution participant. See

infra Sections II.C.2. and II.C.5.

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b. Prospective Underwriter

A prospective underwriter is defined as a person: who has submitted

a bid to an issuer or selling security holder, and knows or is

reasonably certain that such bid will be accepted, whether or not the

terms and conditions of the underwriting have been agreed upon; or who

has reached, or is reasonably certain to reach, an understanding with

an issuer, selling security holder, or managing underwriter that such

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

conditions of the underwriting have been agreed upon.16 The

definition differs from the proposal in that the phrase ``is reasonably

certain'' replaces ``reasonably expects.'' Several commenters requested

that the proposed definition provide greater certainty as to when a

person becomes a prospective underwriter. They believed that, as a

practical matter, it may be difficult or even impossible for a broker-

dealer to know when it ``reasonably expects'' to have its bid accepted

or to reach an understanding with an issuer. Although the definition as

adopted does not provide a bright line test, the practical effect

should be to reduce the circumstances in which a broker-dealer will be

a prospective underwriter. The definition reflects the Commission's

view that there is frequently some point prior to when a bid actually

has been accepted, or a broker-dealer has been told that it will be an

underwriter, when it is reasonably certain that such person will be an

underwriter, and that the incentive to facilitate the distribution is

present at that point.

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\16\ If a broker-dealer has entered into a continuing agreement

with an issuer or selling security holder regarding takedowns of

securities off a shelf, such agreement typically would make the

broker-dealer reasonably certain that it would participate in a

distribution off the shelf.

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c. Completion of Participation in the Distribution

Under Regulation M, a person determines when its completion of

participation in the distribution occurs based on the person's role in

the distribution. An underwriter is deemed to have completed its

participation in a distribution when its participation has been

distributed, including all other securities of the same class that are

acquired in connection with the distribution, and after any

stabilization arrangements and trading restrictions in connection with

the distribution have been terminated.

The definition contains a proviso that an underwriter's

participation is not deemed to be completed, however, if a syndicate

overallotment option is exercised in an amount that exceeds the net

syndicate short position at the time of such exercise.17 This

proviso comports with a provision of Rule 10b-6 and is intended to

assure that the underwriter's selling efforts in

[[Page 523]]

connection with the distribution have in fact ceased before trading

prohibitions are lifted. Consistent with Rule 10b-6 interpretation, if

an overallotment option is exercised for an amount of securities that

exceeds the net syndicate short position (i.e., taking into account

shares purchased in stabilizing or syndicate short covering

transactions), the distribution will not be deemed completed and

purchases made prior to the exercise of the option would constitute a

violation of Regulation M.18 Any other distribution participant

will have completed its participation when its allotment has been

distributed.19 Several commenters asked the Commission to clarify

that securities acquired for investment by persons participating in a

distribution would be considered to be distributed. Consistent with an

interpretation of Rule 10b-6, securities acquired in a distribution for

investment purposes by anyone participating in the distribution, or any

affiliated purchaser, are considered to be distributed.20

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\17\ See Letter regarding Overallotment Options (November 27,

1996), 1996 SEC No-Act. LEXIS 868.

\18\ See Securities Exchange Act Release No. 19565 (March 4,

1983), 48 FR 10628, 10640 (``Release 34-19565'').

\19\ See infra Section II.C.2.a., discussing the definition of

completion of participation in the distribution as it relates to

issuers and selling security holders.

\20\ The definition of completion of participation in the

distribution codifies the approach taken by the staff in Letter

regarding VLI Corporation, [1982-1983] Fed. Sec. L. Rep. (CCH) para.

77,625 (October 17, 1983) (``VLI Letter'').

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d. Affiliated Purchaser

The Commission proposed to define affiliated purchaser for Rules

101 and 102 as: (1) a person acting in concert with a distribution

participant, issuer, or selling security holder in connection with the

acquisition or distribution of a covered security; (2) an affiliate who

controls the purchase of such securities by a distribution participant,

issuer, or selling security holder, or whose purchases are controlled

by such persons, or whose purchases are under common control with those

of such persons; or (3) an affiliate of a distribution participant,

issuer, or selling security holder who regularly purchases securities

for its own account or for the account of others, or who recommends or

exercises investment discretion with respect to the purchase or sale of

securities (``financial services affiliates'').

The Commission proposed excluding a financial services affiliate of

a distribution participant, but not that of an issuer or selling

security holder, from the definition if: (1) the affiliate was a

separate and distinct organizational entity from, having no officers or

employees in common with, the distribution participant; (2) the

affiliate's bids for, purchases of, and inducements to purchase

securities in distribution were made in the ordinary course of its

business; and (3) the distribution participant maintained and enforced

written policies and procedures designed to segregate the flow of

information between the distribution participant and its affiliates

(``information barriers''), and obtained an annual independent

assessment of the operation of its information barriers.

Although commenters generally supported the Commission's efforts to

revise the affiliated purchaser definition, several recommended that

financial services affiliates of issuers and selling security holders

also be excluded from this definition. Moreover, many commenters stated

that precluding common officers and employees and requiring that the

distribution participant and affiliate be separate and distinct

organizational entities would prevent a large number of multi-service

financial institutions from relying on this exception. Noting that

large financial services providers frequently have at least some

officers or employees with overlapping responsibilities, many

commenters argued that the presence of common officers or employees

should not preclude an affiliate from availing itself of the exclusion

where the affiliate's purchases are made in the ordinary course of its

business and the distribution participant has maintained and enforces

appropriate information barriers.

The Commission is adopting the first two prongs of the definition

substantially as proposed.21 In response to several commenters'

concerns, the Commission has determined to modify the third prong of

the definition. As adopted, the exclusion is available to affiliates of

distribution participants, issuers, and selling security holders.

Moreover, the condition prohibiting common officers (or persons

performing similar functions) or employees (other than clerical,

ministerial, or support personnel) has been narrowed to preclude

commonality only with respect to those officers or employees that

direct, effect, or recommend transactions in securities.22

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\21\ None of the commenters objected to the substance of the

first two prongs of the proposed definition, although several

commenters believed that these provisions would be sufficient to

capture any affiliate with both the means and the incentive to

manipulate. As adopted, the first prong of the definition remains

unchanged, and the only modification to the second prong is the

addition of language providing that an ``affiliate'' may be a

separately identifiable department or division of a distribution

participant, issuer, or selling security holder.

\22\ The Commission believes that this modification will resolve

substantially commenters' concerns that sharing one or more senior

executives with a distribution participant, issuer, or selling

security holder would preclude an affiliate from availing itself of

the exclusion. For example, the requirement would not preclude

common executives charged with risk management, compliance, or

general oversight responsibilities.

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A number of commenters argued that information barriers would not

deter manipulative activity because general information regarding a

distribution is public. The Commission nevertheless is of the view that

information barriers can serve to restrict the flow of non-public

information that might inappropriately influence an affiliate's

transactions in covered securities. For example, appropriate

information barriers would prevent the communication of the details of

pricing discussions with the issuer and prospective purchasers, or

knowledge as to the demand for the offering.

As adopted, the information barrier requirements specify that the

distribution participant, issuer, or selling security holder must

maintain and enforce written policies and procedures to prevent the

flow of information to or from the affiliate that might result in a

violation of Rules 101, 102, or 104 of Regulation M,23 and obtain

an annual, independent review of the operation of its information

barriers. As noted in the Proposing Release, an internal audit group

may perform the review if such group is independent of the distribution

participant, issuer, or selling security holder's corporate financing,

trading, and advisory departments.24

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\23\ The Commission notes that this provision does not require

the affiliate to maintain and enforce such information barriers.

\24\ Proposing Release, 61 FR at 17117. Several commenters

requested that the proposed exclusion clarify that an internal audit

group may perform the review.

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The Commission has determined to eliminate the requirement that the

affiliate be a separate and distinct organizational entity from the

distribution participant, issuer, or selling security holder in the

sense of requiring a separate legal entity, because such a condition

could result in elevating form over substance. Moreover, in response to

comments regarding the growth and complexity of multi-service financial

institutions, language providing that an ``affiliate'' may be a

separately identifiable department or division of a distribution

participant, issuer, or selling security holder has been added to the

second and third prongs of the definition. These changes broaden the

scope of financial

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services affiliates that may be eligible for the exclusion.

The Commission believes, however, that affiliates should be

restricted from engaging in certain types of activities that present

the greatest potential for manipulation during the course of a

distribution. As adopted, the definition provides that any affiliate

that, during the applicable restricted period, acts as a market maker

(other than as a specialist in compliance with the rules of a national

securities exchange), or engages, as a broker or a dealer, in solicited

transactions or proprietary trading activities, in covered securities

is an affiliated purchaser. An affiliate (whether an internal unit or a

separate legal entity) engaged in these activities is not eligible for

the exclusion to the affiliated purchaser definition.25 In

contrast, an affiliate acting as an investment company or investment

adviser, or in some other non-broker-dealer capacity, would be eligible

for the exclusion.26

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\25\ This means, for example, that a broker-dealer that does not

make a market in a covered security, or that ceases market maker

activity in covered securities during the applicable restricted

period, would not fall within the definition of affiliated

purchaser. Accordingly, an issuer affiliate that engages only in

unsolicited brokerage transactions in covered securities would not

fall within the definition.

\26\ For example, a trustee or other pension plan administrator

may avail itself of the exclusion, provided such entity satisfies

the remaining conditions of the exclusion.

A multi-service financial institution may engage in both

investment advisory services and trading activities. To the extent

that the institution's investment advisory services are performed by

a separately identifiable department, with no officers or employees

that direct, effect, or recommend transactions in securities in

common with the trading department, then the investment advisory

department may avail itself of the exclusion, provided the remaining

conditions of the definition are satisfied. If the same individuals

provide investment advisory services and engage in trading

activities for the institution, however, it would be difficult, if

not impossible, to attribute those functions to ``separately

identifiable'' departments. Similarly, where the same individuals

direct, effect, or recommend securities transactions for two

separately organized affiliates, one providing investment advisory

services and the other engaging in solicited activities, such

persons could not avail themselves of the exclusion by simply

attributing their solicited transactions to their investment

advisory role.

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The Commission believes that these modifications to the definition

of affiliated purchaser will resolve many of the commenters' concerns

and avoid unnecessary burdens on multi-service financial organizations

with affiliates engaged in financial advisory and other

services.27

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\27\ The variety and complexity of organizational structures

means that Regulation M may apply to some affiliates that it may be

appropriate to exclude. In such cases, the Commission, through the

Division of Market Regulation, will entertain exemption requests.

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3. Securities Subject to Rule 101

The Commission proposed applying the trading restrictions of Rule

101 to covered securities, which would include the security that is the

subject of a distribution (subject security) and reference securities.

The Commission is adopting the definition of covered security as

proposed, but at the suggestion of some commenters has revised the

definition of reference security to describe more specifically the

situations when the term applies. The term reference security is

defined as a security into which a subject security may be converted,

exchanged, or exercised, or which, under the terms of the subject

security, may in whole or in significant part determine the value of

the subject security.

Several commenters supported the proposed definitions. In general,

these commenters believed that the proposed coverage of securities

represented a significant improvement from the approach under Rule 10b-

6, which extended trading restrictions to any security of the ``same

class and series'' as the security being distributed and any ``right to

purchase'' such security.\28\ One commenter additionally noted that the

elimination of the same class and series analysis would ease greatly

the task of identifying securities that are subject to trading

restrictions during debt offerings. Other commenters indicated

uncertainty regarding the applicability of Regulation M to debt

offerings and requested clarification on the coverage of debt

securities that are ``identical in principal features.''

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\28\ See Proposing Release, text accompanying notes 29 and 30,

61 FR 17114.

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The elimination of the same class and series concept will reduce

significantly the application of trading restrictions to nonconvertible

debt securities that are not rated investment grade.\29\ Bids for and

purchases of outstanding nonconvertible debt securities are not

restricted unless the security being purchased is identical in all of

its terms to the security being distributed. For example, Rule 101 does

not apply to a security if there is a single basis point difference in

coupon rates or a single day's difference in maturity dates, as

compared to the security in distribution.\30\ In the rare situations in

which Rule 101 will apply to outstanding debt, the restricted period

will generally be five business days.

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\29\ Nonconvertible debt and certain other securities that are

rated investment grade are excluded from Rule 101. See infra Section

II.B.6.b.

\30\ In a distribution of equity securities, however,

outstanding classes of securities that differ only in voting rights

from the distributed security will be deemed to be the same security

for purposes of Regulation M.

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In addition, derivative securities (i.e., those that derive all or

part of their value from a security being distributed) are not subject

to the trading prohibition of Rule 101. Thus, for example, bids for or

purchases of options, warrants, rights, convertible securities, or

equity-linked securities are not restricted during a distribution of

the related common stock because, while they derive their value from

the security being distributed, they do not by their terms affect the

value of the security in distribution. The National Association of

Securities Dealers, Inc. (``NASD'') expressed concern about permitting

bids for and purchases of derivative securities in the case of a

distribution of an underlying security, because trading in derivative

securities can have a significant impact on the underlying

security.\31\ The NASD recommended that the Commission consider

limiting the exclusion to those derivative securities that are not

likely to present manipulative risk, such as ``out-of-the-money''

options. The Commission recognizes that derivative securities, even

those that are out-of-the-money, can be used to manipulate the price of

an underlying security through inducing arbitrage and other

transactions involving the underlying security. It is the Commission's

intention, however, to focus trading restrictions on those securities

that present the greatest manipulative potential. Moreover, any attempt

to manipulate a security in distribution by transactions involving

derivative securities will continue to be addressed by the general

anti-manipulation provisions, including Sections 9(a)(2) and 10(b) of,

and Rule 10b-5 under, the Exchange Act.

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\31\ See Letter from Mary L. Schapiro, President, NASD

Regulation, Inc. and Alfred R. Berkeley, III, President, Nasdaq, to

Jonathan G. Katz, Secretary, SEC (July 23, 1996) (``NASD Comment

Letter'').

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Regulation M does apply to reference securities, such as common

stock underlying an exercisable, exchangeable, or convertible security

that is being distributed. The Commission believes that transactions in

reference securities can have a direct and substantial effect on the

pricing and terms of the security in distribution.

The definition of reference security also encompasses a security

underlying an instrument, such as an equity-linked security, that does

not give the holder the right to acquire the security, but whose value

is or may be derived from such security.\32\ A security will be a

[[Page 525]]

reference security only when it, or an index of which it is a

component, is referred to in the terms of a subject security. A

security of the same or similar issuer will not be deemed a reference

security merely because its price is used as a factor in determining

the offering price of a security in distribution.

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\32\ Rule 10b-6 by its terms did not apply to the underlying

security in these circumstances. The Commission believes, however,

that Regulation M should apply to a security whenever it has a price

relationship to a subject security as a result of the terms of that

security.

In some cases, a reference security may have an extremely

attenuated relationship to the security in distribution. While the

Commission does not believe that a specific percentage test is a

workable means to identify these cases, the staff will provide

appropriate guidance in response to specific inquiries.

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Commenters sought clarification concerning whether an issuer or

distribution participant would be permitted to write a put or maintain

a ``short put'' position during a distribution of an underlying

security.\33\ Transactions in derivative securities, including put

options, are not subject to Rule 101 during an offering of the

underlying security. In addition, maintaining a short put position is

not deemed to be a continuing bid for the underlying security for

purposes of Regulation M.

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\33\ Cf. Letter regarding The Chicago Board Options Exchange,

[1990-1991] Fed. Sec. L. Rep. (CCH) para. 79,665 (February 22,

1991).

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4. Restricted Periods of Rule 101

a. Duration. As discussed below, the Commission is adopting the

exclusion from Rule 101 for actively-traded securities.\34\ This

provision removes from Rule 101 securities with an ADTV value of at

least $1 million where the issuer's common equity securities have a

public float value of at least $150 million. For the remaining

securities, Rule 101 restricts transactions by distribution

participants in covered securities, unless an exception applies, for

the following periods:

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\34\ See infra Section II.B.6.a., discussing the actively-traded

securities exception, which excludes from Rule 101 securities having

an ADTV value of at least $1 million and whose issuer's common

equity securities have a public float value of at least $150

million.

in a distribution of a security with an average daily

trading volume (ADTV) value of at least $100,000, whose issuer has

outstanding common equity securities having a public float value of

at least $25 million, the restricted period begins on the later of

one business day prior to the date on which the subject security's

price is determined or the date on which the person becomes a

distribution participant, and ends upon that person's completion of

participation in the distribution; and

in a distribution of any other security, the restricted

period begins on the later of five business days prior to the date

on which the subject security's price is determined or the date on

which the person becomes a distribution participant, and ends upon

that person's completion of participation in the distribution.

The Commission proposed that the restricted periods for an offering

would begin one or five business days prior to the pricing of the

offering, depending upon the security's ADTV value alone.\35\ In

addition, rather than using the date of commencement of offers or sales

as a reference, the Commission proposed to determine the restricted

period with reference to the date on which the offering is priced.

Commenters generally supported shortening the restricted periods, and

favored the one and five business days periods keyed off the offering's

pricing.

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\35\ Proposing Release, 61 FR at 17113.

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The Commission believes that the ADTV standard is most relevant for

determining which securities are more difficult to manipulate.

Nevertheless, the use of a trading volume standard alone could skew the

application of Rule 101 based on short-term, aberrational increases in

trading volume. To prevent this result, the Commission has added a

public float component to the test for determining the applicable

restricted period.\36\ The public float component is intended to

capture within Rule 101 those securities that experience unusual

trading volume relative to their public float value. While the use of a

two-part test requires distribution participants to make an additional

calculation, the Commission believes that the combination of these

components better identifies securities that are more likely to be

resistant to manipulation.

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\36\ The Commission has determined that using a public float

value component alone would not differentiate securities

sufficiently with respect to the likelihood of manipulation because

of the wide variations in ADTV value for securities with similar

public float value.

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Rule 10b-6 contained restrictions that principally applied during a

two or nine day ``cooling-off period.'' Many securities that had a two

day cooling-off period under Rule 10b-6 will now have a one day

restricted period under Regulation M, or will be free from the

restrictions of Rule 101 because they are actively-traded

securities.\37\ Even some nine day securities under Rule 10b-6 will now

have a one day restricted period under Regulation M.\38\ Approximately

one-quarter of the securities that qualified for a two day cooling-off

period under Rule 10b-6 are now subject to a five day restricted period

because of the different criteria used in Regulation M and Rule 10b-6

for distinguishing securities. While the restricted periods under

Regulation M are increased for some securities, other provisions of

Regulation M, such as Rule 103 (permitting passive market making for

all Nasdaq securities), will address liquidity concerns with respect to

many of these securities.

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\37\ Based on 1995 volume and price data analyzed by the

Commission's Office of Economic Analysis (``OEA''), the Commission

estimates that 6,156 securities (out of a total of 7,822 securities

listed on the New York Stock Exchange, Inc. (``NYSE''), the American

Stock Exchange, Inc. (``Amex''), and (Nasdaq) were subject to a two

day cooling-off period under Rule 10b-6. Under Regulation M, of

those securities approximately 1,901, or 30.9%, are excluded from

the rule; 2,693, or 43.7%, are subject to a one day restricted

period; and 1,562, or 25.4%, are subject to a five day restricted

period.

\38\ Based on 1995 volume and price data analyzed by OEA, the

Commission estimates that 1,666 securities (out of a total of 7,822

NYSE, Amex, and Nasdaq-listed securities) were subject to a nine day

cooling-off period under Rule 10b-6. Under Regulation M, of those

securities, 11, or 0.7%, are excluded from the rule; 278, or 16.7%,

are subject to a one day restricted period; and 1,377, or 82.6%, are

subject to a five-day restricted period.

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b. Calculation of ADTV and Public Float Value.

The ADTV of a covered security is defined on the basis of reported

worldwide average daily trading volume during a specified period prior

to the filing of the registration statement or prior to the pricing of

the offering, depending on the circumstances. Some commenters

questioned whether ADTV can be measured uniformly across markets. The

NYSE and the Amex requested that the Commission adopt different

standards for determining trading volume on auction and dealer

markets.\39\ These exchanges asserted that the Commission's reliance on

reported trading volume to determine this exclusion's availability is

discriminatory and anti-competitive, because such a standard allegedly

favors dealer markets where dealer interpositioning increases volume as

compared with auction markets. The Commission does not believe that it

is necessary or appropriate to make distinctions based on the type of

market on which the security is traded.\40\ The Commission proposed a

three-month calendar period for calculating ADTV. The NASD recommended

a rolling 60 day period, calculated as of a date within 10 business

days prior to pricing, for determining ADTV.\41\ Commenters also

requested guidance regarding what

[[Page 526]]

information sources may be used to calculate ADTV, and suggested that

the Commission designate the types of information that are acceptable

for determining ADTV.

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\39\ Letter from James E. Buck, Senior Vice President and

Secretary, NYSE, to Jonathan G. Katz, Secretary, SEC (May 31, 1996);

Letter from James F. Duffy, Executive Vice President and General

Counsel, Amex, to Jonathan G. Katz, Secretary, SEC (June 25, 1996).

\40\ See infra Section IV., discussing in greater detail the

anti-competitive concerns raised by the NYSE and the Amex.

\41\ See NASD Comment Letter, at p. 3.

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The Commission believes that, with the addition of a test based on

public float value that will tend to correct for volume aberrations, a

60 day rolling period provides a sufficient length of time to measure

the trading volume of a security. Therefore, the rule permits

distribution participants to use a two calendar month or a 60 day

rolling period. The 60 day rolling period for calculating ADTV must end

within 10 calendar days of the filing of a registration statement, or,

if there is no registration statement or if the distribution is a shelf

distribution, within 10 calendar days of the offering's pricing. The 10

day period will allow distribution participants in any type of

distribution sufficient time to conform to the applicable restricted

period. The Commission has decided not to designate acceptable

information sources for determining ADTV; rather, a distribution

participant should have flexibility in determining a security's ADTV

value from information that is publicly available, if such participant

has a reasonable basis for believing that the information is

reliable.\42\ Furthermore, in calculating the dollar value of ADTV, any

reasonable and verifiable method may be used. For example, it may be

derived from multiplying the number of shares by the price in each

trade, or from multiplying each day's total volume of shares by the

closing price on that day.

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\42\ Cf. Securities Exchange Act Release No. 27247 (September

14, 1989), 54 FR 39194, 39197-98 (discussing the standard under Rule

15c2-11 under the Exchange Act, 17 CFR 240.15c2-11, for a broker-

dealer to have a reasonable basis that certain information is true

and accurate). For instance, a distribution participant may rely on

trading volume as reported by an SRO or comparable entity, or any

other source believed to be reliable. Electronic information systems

that provide information regarding securities in markets around the

world could provide an easy means to determine worldwide trading

volume in a particular security.

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As for public float value, the Commission is adopting a definition

that reflects its usage in Form 10-K (i.e., the aggregate amount of

common equity securities held by non-affiliates).\43\ For example, for

reporting issuers the public float value should be taken from the

issuer's most recent Form 10-K or based upon more recent information

made available by the issuer.

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\43\ 17 CFR 249.310. See also Securities Act Release No. 7326

(August 30, 1996), 61 FR 47706 (proposing the expansion of short-

form registration to include companies with non-voting common

equity). Form 20-F (17 CFR 249.220f), the annual report form used by

foreign private issuers under the Exchange Act, does not require

disclosure of public float information. Nonetheless, the public

float value of such issuer should be determined in the same manner

as provided in Form 10-K.

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5. Offerings Subject to Rule 101

a. Generally. The provisions of Rule 101 apply in connection with a

distribution of securities.\44\ The same types of offerings or other

transactions that satisfied the distribution criteria under Rule 10b-6

(i.e., the magnitude of the offering/selling efforts test) also are

subject to Rule 101. These include public offerings, private

placements, shelf offerings, mergers and other acquisitions, exchange

offers, forced conversions of securities, warrant solicitations, and

at-the-market offerings.

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\44\ See supra Section II.B.1., discussing the definition of

distribution.

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b. Shelf Offerings. The Commission is modifying its approach to

shelf-registered distributions by replacing the ``single distribution

position'' taken under Rule 10b-6.\45\ Under Regulation M, each

takedown off a shelf is to be individually examined to determine

whether such offering constitutes a distribution (i.e., whether it

satisfies the ``magnitude'' of the offering and ``special selling

efforts and selling methods'' criteria of a distribution). Under prior

Commission interpretation, if the aggregate amount of securities

registered on a shelf constituted a Rule 10b-6 distribution, each

takedown was deemed to be part of that single distribution for purposes

of the rule, regardless of its individual magnitude.\46\

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\45\ See Release 34-19565, 48 FR at 10631.

\46\ See Proposing Release, 61 FR at 17115, and Release 34-

19565, 48 FR at 10631. See also Securities Exchange Act Release No.

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

23611'').

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The Commission's modified approach means that a broker-dealer

participating in a takedown off a shelf must determine whether it is

participating in a distribution.\47\ In those situations where a

broker-dealer sells shares on behalf of an issuer or selling security

holder in ordinary trading transactions into an independent market

(i.e., without any special selling efforts) the offering will not be

considered a distribution and the broker-dealer will not be subject to

Rule 101.\48\ A broker-dealer likely would be subject to Rule 101,

however, if it enters into a sales agency agreement that provides for

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

securities are sold in ordinary trading transactions.

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\47\ An issuer's description in a shelf registration statement

of a variety of potential selling methods will not cause, by itself,

any sales off the shelf to be treated as a distribution, unless the

broker-dealer in fact uses special selling efforts or selling

methods in connection with particular sales off the shelf, and the

sales are of a magnitude sufficient to demonstrate the existence of

a distribution. Cf. Securities Exchange Act Release No. 18528 (March

3, 1982), 47 FR 11482, 11485.

\48\ This approach assumes that the broker-dealer is disposing

of shares in ordinary trading transactions into an independent

market (i.e., one not dominated or controlled by the broker-dealer,

and where the price is not manipulated by the broker-dealer or

others acting in concert with the broker-dealer). Release 34-23611,

51 FR at 33247.

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c. Mergers, Acquisitions, and Exchange Offers. Many commenters

questioned the application of Rule 101's restricted periods to mergers,

acquisitions, and exchange offers. These commenters noted that during

merger distributions subject to Rule 10b-6, trading restrictions were

imposed during the applicable two or nine day period prior to the

mailing of proxy solicitation materials and for the duration of the

proxy solicitation.\49\ Similarly, the Commission also considered the

commencement of any valuation period or any election period as the

equivalent of the ``commencement of offers or sales,'' requiring bids

and purchases to cease during the applicable two or nine day period and

for the duration of the valuation or election period.\50\ Several

commenters stated that by requiring the restricted period to commence

one or five days prior to pricing, it is possible that the restricted

period for a merger distribution could begin several months prior to

the mailing of the proxy materials. These commenters noted that in such

situations the restricted period could be much lengthier under

Regulation M, as compared to the practice under Rule 10b-6.

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\49\ See Release 34-19565, 48 FR at 10638-39.

\50\ Id. at 10639.

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The Commission believes that mergers, acquisitions, and exchange

offers involve distributions in which interested persons have

considerable incentive to manipulate. The Commission agrees with the

commenters that the Regulation M restricted periods should reflect the

characteristics of these types of distributions. Accordingly, as

adopted the restrictions of Regulation M begin on the day when proxy

solicitation or offering materials first are disseminated to security

holders and end with the completion of the distribution (i.e., the time

of the shareholder vote or the expiration of the exchange offer).\51\

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\51\ In addition, Rule 10b-13 under the Exchange Act continues

to prohibit any purchases or arrangements to purchase securities

that are the subject of an exchange offer, or a security immediately

convertible into or exchangeable for those securities, from the time

of public announcement until the expiration of the exchange offer.

17 CFR 240.10b-13.

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[[Page 527]]

Consistent with an interpretation under Rule 10b-6, a restricted

period also will apply during any period where the market price of the

offered security will be a factor in determining the consideration to

be paid pursuant to a merger, acquisition, or exchange offer. Thus,

activity proscribed by Rules 101 and 102 must cease one or five

business days before the commencement of any valuation period and for

the duration of such period.\52\

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\52\ Release 34-19565, 48 FR at 10639.

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d. At-the-market Offerings. In an at-the-market offering, sales

prices are established during the course of the offering based upon

market conditions at the time of individual sales.\53\ Accordingly, the

restricted period for such an offering would commence one or five

business days before the pricing of each sale and continue until the

person's participation in the distribution is completed. In practice,

the application of Rule 101 will essentially be the same as in the case

of a fixed price offering, where one price is established for the

entire distribution, because the activities of distribution

participants are restricted during the entire course of offers and

sales, whether the securities are sold at fixed or varying prices.

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\53\ The term at-the-market offering is defined as an offering

of securities at other than a fixed price.

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6. Securities Excepted from Rule 101

a. Exception for Actively-traded Securities. The Commission

proposed excluding from Rule 101 all securities with a published ADTV

value of at least $1 million, and requested comment on whether another

test, such as a public float test, should be used to determine which

securities should be excluded from the rule. Commenters supported an

exclusion for actively-traded securities, with two commenters

suggesting a lower threshold and one recommending a threshold of $10

million. The Commission is adopting an exception for those securities

that have an ADTV value of at least $1 million that are issued by an

issuer whose common equity securities have a public float value of at

least $150 million.

The Commission continues to believe that an exclusion for actively-

traded securities is appropriate. The costs of manipulating such

securities generally are high. In addition, because actively-traded

securities are widely followed by the investment community, aberrations

in price are more likely to be discovered and quickly corrected.

Moreover, actively-traded securities are generally traded on exchanges

or other organized markets with high levels of transparency and

surveillance.

The reasons for incorporating a dual ADTV value/public float value

test for the restricted periods similarly apply to determining whether

securities qualify for the actively-traded securities exception.\54\

The Commission selected $150 million for the public float value test

because it believes that the securities of issuers with a public float

value at or above this threshold, and that also have an ADTV value of

at least $1 million, have a sufficient market presence to make them

less likely to be manipulated. As discussed above, the $150 million

public float value test is intended in part to exclude issuers from the

actively-traded securities exception where a high trading volume level

is an aberration.

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\54\ For example, the Commission considered using the $75

million public float value measure included in the eligibility

criteria for Forms S-3 and F-3 under the Securities Act. However,

the Commission adopted that threshold for different reasons, i.e.,

information regarding companies with a public float value of at

least $75 million is efficiently assimilated by the market because

they are likely to be followed by multiple analysts. See Securities

Act Release No. 7053 (April 19, 1994), 59 FR 21644; Securities Act

Release No. 7029 (November 3, 1993), 58 FR 60307. Therefore, it was

appropriate to permit incorporation of Exchange Act filings in

registration statements filed by such issuers.

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The combined minimums of $1 million ADTV value for the securities

and $150 million public float value removes from Rule 101 the equity

securities of approximately 1,900 domestic issuers, as well as those of

a substantial number of foreign issuers.\55\ The Commission estimates

that the addition of a public float test reduces by approximately 9%

the number of domestic issuers whose common stock would be excepted

from Rule 101 based solely on an ADTV test.\56\

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\55\ Based on transaction information for 1995 analyzed by OEA,

approximately 1,106 securities listed on the NYSE, 770 securities

quoted on Nasdaq, and 36 securities listed on the Amex would be

excluded from Rule 101. The general increase in security prices and

trading volume since year-end 1995 likely will increase the number

of securities satisfying the ADTV minimum.

\56\ Based on 1995 volume and price data analyzed by OEA, 2,103

securities have an ADTV value of at least $1 million; 1,912

securities have an ADTV value of at least $1 million and a market

capitalization of at least $150 million.

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b. Investment Grade Securities. The Commission is adopting an

exception to Rule 101 for nonconvertible debt securities,

nonconvertible preferred securities, and asset-backed securities,

provided that the security being distributed is rated investment grade

by at least one nationally recognized statistical rating

organization.\57\ The Proposing Release recommended excepting

investment grade nonconvertible debt and preferred securities and noted

that the comparable Rule 10b-6 exception was based on the premise that

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

ratings, are largely fungible and, therefore, are less likely to be

subject to manipulation. The Commission solicited comment on whether

investment grade asset-backed securities have the same characteristics

with respect to trading as nonconvertible investment grade debt of

corporate issuers, and whether such securities should be excepted from

the rule.

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\57\ The term nationally recognized statistical rating

organization in paragraph (c)(2) of Rule 101 has the same meaning as

that term is used in 17 CFR 240.15c3-1(c)(2)(vi).

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Several commenters stated that investment grade asset-backed

securities should be excepted from Rule 101 because they are the

functional equivalent of investment grade debt. One commenter suggested

using the definition of asset-backed security contained in the

Instruction to Form S-3 for purposes of Rule 101. Another commenter,

although not proposing a definition of asset-backed security,

recommended an exception for investment grade asset-backed securities

backed by a fixed pool of receivables.

Asset-backed securities are excluded from Rule 101 because such

securities trade primarily on the basis of yield and credit rating. The

principal focus of investors in the asset-backed securities market is

on the structure of a class of securities and the nature of the assets

pooled to serve as collateral for those securities, rather than the

identity of a particular issuer. Investment grade asset-backed

securities also are similar to investment grade nonconvertible debt and

preferred securities. Therefore, Rule 101 excepts securities that are

``primarily serviced by the cashflows of a discrete pool of receivables

or other financial assets, either fixed or revolving, that by their

terms convert into cash within a finite time period plus any rights or

other assets designed to assure the servicing or timely distribution of

proceeds to the security holders'' 58 and that are rated

investment grade.

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\58\ This definition is identical to the definition of asset-

backed security contained in General Instruction I.B.5. to Form S-3,

17 CFR 239.13(b).

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A few commenters also proposed that an even broader exception for

debt and preferred securities be adopted, suggesting that high-yield

debt securities be excepted from Rule 101 when those securities satisfy

certain criteria. One commenter proposed that all debt be excluded from

coverage of

[[Page 528]]

Rule 101. The Commission believes that, as a practical matter, Rule 101

and Rule 102 will have very limited impact on debt securities, except

for the rare situations where selling efforts continue over a period of

time.59 In those circumstances, where the incentive to manipulate

can escalate, the Commission believes that the application of

Regulation M is appropriate.

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\59\ See supra Section II.B.3., discussing covered securities.

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c. Exempted Securities. The Commission is adopting the proposed

exception to Rule 101 for ``exempted securities'' as defined in Section

3(a)(12) of the Exchange Act.60 Transactions in these securities

are not restricted by Rule 101. This exception is similar to a

provision contained in Rule 10b-6.

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\60\ 15 U.S.C. 78c(a)(12).

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d. Face-amount Certificates or Securities Issued by an Open-end

Management Investment Company or Unit Investment Trust. The exception

to Rule 101 for 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, is adopted as

proposed. Transactions in these securities are not covered by Rule 101.

An identical provision existed in Rule 10b-6.

17. Activities Excepted from Rule 101

a. Exception 1--Research. The Commission is adopting exception 1 to

Rule 101, which permits the publication or dissemination of any

information, opinion, or recommendation relating to a covered security

if the conditions of either Rule 138 or Rule 139 under the Securities

Act are satisfied.\61\ This exception more closely aligns Rule 101 with

the Securities Act rules governing permissible research activities by

broker-dealers participating in offerings of securities.62

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\61\ 17 CFR 230.138, 230.139.

\62\ Exception 1 differs from a previous staff position that

certain research reports were not prohibited inducements to purchase

if such research was issued by a broker-dealer in the ordinary

course of business, and satisfied either Rule 138 or Rule 139(b), or

satisfied Rule 139(a) and did not contain a recommendation or

earnings forecast more favorable than that previously disseminated

by the firm. Securities Exchange Act Release No. 21332 (September

19, 1984), 49 FR 37569, 37572 n.25.

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As proposed, the exception required the research to be published or

disseminated ``in the ordinary course of business.'' Several commenters

found this phrase to be confusing because Rule 138 requires that

research be published or distributed in the ``regular course of

business,'' 63 and Rule 139 requires that information, opinions,

or recommendations be contained in a publication that is distributed

with ``reasonable regularity in the normal course of business.''

64 The Commission has deleted as redundant the phrase ``in the

ordinary course of business'' from exception 1.

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\63\ 17 CFR 230.138 (a) and (b).

\64\ 17 CFR 230.139(b)(1)(i).

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Commenters also were uncertain about the application of this

exception to electronically disseminated research. The Commission

believes that if a distribution participant, in the normal course of

its business, provides research reports to independent research

services that make such reports available to their subscribers

electronically, whether or not the subscribers are customers of or have

previously received research from the broker-dealer, such research is

excepted from Rule 101. 65 Similarly, a distribution participant

may update its mailing list (i.e., new persons may be added) where it

is intended that they receive all future research sent to others on the

list, and not just the research related to the security in

distribution.

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\65\ Also, a broker-dealer may deliver research reports to its

customers via electronic means as a substitute for paper delivery.

See Securities Exchange Act Release No. 37182 (May 9, 1996), 61 FR

24644.

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Some commenters inquired whether the exception would be available

to unregistered offerings, because Rules 138 and 139 pertain to the

dissemination of research during registered offerings. In the

Commission's view, for purposes of Rule 101, exception 1 is available

during distributions that are not registered under the Securities Act,

as long as the conditions of either Rule 138 or Rule 139 are satisfied,

other than those pertaining to the filing of a registration statement.

A few commenters further recommended that research disseminated outside

of the United States during a global offering be excepted from Rule

101's coverage, if such research is disseminated in conformity with

local rule or custom. The Commission has determined that the conditions

of Rules 138 and 139 (other than registration) define the appropriate

parameters for research activities involving securities distributed in

the United States because research activities outside the United States

in connection with a distribution subject to the rule could be used to

facilitate the distribution in the United States. The Commission notes,

however, that many of the securities distributed in global offerings

will be subject to the rule's actively-traded securities exception and,

therefore, not subject to Rule 101's provisions. 66

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\66\ Nevertheless, there may be other circumstances in which the

dissemination of research that does not meet the conditions of Rules

138 or 139 outside the United States may be appropriate during a

global offering. The staff will provide guidance on a case-by-case

basis.

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b. Exception 2--Transactions Complying with Certain Other Sections.

Exception 2, which allows passive market making transactions and

stabilizing transactions complying with Rules 103 or 104, respectively,

is adopted as proposed.

c. Exception 3--Odd-Lot Transactions. Exception 3, permitting

distribution participants to bid for or purchase odd-lots during the

restricted period, is adopted as proposed. Accordingly, a distribution

participant may purchase odd-lots during a distribution. Among other

things, this exception permits distribution participants to engage in

activities in connection with issuer odd-lot tender offers conducted

pursuant to Rule 13e-4(h)(5) under the Exchange Act, including

effecting purchases necessary to permit odd-lot holders to ``round-up''

their holdings to 100 shares.

d. Exception 4--Exercises of Securities. Exception 4 permits

distribution participants to exercise any option, warrant, right, or

any conversion privileges set forth in the instrument governing a

security. This exception does not distinguish call options acquired

before the person became a distribution participant from those acquired

afterwards. In addition, the exception covers exercises of non-

standardized call options.

Supporters of this exception noted that option exercises do not

involve significant manipulative potential because of the

unpredictability of the timing and the extent of purchases by persons

writing call options. As noted earlier, the NASD expressed more general

concerns about Regulation M's limited coverage of derivative

securities.67 The Commission believes that exercises or

conversions of derivative securities generally have an uncertain and

attenuated manipulative potential and, for that reason, has adopted the

exception as proposed.68

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\67\ See supra text accompanying note 31.

\68\ The Commission cautions that in connection with exercises

of non-standardized options and other securities that are privately

negotiated between the parties, there may be circumstances when the

exercise of a call option, for example, could be made for the

purpose of requiring the other party to acquire the security. In

such a case, the purchase by the party exercised against may be

deemed to be a purchase by the exercising party.

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In light of the treatment of derivative securities under Regulation

M, the Commission is rescinding Rule 10b-8,

[[Page 529]]

which pertained to distributions through rights. This rule contained

overly rigid and complex restrictions on purchases of rights and

regulated sales of offered securities. Bids for and purchases of rights

are not subject to Rules 101 and 102, although bids for and purchases

of a security that is the subject of a rights distribution are

restricted by these rules.

e. Exception 5--Unsolicited Transactions. The Commission is

adopting an exception to Rule 101 for unsolicited brokerage

transactions, and for certain unsolicited purchases as principal. This

exception incorporates the provision contained in exception (xi)(D) to

Rule 10b-6 for unsolicited principal transactions, and, similar to

exception (ii) to Rule 10b-6, permits unsolicited purchases that are

not effected from or through a broker or dealer, on a securities

exchange, or through an inter-dealer quotation system or electronic

communications network (``ECN'') as defined in Rule 11Ac1-1(a)(8) under

the Exchange Act.69

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\69\ 17 CFR 240.11Ac1-1(a)(8). See Securities Exchange Act

Release No. 37619A (September 6, 1996), 61 FR 48289 (``Release 34-

37619A''), for a discussion of ECNs. A purchase in response to an

order or quote displayed on an ECN would not constitute an

unsolicited transaction.

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This exception places no restrictions on distribution participants

effecting unsolicited brokerage transactions during a distribution.

70 In addition, unsolicited purchases as principal are also

unrestricted. Although the Commission did not propose an exception to

Rule 101 for unsolicited principal purchases, many commenters asserted

that exception (ii) to Rule 10b-6 pertaining to such purchases was, in

fact, widely used. The Rule 101 exception for unsolicited purchases

differs from the analogous Rule 10b-6 exception, however, because it

does not require that purchases be of ``block'' size.\71\

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\70\ This exception incorporates the provisions of Rule 10b-

6(a)(5)(B). In addition, consistent with an interpretation under

Rule 10b-6, a broker-dealer who receives an unsolicited order to

sell may solicit purchasers in executing the transaction as broker

for the seller.

\71\ Also, the exception as adopted does not incorporate the

phrase ``privately negotiated'' because it is unnecessary in light

of the other terms of the exception.

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Furthermore, the exception applies to purchases effected otherwise

than through a broker-dealer, on a securities exchange, or through an

inter-dealer quotation system or ECN, because those purchases are less

likely to be used to influence the price of a security that is the

subject of a distribution. This clause of the exception permits

distribution participants and affiliated purchasers to purchase covered

securities from persons, other than broker-dealers, who were not

solicited by the distribution participant or its affiliated purchasers

and precludes purchases through an exchange, Nasdaq, or alternative

trading system.

This exception reflects the view that unsolicited purchases,

regardless of their size, generally do not raise the concerns at which

Rule 101 is directed when those purchases are not effected through

market mechanisms. In such circumstances, those purchases are less

likely to affect the offered security's price.

f. Exception 6--Basket Transactions. Exception 6 relates to

purchases of covered securities made in connection with basket

transactions. This exception permits transactions in covered securities

when the aggregate dollar value of any bids for or purchases of a

covered security constitutes 5% or less of the total dollar value of

the basket being purchased, and the basket contains at least 20 stocks.

The exception is available with respect to both index-related

baskets and customized baskets. To qualify for the exception, the

basket transaction must 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).\72\ The exception also permits 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.

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\72\ Proposing Release, 61 FR at 17118.

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While supporting the flexibility of the basket transaction

exception, some commenters suggested alternatives, including using

either a single percentage test of 5% or 10%, or a 10%/10 stock or 10%/

15 stock standard. The Commission believes that the majority of stocks

contained in baskets will be excepted under the actively-traded

securities exception and that the 5%/20 stock standard allows trading

in most basket transactions while ensuring that such transactions are

not easily used to influence the price of a security. The Commission is

concerned that, given the possibility that a distribution participant

could time its basket transactions for maximum price effect, a less

rigorous standard could lead to abuse. Further, the inclusion of the 20

stock criterion provides an objective indication of the bona fide

nature of the basket transaction.

Commenters also stated that this exception should allow for

rebalancing any customized basket covered by the exception, or for

rebalancing in a covered security that is consistent with rebalancing

activity in other stocks contained in the basket. In the Commission's

view, allowing distribution participants to make adjustments in

customized baskets may give a distribution participant the means to

effect significant transactions in covered securities (e.g., by

deciding to include a security in distribution in a basket without a

reason independent of the distribution), thereby raising manipulative

concerns. Accordingly, the Commission is not permitting adjustments to

rebalance customized baskets, unless the adjustments themselves qualify

under the 5%/20 stock test.

g. Exception 7--De Minimis Transactions. The Commission is adopting

exception 7 for de minimis transactions. As proposed, the exception

applied to unaccepted bids and aggregate purchases of 1% of a

security's ADTV. Several commenters stated that a 1% level was too

limited to be useful. For this reason, a few commenters proposed

raising the de minimis threshold to 5% of the security's ADTV.

Commenters also requested clarification that the de minimis test could

be applied to more than one transaction. In addition, some commenters

suggested that any bid or purchase not exceeding a de minimis amount

should be eligible for the exception.

Because the Commission believes that an exception for small,

inadvertent transactions lacking market impact is appropriate, it is

adopting an exception for de minimis transactions. The purchasing level

has been increased to 2% to give distribution participants greater

margin for error, while retaining the exception's de minimis nature.

Unaccepted bids, and purchases during the restricted period that in the

aggregate do not exceed 2% of the ADTV of the security in distribution,

are excepted from the rule, if the person has maintained and enforces

written policies and procedures reasonably designed to achieve

compliance with the rule. Once inadvertent transaction(s) are

discovered, subsequent transaction(s) would not be covered by this

exception. Also, this de minimis exception does not apply to Nasdaq

passive market making transactions.

Commenters recommended that the exception be extended to include

solicited brokerage transactions and

[[Page 530]]

bids that are accepted, but that do not result in a purchase because

the trade is broken. The Commission clarifies that the exception is

available to transactions resulting from solicited brokerage provided

that the conditions of the exception are satisfied. However, any

purchase, even if the trade subsequently is broken, must be considered

a purchase for purposes of this exception.

One commenter asserted that the proviso requiring written policies

and procedures is unnecessary. This requirement is adopted as proposed,

however, because the Commission believes that the presence of

compliance procedures buttresses the inadvertent character of excepted

de minimis transactions. The Commission notes that repeated reliance on

the exception would raise questions about the adequacy and

effectiveness of a firm's procedures. Therefore, upon the occurrence of

any violation, a broker-dealer is expected to review its policies and

procedures and modify them as appropriate.

h. Exception 8--Transactions in Connection with a Distribution. The

Commission is adopting the exception for transactions in connection

with a distribution substantially as proposed. Exception 8 permits

transactions among distribution participants in connection with the

distribution and purchases from an issuer or selling security holder in

connection with the distribution that are not effected on a securities

exchange or through an inter-dealer quotation system, or through an

ECN. Based on commenters' views, the portion of the proposed exception

relating to offers to sell or the solicitation of offers to buy the

securities being distributed or offered as principal is now contained

in exception 9.\73\

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\73\ A distribution participant relying on this exception must

be prepared to sell the securities if the offer is accepted.

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i. Exception 9--Offers to Sell or the Solicitation of Offers to

Buy. The Commission is adopting the exception for offers to sell or the

solicitation of offers to buy the securities being distributed

(including securities acquired in stabilizing), or securities offered

as principal by the person making such offer or solicitation.

j. Exception 10--Transactions in Rule 144A Securities. The

Commission is adopting the exception for transactions in securities

eligible for resale under Rule 144A(d)(3) (``Rule 144A securities'')

substantially as proposed.\74\ As adopted, the exception permits

transactions in Rule 144A securities during a distribution of such

securities, provided that sales of such securities within the United

States are made solely to: qualified institutional buyers (``QIBs''),

or persons reasonably believed to be QIBs, in transactions exempt from

registration under the Securities Act (``Rule 144A distributions''); or

persons not deemed to be ``U.S. persons'' for purposes of Rule

902(o)(2) or (o)(7) of Regulation S under the Securities Act, during a

concurrent Rule 144A distribution to QIBs.\75\ The exception covers

both the Rule 144A security being distributed and any reference

security.

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\74\ See 17 CFR 230.144A(d)(3).

\75\ 17 CFR 230.902(o)(2) and (o)(7). This follows the position

taken under Rule 10b-6 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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In the Proposing Release, the Commission noted that an exception

based on the categories of persons to whom the securities are

distributed may be viewed as a departure from the anti-manipulation

approach of Regulation M, because no class of investors, including

large institutions, is immune to injury from securities fraud or

manipulation.\76\ Nevertheless, the Commission considers it appropriate

to reduce the scope of Rule 101's prophylactic protections in the case

of QIBs, because QIBs have considerable ability to obtain, consider,

and analyze market information, and the Commission is not aware of

complaints of manipulation in this context.\77\ Moreover, in light of

the characteristics of Rule 144A securities (e.g., eligible securities

are not listed on a U.S. exchange or quoted on Nasdaq), the exception

does not distinguish between Rule 144A distributions to QIBs of foreign

and domestic securities.\78\

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\76\ Proposing Release, 61 FR at 17119 n.61.

\77\ The Commission wishes to emphasize that QIBs will continue

to be protected by the general anti-manipulation and anti-fraud

provisions, including Section 17(a) of the Securities Act, and

Sections 9(a) and 10(b) of the Exchange Act, and Rule 10b-5

thereunder.

\78\ See Proposing Release, 61 FR at 17119.

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Several commenters recommended broadening the proposed exception to

include contemporaneous sales within the United States to certain

institutional accredited investors. Some of these commenters suggested

that the exception permit sales to institutional accredited investors

where sales to QIBs exceeded a certain percentage of the total

distribution.\79\ The Commission is not adopting these recommendations

because institutional accredited investors encompass a much broader

category of persons, a large segment of which do not have

characteristics comparable to those of QIBs which underlie this

exception.

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\79\ The percentages recommended by commenters ranged from 50%

to 80%.

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8. Exemptive Authority

The Commission proposed to include within Rule 101 a provision

permitting the Commission to exempt any transaction or transactions

from the rule on a case-by-case basis. Two commenters recommended that

the exemptive authority provision be expanded to permit exemptions for

securities or classes of securities. To increase flexibility in the

exemption process, the Commission is adopting this suggested addition.

An exemption may be granted either unconditionally or on specified

terms and conditions.\80\

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\80\ The Commission is revising its Rules of Practice and

Investigations to provide that exemptions may be granted by

designated persons in the Division of Market Regulation pursuant to

authority delegated by the Commission. See 17 CFR 200.30-3 of this

chapter, as amended. Rules 102, 104, and 105 include similar

provisions authorizing the Commission to grant exemptions from those

rules, and this authority also will be delegated to designated

persons in the Division of Market Regulation.

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C. Rule 102--Activities by Issuers and Selling Security Holders

1. Generally

Rule 102 covers certain activities of issuers and selling security

holders, and their affiliated purchasers, during a distribution of

securities. Rule 102 is similar in format to Rule 101: issuers and

selling security holders, and their affiliated purchasers, must refrain

from bidding for, purchasing, or attempting to induce any person to bid

for or purchase a covered security during the applicable restricted

period, unless an exception permits the activity.

Rule 102 contains fewer exceptions than Rule 101 because issuers

and selling security holders have the greatest interest in an

offering's outcome and generally do not have the same market access

needs as underwriters. The exceptions in Rule 102 permit: transactions

in nonconvertible investment grade securities and transactions during

Rule 144A distributions; exercises of options and other securities,

including rights; and odd-lot transactions and associated round-up

transactions during an issuer odd-lot tender offer. Closed-end

investment companies that engage in continuous offerings of securities

also may conduct certain tender offers for those securities during such

distributions. There is no general exception for actively-traded

securities, although a limited exception is included

[[Page 531]]

for certain actively-traded reference securities.

Furthermore, most transactions in connection with dividend

reinvestment and stock purchase plans are excluded from Rule 102. Only

plan distributions involving securities obtained directly from the

issuer are subject to Rule 102. Several commenters asked that the

Commission further explain the treatment of plans under Rule 102. This

release provides guidance on the types of plan activities that may be

engaged in without constituting special selling efforts and selling

methods within the meaning of the definition of distribution, and

clarifies that certain dividend reinvestment and stock purchase plans

offered by bank-registered transfer agents and registered broker-

dealers qualify for the plan exception.

2. Persons Subject to Rule 102

a. Generally. Rule 102 applies to issuers, selling security

holders, and their affiliated purchasers. Several commenters sought

clarification as to whether an issuer's transactions in a covered

security would be restricted during a distribution effected solely by

or on behalf of a selling security holder not affiliated with the

issuer. The Commission does not intend to limit an issuer's activities

during a distribution effected solely by or on behalf of a selling

security holder if the issuer is not an affiliated purchaser of the

selling security holder, and has modified paragraph (a) of Rule 102

accordingly.\81\ An issuer will be deemed to have completed its

participation in a distribution when the entire distribution is

completed.82

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\81\ The interpretations contained in Release 34-23611 regarding

shelf distributions by selling security holders will continue to

have relevance. See infra Section II.C.4.b.

\82\ Cf. supra Section II.B.2.c., discussing when distribution

participants are considered to complete their participation in a

distribution. See also the definition of ``completion of

participation in a distribution.''

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b. Affiliated Purchaser. As discussed earlier, several commenters

recommended excepting financial services affiliates of issuers and

selling security holders from the definition of ``affiliated

purchaser.'' 83 As adopted, the definition of affiliated purchaser

excludes financial services affiliates of an issuer or selling security

holder if the issuer or selling security holder maintains and enforces

information barriers between itself and such affiliates. In addition, a

proviso has been added to paragraph (a) of Rule 102 that provides that

any affiliated purchaser of an issuer or selling security holder that

is acting as a distribution participant may comply with Rule 101,

rather than Rule 102.84 This accommodates the ordinary market

activities of broker-dealers and other financial institutions

participating in a distribution because they are subject to SRO

surveillance.

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\83\ See supra Section II.B.2.d.

\84\ The proviso to Rule 101 specifies that, where a

distribution participant or an affiliated purchaser of a

distribution participant is itself the issuer or selling security

holder, Rule 102 applies. See supra Section II.B.2.a.

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3. Securities Subject to Rule 102

The restrictions of Rule 102 apply to covered securities in the

same manner as Rule 101.85 Thus, persons subject to Rule 102 are

precluded during the restricted period from bidding for or purchasing

the subject security or any reference security.

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\85\ See supra Section II.B.3.

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4. Offerings Subject to Rule 102

a. Generally. As with Rule 101, Rule 102 applies only when there is

a distribution of securities.86

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\86\ See supra Section II.B.5., discussing the types of

offerings and other transactions that are subject to Rule 101.

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b. Shelf Offerings. In the case of an offering of securities

pursuant to a shelf registration statement, the Commission will apply

Regulation M in a manner consistent with interpretations under Rule

10b-6 regarding the restrictions on issuers and selling security

holders during shelf offerings.\87\ Thus, an issuer and all of its

affiliated purchasers are subject to the applicable restricted period

of Rule 102 when sales off a shelf by an issuer, or by any affiliated

purchaser, constitute a distribution of securities. Similarly, when a

selling security holder sells off the shelf and such sales constitute a

distribution, all other shelf security holders who are affiliated

purchasers of the selling security holder are subject to the applicable

restricted period of Rule 102.

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\87\ See Release 34-23611, 51 FR at 33242.

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5. Securities Excepted from Rule 102

a. Actively-traded Reference Securities. Many commenters maintained

that issuers, selling security holders, and their affiliated purchasers

should have the benefit of an actively-traded securities exception

similar to that in Rule 101. The Commission believes that persons

subject to Rule 102 should not be able to trade in their securities,

whether or not they are actively traded. The Commission's view is based

on issuers' and selling security holders' stake in the proceeds of the

offering, and their generally lesser need to engage in securities

transactions.

Certain commenters noted that, as proposed, Regulation M would have

prevented an issuer of equity-linked securities, or its affiliated

purchasers, from engaging in hedging activity in the associated

reference security, even when that security was actively traded.

According to these commenters, the ability to conduct such hedging

activity immediately prior to the pricing of an equity-linked security

is critical to the structure of such distributions.

In response to these comments, the Commission has determined to

provide a limited exception from Rule 102 for actively-traded reference

securities that are not issued by the issuer of the security in

distribution, or by any affiliate of the issuer. This exception permits

the type of hedging activity that was not previously subject to Rule

10b-6. Thus, the issuer of an equity linked security, or a security

holder selling an equity-linked security, can purchase in a hedging

transaction an actively-traded reference security issued by an

unaffiliated entity. However, the issuer or selling security holder of

an equity-linked security is prohibited from purchasing any reference

security for which it, or any of its affiliates, is the issuer. Of

course, the general anti-fraud and anti-manipulation provisions of the

federal securities laws are applicable to any transactions associated

with distributions of equity-linked securities.

b. Other Excepted Securities. The Commission is adopting as

proposed the exceptions in Rule 102 for ``exempted securities'' as

defined in Section 3(a)(12) of the Exchange Act, and face-amount

certificates or securities issued by an open-end management investment

company or unit investment trust. In addition, the Commission has

determined to include in Rule 102 an exception for investment grade

nonconvertible debt, nonconvertible preferred securities, and asset-

backed securities, based on commenters' views and the rationales

indicated above for an identical exception to Rule 101.88

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\88\ See supra Section II.B.6.c.

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6. Activities Excepted from Rule 102

a. Exception 1--Odd-Lot Transactions. Rule 102 contains an

exception for odd-lot transactions, which permits issuer odd-lot tender

offers. This exception, which is identical to exception 3 to Rule 101,

will provide greater flexibility to issuers conducting odd-lot tender

offers during a distribution.89 Moreover, as modified from the

proposal, this exception permits an issuer conducting an odd-lot tender

offer to engage in transactions

[[Page 532]]

necessary to enable shareholders to round-up their holdings to 100

shares.90

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\89\ See supra Section II.B.7.c.

\90\ Today, the Commission also is adopting an amendment to Rule

13e-4(h)(5) to permit issuers to conduct odd-lot offers, including

continuous, periodic, or extended odd-lot offers, for their equity

securities without establishing a record date of ownership for

shareholder eligibility to participate in the offer. Securities

Exchange Act Release No. 38068 (December 20, 1996).

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b. Exception 2--Transactions by Closed-end Investment Companies.

Exception 2, as it relates to transactions complying with Rule 23c-3

under the Investment Company Act,91 is adopted as proposed.

Accordingly, repurchases by closed-end investment companies that are

conducted in compliance with Rule 23c-3 will not violate Rule 102.

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\91\ 17 CFR 270.23c-3.

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Unlike so-called ``interval'' funds, which buy back their

securities pursuant to Rule 23c-3, other closed-end funds are more

circumscribed as to their repurchases.92 Many of these closed-end

funds advise investors in their prospectuses that investments in the

funds should be considered illiquid, particularly as the fund does not

intend to seek a public trading market for its securities. To provide

their investors with an opportunity to sell their securities, these

funds often disclose that they may consider conducting periodic tender

offers to repurchase all or a portion of their outstanding securities

at the then current net asset value. A few commenters raised issues

about the continuation of Rule 10b-6 exemptions granted to those

closed-end funds that conduct periodic tender offers for their

securities pursuant to Rule 13e-4 under the Exchange Act,93 when

the funds are engaged in continuous offerings pursuant to Rule 415

under the Securities Act.94

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\92\ Cf. 15 U.S.C. 80a-23(c).

\93\ 17 CFR 240.13e-4.

\94\ 17 CFR 230.415. See, e.g., Letter regarding Brazilian

Investment Fund, Inc., [1993] Fed. Sec. L. Rep. (CCH) para. 76,712

(August 6, 1993).

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Exception 2 is available to a registered closed-end investment

company that engages in a continuous offering of its securities

pursuant to Rule 415 and repurchases, at net asset value, securities of

the same class in a tender offer conducted pursuant to Rule 13e-4,

provided that there is no widely available alternative transaction

mechanism for its securities (i.e., the securities are not traded on a

securities exchange or through an inter-dealer quotation system or

ECN). This exception accommodates those closed-end funds that currently

have Rule 10b-6 exemptions, and benefits additional closed-end funds

with similar distribution and repurchase features, because they will

not need to seek exemptive relief under Regulation M.

c. Exception 3--Redemptions by Commodity Pools or Limited

Partnerships. The Commission is incorporating exception 3 to permit

redemptions by commodity pools or limited partnerships that are

effected at a price based on the securities' net asset value in

accordance with the terms and conditions of the governing instruments,

as long as the securities are not traded on an exchange, or through an

inter-dealer quotation system or ECN. This exception is being adopted

in response to commenter concerns, and permits commodity pools and

limited partnerships to effect redemptions of their securities without

seeking exemptive relief under Regulation M. Redemptions of such

securities pursuant to their governing instruments at a price based on

net asset value are unlikely to raise manipulative concerns.

d. Exception 4--Exercises of Securities. The Commission is adopting

exception 4 relating to the exercises of call options and other

securities as proposed. This exception is identical to exception 4 to

Rule 101, and permits the exercise of rights in connection with

convertible, exchangeable, or exercisable securities, including options

received in connection with employee benefit plans.

e. Exception 5--Transactions in Connection with the Distribution.

Exception 5 is adopted as proposed. This exception permits offers to

sell and the solicitation of offers to buy the securities being

distributed, and enables an issuer or selling security holder to

conduct an offering on its own behalf.95

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\95\ Regulation M does not preclude affiliates of an issuer

(e.g., officers or directors) from purchasing securities in the

offering. See also supra Section II.C.2.a., regarding a person's

completion of participation in the distribution.

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f. Exception 6--Unsolicited Purchases

In the Proposing Release, the Commission solicited comment on an

exception similar to that contained in Rule 10b-6 for unsolicited

privately negotiated purchases. This exception from Rule 102 is

identical to the unsolicited purchases exception from Rule 101.96

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\96\ See supra Section II.B.7.e., discussing exception 5 to Rule

101.

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g. Exception 7--Transactions in Rule 144A Securities

Based on commenters' views and the basis discussed above for

excepting transactions in Rule 144A securities from Rule 101, the

Commission has determined to include an identical exception in Rule

102.

7. Plans

a. Generally

The Commission is adopting the dividend (or interest) reinvestment

and stock purchase plan provisions of Rule 102 substantially as

proposed.97 The treatment of plans under Regulation M reflects a

continuation of the Commission's efforts to facilitate the use of plans

as an alternative means for investors to purchase and sell securities,

while maintaining essential investor protections.98

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\97\ The term plan is defined in Rule 100 as any bonus, profit-

sharing, pension, retirement, thrift, savings, incentive, stock

purchase, stock option, stock ownership, stock appreciation,

dividend reinvestment, or similar plan; or any dividend or interest

reinvestment plan or employee benefit plan as defined in 17 CFR

230.405.

\98\ See, e.g., 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); Letter

regarding First Chicago Trust Company of New York, [1994] Fed. Sec.

L. Rep. (CCH) para. 76,939 (December 1, 1994) (``First Chicago

Letter''); Letter regarding Bank-Sponsored Investor Services

Programs, [1995] Fed. Sec. L. Rep. (CCH) para. 77,122 (September 14,

1995) (``Bank Sponsored Programs Letter'') (collectively, ``Plan

Letters'').

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Paragraph (c)(1) of Rule 102 excepts most distributions of

securities pursuant to plans.99 The Commission has modified the

introductory text of this paragraph to clarify that this exception

includes plans operated by registered bank transfer agents or

registered broker-dealers (``investor services plans''), as well as

those plans operated by or on behalf of an issuer.100

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\99\ Of course, where an issuer plan does not involve a

distribution (because there is insufficient magnitude, or because

special selling efforts and selling methods are not used to sell the

securities), Rules 101 and 102 do not apply.

\100\ Although Regulation M supersedes the Plan Letters as they

relate to Rule 10b-6, the staff positions taken in the Plan Letters

on the application of other securities law provisions (i.e., Section

5 of the Securities Act, 15 U.S.C. 77e, and Sections 13(e), 14(d),

14(e), 15(a), and 17A of, and Rule 10b-13 under, the Exchange Act,

15 U.S.C. 78m(e), 78n(d), 78n(e), and 17 CFR 240.10b-13,

respectively) remain in effect.

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The rule divides plans into three categories: (1) plans that are

available only to employees and shareholders (``employee-shareholder

plans''); (2) plans, including investor services plans, that are

available to persons other than, or in addition to, employees and

shareholders, where securities for the plan are purchased from a source

other than the issuer or an affiliated purchaser of the issuer (i.e.,

in the open market or in privately negotiated transactions) by an agent

independent of the issuer (``open market plans''); and (3) plans that

are available to persons other than, or in addition to, employees and

shareholders where securities for the

[[Page 533]]

plan are purchased directly from the issuer or an affiliated purchaser

of the issuer (``direct issuance plans'').

b. Employee-shareholder Plans

Rule 102(c)(1)(i) covers employee-shareholder plans, and excludes

any distribution pursuant to a plan by or on behalf of an issuer or a

subsidiary of an issuer, when the distribution is made solely to

employees or shareholders of the issuer or its subsidiaries, or to a

trustee or other person acquiring the securities for the accounts of

such persons. This means that Rule 102 imposes no restrictions on

transactions in the subject securities by the issuer or its affiliated

purchasers during employee-shareholder plan distributions.101 The

scope of eligible employees, and therefore the scope of the exception,

is broader under this provision than under Rule 10b-6.

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\101\ However, such activity may be subject to Rule 102 if the

issuer is engaged in another distribution, and the transactions for

the plan are attributable to the issuer. Rule 102 provides that plan

transactions will not be attributable to the issuer if they are

effected by an agent independent of the issuer.

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c. Open Market Plans

Rule 102(c)(1)(ii) excepts from the rule's coverage distributions

involving open market plans, including investor services plans, where

purchases for the plan are made by an agent independent of the issuer

from sources other than the issuer or an affiliated purchaser of the

issuer (i.e., in the open market or in privately negotiated

transactions).

Several commenters suggested revising the definition of agent

independent of the issuer, including permitting the issuer to specify

the broker or dealer who would make purchases for the plan and to

change the source of securities for its plan more than once in any

three month period. The Commission has determined not to make such

changes at this time, because the definition has implications beyond

Regulation M (i.e., it also relates to issuer repurchase programs

conducted pursuant to Rule 10b-18 under the Exchange Act).102

Nevertheless, the Commission will examine this definition in connection

with its anticipated review of Rule 10b-18, and will reconsider these

comments in that process.

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\102\ 17 CFR 240.10b-18.

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The definition of agent independent of the issuer specifies, among

other things, that an issuer may not control, directly or indirectly,

the timing of purchases by the agent. The Proposing Release stated that

an agent would not be considered independent if the issuer directs the

timing of purchases of securities by the agent, including a requirement

that securities to fund the plan must be purchased on the plan's

investment date. The release provided, however, that an issuer may

establish general conditions for the operation of its plan, including,

for example, requirements concerning the return of uninvested funds to

plan participants, or requirements that optional cash payments be

invested within 35 days of receipt.103 A number of commenters

requested additional guidance on the timing element for plan purchases.

The Commission notes that, although an issuer may not specify a

particular time for such purchases, the issuer may specify a range of

days for plan purchases based on a particular event (e.g., that plan

purchases will be made within five days of the plan's investment date,

or the stock's dividend date), or may specify that plan purchases will

be made on or as soon as practicable after the plan's investment date,

or the stock's dividend date. Moreover, the plan's agent could be

deemed an agent independent of the issuer for purposes of Rule 102 if

the plan's formula specifies the date, but not the times, of purchases

pursuant to the plan, provided that the plan provisions regarding the

purchase date are not changed more than once in any three-month

period.104

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\103\ Proposing Release, 61 FR at 17121 n.71, citing 1994 STA

Letter (modifying Letter regarding Lucky Stores, Inc., [1974-1975]

Fed. Sec. L. Rep. (CCH) para.79,903 (June 5, 1974)).

\104\ Purchases by an independent agent for a plan can involve a

certain magnitude, frequency, and duration that are known to the

issuer. If an issuer schedules a non-plan distribution to coincide

with such plan purchases, questions may be raised under the general

anti-fraud and anti-manipulation provisions of the federal

securities laws.

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d. Direct Issuance Plans

Distributions pursuant to direct issuance plans (i.e., a plan that

is available to persons other than, or in addition to, employees and

shareholders where the issuer or affiliated purchaser of the issuer

provides the shares for the plan) are not excepted from Rule 102. In

the Commission's view, if the magnitude of securities offered through

such plan, and the selling efforts and selling methods used to

distribute such securities would constitute a distribution as defined

in Rule 100, this type of offering raises the manipulative concerns

underlying Regulation M.105 Because the issuer is receiving the

proceeds of the offering, this kind of plan bears a close resemblance

to a public offering. Consistent with prior interpretations concerning

valuation periods for plans, Rule 102 applies during any valuation

period for a direct issuance plan.

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\105\ Where a plan provides that securities for the plan may be

purchased either in the open market or provided directly by the

issuer, paragraph (c)(1)(ii) is only available when the plan

securities are purchased in the open market. If the plan securities

are obtained directly from the issuer, the plan must be treated as a

direct issuance plan.

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To determine the magnitude of a direct issuance plan, only those

persons to whom plan communications are directed at a particular time

(rather than all current plan participants) should be considered.

Moreover, the Commission will not deem special selling efforts and

selling methods to be present in a direct issuance plan where only one

or a combination of announcements, newspaper advertisements, circulars,

notices, investor fairs, or Internet home pages are used to disseminate

information about the availability of the plan to the public, or the

issuer provides information about the plan to persons with whom the

issuer has a pre-existing, continuing relationship involving the

receipt of written communications by existing means of communication

(e.g., a bill, annual report, or payroll stub).106 The information

contained in such materials distributed by an issuer or its agent may

include no more than the information allowed, nor less than that

required, under Rule 134 under the Securities Act (i.e., ``tombstone

advertisements''): 107 generally, the issuer's name, the issuer's

type of business, the type of security being offered in the direct

issuance plan (i.e., common or preferred stock), the price of the

security or the method of price determination, and information on how

and where a prospectus may be obtained.

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\106\ This includes communications to shareholders, employees,

customers, and other persons with a pre-existing relationship with

the issuer, such as independent contractors, franchisees, and

suppliers. See Securities Exchange Act Release No. 37182 (May 15,

1996), 61 FR 24644, 24650 (providing guidance for use of electronic

media for delivery of information). See also Securities Exchange Act

Release No. 36345 (October 13, 1995), 60 FR 53458.

\107\ 17 CFR 230.134.

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8. Exemptive Authority

Consistent with the expansion of the exemptive authority provision

in Rule 101, the Commission is adopting a provision in Rule 102

pursuant to which it may grant an exemption from Rule 102 to any

transaction or class of transactions, or any security or class of

securities. Such exemptions may be granted either unconditionally or on

specified terms and conditions.

9. Rule 10b-18

Rule 10b-18 under the Exchange Act provides that an issuer and its

affiliated

[[Page 534]]

purchasers will not incur liability under the anti-manipulation

provisions of Section 9(a)(2) of the Exchange Act or Rule 10b-5 under

the Exchange Act, if the issuer purchases common stock in compliance

with the rule's conditions concerning the time, price, volume, and

manner of purchases. 108 The Commission proposed to amend Rule

10b-18 to preclude an issuer from relying on this safe harbor when the

issuer or its affiliated purchasers were engaged in a distribution for

purposes of Rule 102.

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\108\ 17 CFR 240.10b-18.

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The few comments received on this proposal were negative. The

Commission has determined that significant revisions to Rule 10b-18

should be considered in connection with a comprehensive review of Rule

10b-18 to be conducted in the near future. However, the Commission is

adopting an amendment to Rule 10b-18 precluding reliance on the safe

harbor during the Rule 102 restricted period, when the issuer or any

affiliated purchaser is distributing the issuer's common stock or any

other security for which the common stock is a reference

security.109

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\109\ To reflect the use in Rule 10b-18 of the Regulation M

definition of plan, the Commission is adopting technical amendments

to paragraphs (a)(3), (a)(5), and (a)(6) of Rule 10b-18 to change

the term ``issuer plan'' to ``plan.'' In addition, the term agent

independent of the issuer for purposes of Rule 10b-18 is now defined

in Rule 100 of Regulation M. This differs from the proposal which

would have removed the safe harbor during the entire distribution

period.

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D. Rule 103--Passive Market Making

The Commission is adopting Rule 103 to replace Rule 10b-6A. Rule

103 and related exception 2 to Rule 101 permit, in connection with a

distribution of a Nasdaq security, passive market making on Nasdaq

during the restricted period of Rule 101, when market making by

distribution participants otherwise is prohibited. The purpose of Rule

103 is to alleviate special liquidity problems that could exist for a

Nasdaq security in distribution, if distribution participants or their

affiliates who are Nasdaq market makers were required to withdraw as

market makers during the restricted period. Exchange-traded securities

usually do not experience this problem because specialists in most

cases are not affiliated with distribution participants.

Rule 103 retains the core provisions of Rule 10b-6A with respect to

the price levels of bids and purchases that can be made by a Nasdaq

passive market maker. Rule 103 generally limits a passive market

maker's bids and purchases to the highest current independent bid

(i.e., a bid of a Nasdaq market maker who is not participating in the

distribution). The Commission believes that this condition is

fundamental to the concept of passive market making. Additionally, the

rule limits the amount of net purchases that a passive market maker can

make on any day to 30% of its ADTV, although an initial ADTV limit of

200 shares is now available for less active market makers. The 30% ADTV

limitation is designed to prevent an amount of purchasing activity that

could produce the price effects of stabilization, while generally

permitting a level of activity associated with normal market making.

The rule also contains a provision limiting the bid size a passive

market maker may display and requirements relating to notification,

identification, and disclosure of passive market making.

Rule 103 incorporates several new provisions that add significant

flexibility to passive market making and permit this activity in a far

greater number of contexts. The rule eliminates the offering

eligibility criteria that were contained in Rule 10b-6A, except that

best efforts and at-the-market offerings remain ineligible for passive

market making.110 Moreover, all Nasdaq securities qualify for

passive market making, including Nasdaq reference securities. The

requirement that underwriters or prospective underwriters account for

at least 30% of total trading volume is eliminated because the

Commission believes that passive market making could enhance liquidity,

even where the syndicate accounts for a minor portion of normal market

making activity. Rule 103 also permits passive market making throughout

the entire applicable restricted period, rather than requiring that it

cease with the commencement of offers or sales, because passive market

making is now available for many more kinds of distributions, including

those that can extend over a significant period of time. Passive market

making is prohibited, however, when a stabilizing bid pursuant to Rule

104 is in effect.

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\110\ The Commission previously noted that the NASD surveillance

system, with respect to passive market making, does not easily

accommodate at-the-market offerings. Securities Exchange Act Release

No. 32117 (April 14, 1993), 58 FR 19598, 19600 (``Release 34-

32117''). The Commission believes that NASD surveillance is an

essential consideration in expanding the contexts in which passive

market making is permitted.

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The NASD and other commenters proposed either eliminating the 30%

ADTV limitation entirely, or, alternatively, increasing it to at least

50%. Commenters did not provide any empirical evidence or other

objective information supporting a different standard or demonstrating

that the 30% ADTV limitation significantly decreases the liquidity of

securities subject to passive market making. As with Rule 10b-6A, the

30% ADTV limitation is applicable only to net purchases (i.e., total

purchases minus total sales). Accordingly, as long as sufficient sales

are made, there is no limit on total purchases. The Commission

continues to believe that a purchasing limitation is fundamental to the

concept of passive market making, and that the 30% ADTV limitation

permits a normal level of market making activity. In addition, the

Commission believes that the adjustment discussed below allowing all

passive market makers to have an initial ADTV limit of at least 200

shares will enable less active market makers to participate in passive

market making. Of even greater significance is the fact that actively-

traded Nasdaq securities are not subject to the requirements of Rule

103 at all, and nearly all other Nasdaq securities will have shorter

restricted periods. These features of Regulation M should substantially

enhance liquidity for these securities.

As proposed, passive market makers would have been allowed to bid

for one round lot (i.e., 100 shares) if they had an initial or

remaining net purchasing capacity of between one and 99 shares. This

provision was intended to permit less active or smaller market makers

who are syndicate members to be passive market makers. The NASD

supported providing passive market makers with the ability to bid for

and purchase at least 1,000 shares, irrespective of a lower ADTV

limitation. The NASD argued that the ADTV limitations of many market

makers are too small to make passive market making viable for them. The

Commission believes that giving all passive market makers an ADTV limit

of 1,000 shares largely would override the 30% ADTV limitation and

unduly advantage market makers with historically small trading volumes

in the security, who would be able to make net purchases several times

larger than their routine market making activity. As adopted, Rule 103

provides that all passive market makers whose initial ADTV limit is

between 1 and 199 shares are allowed a net purchasing capacity of 200

shares. Rule 103 also permits bids for a round lot if a passive market

maker's remaining net purchasing capacity is between 1 and 99

shares.111

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\111\ For example, a passive market maker whose 30% ADTV

limitation is 743 shares and who made net purchases of 700 shares

can still bid for 100 shares.

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[[Page 535]]

Rule 103 allows passive market makers to make bids or purchases at

a price above the highest independent bid where necessary to comply

with any Commission or NASD rule relating to the execution of customer

orders. For example, a passive market maker acting in accordance with

the new Commission rules regarding order handling obligations is

permitted to display customer bids and to execute customer orders in

compliance with the new rules even if the transactions would otherwise

violate Rule 103.112 In addition, the Commission is retaining its

interpretation regarding the application of passive market making in

the context of NASD members' obligation not to trade ahead of customer

limit orders. When a passive market maker is complying with Commission

or NASD rules governing the handling of customer limit orders, it

cannot initiate any transaction on the sell-side of the market that

would create, directly or indirectly, an obligation to purchase a

covered security at a price above that security's highest independent

bid price.113

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\112\ See Release 34-37619A, 61 FR 48289.

\113\ See NASD Manual, Conduct Rules, IM-2110-2.

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The NASD supported permitting the execution of riskless principal

purchases (other than bids disseminated on Nasdaq) at a price higher

than Rule 103 allows, as long as the passive market maker does not

thereafter adjust its bids above the prevailing highest independent

bid. The Commission believes, however, that market maker purchases

above the highest independent bid (except as specifically permitted)

are not consistent with the rule's passive structure.114

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\114\ Rule 103 permits a passive market maker to continue to bid

and effect purchases at its bid at a price exceeding the then

highest independent bid until the passive market maker purchases an

aggregate amount of the covered security that equals or, through the

purchase of all securities that are part a single order, exceeds the

lesser of two times the minimum quotation size for the security, as

determined by NASD rules, or the passive market maker's remaining

purchasing capacity under paragraph (b)(2) of Rule 103.

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In response to the NASD's comment, the Commission is retaining a

modified version of the interpretation regarding contemporaneous

transactions, which provides that if a passive market maker is involved

in a contemporaneous purchase and sale of a security, the passive

market maker can ``net'' the transactions for purposes of the ADTV

calculation as long as the two transactions are reported within 30

seconds of each other.115

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\115\ See Release 34-32117, 58 FR at 19603. The Commission also

is retaining the interpretations in the Rule 10b-6A adopting release

discussing appropriate interaction with other market makers and

permitting the offset of two customer orders received within 15

minutes of each other without affecting net purchasing capacity.

Release 34-32117, 58 FR at 19602-03.

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The NASD also requested that the de minimis exception in Rule 101

apply to passive market making transactions. The Commission believes

that permitting passive market makers to have the benefit of the de

minimis exception would undermine efforts to achieve more rigorous

compliance with passive market making restrictions. Therefore, the de

minimis exception in Rule 101 does not apply to unaccepted bids or to

purchases made by a passive market maker.

E. Rule 104--Stabilization and Other Syndicate Activities

1. Generally

Rule 104, which replaces Rule 10b-7, governs stabilizing and

certain aftermarket syndicate activities in connection with an

offering, and makes it unlawful for any person to stabilize, to effect

any syndicate covering transaction, or to impose a penalty bid in

contravention of the rule's provisions.116 Rule 104 improves the

regulation of stabilization by creating a more flexible framework for

managing the offering process and eliminating much of the complexity

that characterized Rule 10b-7. The Commission is adopting Rule 104

substantially as proposed, but has added provisions to address issues

raised by commenters and has clarified other provisions. Related

amendments to Exchange Act Rule 17a-2, governing the recordkeeping of

stabilizing and certain post-offering syndicate transactions, and to

Items 502(d) and 508 of Regulations S-B and S-K, governing prospectus

disclosure of these activities, are adopted as proposed.

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\116\ Unlike Rules 101 and 102, which apply to a

``distribution,'' Rule 104 governs stabilizing to facilitate an

``offering,'' a term that is broader in scope. Moreover, there is no

exception to Rule 104 for actively-traded securities.

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The purpose of Rule 104 is to permit underwriters and syndicate

members to conduct stabilizing transactions in compliance with the

rule's pricing and other terms for the purpose of preventing or

retarding a decline in the market price of a security to facilitate an

offering. Although stabilization is price-influencing activity intended

to induce others to purchase the offered security, when appropriately

regulated it is an effective mechanism for fostering an orderly

distribution of securities and promotes the interests of shareholders,

underwriters, and issuers.117 The rule addresses the risk that

stabilization will create a false or misleading appearance with respect

to the trading market for the offered security.118

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\117\ See Section 9(a)(6) of the Exchange Act, 15 U.S.C.

78i(a)(6); Concept Release, 59 FR at 21689. See also Securities

Exchange Act Release No. 2446 (March 18, 1940), 11 FR 10971.

\118\ See Securities Exchange Act Release No. 28732 (January 8,

1991), 59 FR 814, 815 (``Release 34-28732'').

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Rule 104 introduces several major features that are different from

Rule 10b-7: a stabilizing bid may be made with reference to the

principal market for the security, wherever located (rather than

focusing only on U.S. markets); a stabilizing bid may be raised to

match independent bids in the market; and a stabilizing bid that has

not been discontinued may be carried over to another market. Rule 104

also accommodates multinational offerings by permitting stabilizing

bids to be made in the currency of the market where the bid is placed,

and by allowing adjustments to such stabilizing bids to account for

fluctuations in the exchange rates between currencies.

Overall, commenters supported efforts to update and simplify the

Commission's stabilization rule. Commenters favored the new provisions

governing price levels for stabilizing bids, which codify and expand

exemptive and no-action relief issued within the last decade by the

Commission and its staff for stabilizing activities involving cross-

border offerings. Some commenters were critical of the new provisions

requiring disclosure, notification, and recordkeeping of syndicate

covering transactions and penalty bids. The Commission, however,

believes that these offering-related activities can influence

aftermarket prices, and has adopted the provisions as an appropriate

method to monitor these activities.

2. Discussion of Provisions Relating to Stabilization

As adopted, Rule 104 provides that no person, directly or

indirectly, may stabilize, effect any syndicate covering transaction,

or impose a penalty bid in connection with an offering of any security

in contravention of the rule's provisions. The term stabilizing is

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 prohibits bids or purchases not

necessary to prevent or retard a decline in the security's price, and

forbids stabilizing

[[Page 536]]

for manipulative purposes, at a price resulting from unlawful activity,

or in an at-the-market offering. Priority must be granted to

independent bids regardless of the size of the independent bid, when

the market where the stabilizing takes place permits or requires such

priority. The placing of more than one stabilizing bid in any one

market at the same price at the same time is prohibited. The Commission

is adopting these provisions substantially as proposed.

Rule 104 excludes from its provisions offerings of securities

eligible for resale under Rule 144A by foreign or domestic issuers made

solely to QIBs in transactions exempt under the Securities Act and to

non-U.S. persons under Regulation S that are made concurrently with a

Rule 144A offering.119 As with other transactions excluded from

Regulations M's coverage, stabilization during these Rule 144A

placements will remain subject to the general anti-fraud and anti-

manipulation provisions of the federal securities laws.

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\119\ Identical exceptions are contained in Rules 101 and 102 of

Regulation M.

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The provision in Rule 10b-7(m) pertaining to limitation of

liability is eliminated. Although one commenter favored retention of

this provision, the Commission believes that because lead managers now

exert considerably more control over stabilizing transactions than when

Rule 10b-7 was adopted, the provision is of marginal utility.

3. Stabilizing Levels

Rule 104 provides considerable flexibility to underwriters

effecting stabilizing transactions. Persons stabilizing the price of a

security can initiate a stabilizing bid in any market with reference to

the independent prices in the principal market for the security,

wherever located, and then maintain, reduce, or raise that bid to

follow the independent market, as long as the bid does not exceed

either the stabilizing bid in the principal market (including a

stabilizing bid in effect at the previous close) or the offering price

of the security.120 Commenters favored using the price in the

security's principal market as a basis for initiating a stabilizing bid

when that market was open. One commenter also advocated the ability to

carry over a stabilizing bid from one market to another market,

irrespective of the current independent prices in any market.

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\120\ The term offering price is defined in Rule 100 as the

price at which the security is being distributed.

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Under Rule 104, the appropriate price level for initiating

stabilizing is based on the security's principal market.121

Although the rule as proposed looked to independent bids in the

principal market to establish the permissible stabilizing level, the

final version of Rule 104 permits a stabilizing bid to reference the

last independent transaction price in the principal market. This

modification responds to a commenter's concern that the public offering

price of an exchange-traded security frequently is set at the last

transaction price and, under Rule 10b-7, the security could be

stabilized at that price. The rule covers the two possible scenarios

for initiating stabilizing: initiating stabilizing in any market when

the principal market is open; and initiating stabilizing in any market

when the principal market is closed.

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\121\ Rule 104, as adopted, uses the term ``initiate,'' rather

than the term ``effect,'' to clarify that ``initiating'' a

stabilizing bid means the first stabilizing bid made in connection

with the offering. Once a stabilizing bid has been initiated, it may

be increased, maintained, reduced, or adjusted in accordance with

the provisions of the rule.

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When the principal market is open, the permissible stabilizing

price level in any market always is established with reference to the

last independent transaction price for the security in its principal

market if two conditions are met: the security must have been traded in

the principal market on the day stabilizing is initiated or on the

preceding business day; and the current asked price in the principal

market must be equal to or greater than the last independent

transaction price. If both conditions are not satisfied, stabilizing

may be initiated in any market at a price no higher than the highest

current independent bid in the principal market.

When the principal market is closed, but quotations have opened in

the market where stabilizing will be initiated, Rule 104 provides that

stabilization may be initiated with reference to the lower of: the

price at which stabilizing could have been initiated in the principal

market at its previous close; or the last independent transaction price

in the market where stabilizing is being initiated. The independent

transaction must have occurred that day or on the preceding business

day and the current asked price in that market must be equal to or

greater than the independent transaction price. If these conditions are

not met, stabilizing may only begin at a price no higher than the

highest current independent bid for the security in the market where

the stabilizing is being initiated.

Rule 104 also includes a new provision for initiating a stabilizing

bid in any market immediately before the opening of quotations. In this

case, stabilizing may be initiated with reference to the lower of: the

price at which stabilizing could have been initiated in the principal

market at its previous close; or the most recent price at which an

independent transaction in the offered security has been effected in

any market after the close of the principal market, if the person

stabilizing knows or has reason to know of such transaction.\122\

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\122\ As proposed, the reference price for initiating a

stabilizing bid in any market, including the principal market,

immediately before it opened was the lower of: the price at which

stabilizing could have been effected at the close of the principal

market; or the most current reported price at which independent

transactions in the offered security have been effected in any

market after the close of the principal market. Rule 104

incorporates a knowledge-based standard to avoid imposition of an

undue burden on underwriters to discover the prices of obscure

transactions, whether reported or not.

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Rule 104 includes maximum caps on the stabilizing price level: no

stabilizing bid may be initiated, maintained, or otherwise adjusted in

any market at a price higher than the stabilizing bid in the principal

market or the security's offering price.

Once a stabilizing bid has been initiated in a market, that bid may

be maintained in that market, subject only to the maximum caps. It also

may be carried over into another market, irrespective of intervening

changes in the independent bids or transaction prices for the security.

A stabilizing bid in effect at the market's close may be maintained

between trading sessions and used to establish a stabilizing bid just

prior to the market's opening of quotations on the next day.123 A

stabilizing bid may be maintained without reduction unless it would

exceed the maximum caps. An underwriter may otherwise reduce a

stabilizing bid at its discretion. If a stabilizing bid is discontinued

(i.e., it is not maintained continuously during a trading session or is

not in effect as of the market's close), stabilizing may be resumed

only at a level at which it then could be initiated in the particular

market, without reference to the earlier stabilizing bid.

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\123\ The end of a trading session will not be deemed to

discontinue a stabilizing bid in effect at the close.

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In perhaps the most significant change from Rule 10b-7, Rule 104

allows a stabilizing bid to be increased to the level of the highest

independent bid in the principal market, or, if the principal market is

closed, the highest independent bid in that market at the

[[Page 537]]

previous close, provided such bid price does not exceed the maximum

caps.

Where an independent market for an offered security does not exist,

the maximum stabilizing level is limited only by the offering price.

Stabilization may be conducted before an offering is priced, consistent

with the conditions of Rule 104. After the offering price is

determined, stabilization may be resumed at a price at which

stabilizing then could be initiated.

Rule 104 also provides for adjustments to a stabilizing bid when

the price of the security being stabilized is adjusted for the payment

of dividends, rights, or distributions, 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. When securities are

being offered as a unit, the component securities shall not be

stabilized at prices that, in the aggregate, are higher than the then

permissible stabilizing price for the unit.

4. Offerings With No U.S. Stabilizing Activities

To further accommodate cross-border transactions, the Commission is

incorporating a new provision, similar to one contained in its 1991

proposing release on stabilizing in the international context,124

that permits stabilizing outside the United States during an offering

in the United States, without complying with Rule 104. The conditions

for this provision are that: there be no stabilization in the United

States; stabilization is not conducted above the U.S. offering price;

and the foreign stabilizing is conducted in a jurisdiction with

comparable regulation of stabilization.\125\ For purposes of this

provision, the Commission recognizes the stabilization regulations of

the U.K. Securities and Investments Board.\126\ The Commission invites

appropriate requests to recognize additional markets as having

comparable stabilization regulations for the purposes of this

provision.

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\124\ Release 34-28732. The proposals contained in Release 34-

28732 are withdrawn, except to the extent they are adopted in Rule

104.

\125\ The Commission by rule, regulation, or order will identify

foreign statutes or regulations that are comparable to Rule 104.

\126\ Chapter III, Part 10 of the Rules of the United Kingdom

Securities and Investments Board.

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5. Disclosure, Notification, and Recordkeeping of Stabilizing

Transactions, Short Covering Transactions, and Penalty Bids

In the Proposing Release, the Commission expressed its view that

syndicate short covering transactions and the imposition of penalty

bids by underwriters are activities that can facilitate an offering in

a manner similar to stabilization. The Commission did not propose to

extend the price conditions of Rule 104 to these aftermarket

activities. Instead, the Commission proposed, and has determined to

adopt, the provisions relating to disclosure, notification, and

recordkeeping of syndicate covering transactions and the imposition of

penalty bids.

Rule 104, like Rule 10b-7, requires any person who enters a bid

that such person knows is for the purpose of stabilizing the price of

any security to notify the market on which the bid is placed, and to

disclose the purpose of such bid to the person to whom the bid is

entered (e.g., the specialist or executing broker-dealer). In the

Commission's view, contemporaneous disclosure of the fact that

stabilizing is occurring is beneficial to the market and its

participants, because it ensures that transactions in a security are

based on all available information. Consistent with this requirement,

the NASD requires market makers intending to initiate stabilization to

provide it with prior notification.127 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 person to whom the bid is made of the stabilizing

purpose of the bid by notifying the NASD. On the exchanges,

underwriters must notify the exchange and must provide disclosure

separately to the recipient of the bid (e.g., the specialist).

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\127\ See NASD Manual, Marketplace Rules, IM-4614.

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Rule 104 also requires any person effecting a syndicate covering

transaction,128 or placing or transmitting a penalty bid,129

to disclose that fact to the SRO that has direct oversight authority

over the principal market in the United States for the security for

which the syndicate covering transaction is effected, or the penalty

bid is imposed. This information will assist the exchanges and the NASD

in carrying out their surveillance responsibilities. Some commenters

asserted that the information regarding aftermarket activities should

be kept confidential to avoid creating the perception of a weak

offering, while a few commenters urged the Commission to facilitate

public dissemination of this information in order to preclude an

unintended manipulative effect, and to prevent the investing public

from unknowingly bearing the cost of these aftermarket activities. The

rule, as adopted, requires disclosure to the SRO but does not require

public disclosure. Should circumstances indicate that such disclosure

is warranted, the Commission may revisit this issue.

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\128\ Rule 100 defines 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.

\129\ Rule 100 defines penalty bid to mean an arrangement that

permits the managing underwriter to reclaim a selling concession

otherwise accruing to a syndicate member (or to a selected dealer or

selling group 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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Under Rule 104, the stabilizing legend required by Rule 10b-7, and

Item 502(d) of Regulations S-B and S-K,130 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, governing the plan of distribution disclosure, is amended 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.131 The objective of these proposals is to provide

meaningful information to prospective investors regarding stabilizing

and related activities.132

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\130\ See 17 CFR 228.502(d) and 229.502(d).

\131\ See 17 CFR 228.508 and 229.508.

\132\ Once a ``plain English'' prospectus is implemented, a

stabilizing legend would no longer be required on the inside front

cover of the prospectus, although the disclosure required by Item

508 of Regulations S-K and S-B would be retained. See Task Force

Report 17-18.

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In addition to the foregoing disclosure requirements, when a person

subject to Rule 104 conducts transactions in securities and the price

of those securities may be or has been stabilized, that person is

required by paragraph (h)(3) of Rule 104 to send to a purchaser, at or

before the completion of the transaction, a document containing a

statement similar to that required by Item 502(d)(1)(i) of Regulations

S-B and S-K. This disclosure may be made by a document, including a

prospectus, confirmation, or other writing that contains language

indicating that the underwriter may effect stabilizing transactions in

connection with an offering of securities.133 The Commission

proposed, but is not

[[Page 538]]

adopting at this time, that similar disclosure be given to purchasers

of securities subject to aftermarket activities. The Commission intends

to reconsider the need for this disclosure as it continues to review

developments in the aftermarket area.

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\133\ This disclosure requirement is not intended to extend the

prospectus delivery period required by Rule 174 under the Securities

Act. The required disclosure may be made by means other than the

prospectus. 17 CFR 230.174.

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Amendments to Rule 17a-2 under the Exchange Act require managing

underwriters to keep records of syndicate covering transactions and

penalty bids, in addition to stabilizing information. Records must

reflect the name and class of securities, the price, date, and time for

each syndicate covering transaction and whether any penalties were

assessed, the names and addresses of the syndicate group members, and

their respective commitments. The records also must reflect the dates

when any penalty bid was in effect. The information is required to be

maintained in a separate file, or in a separately retrievable format,

for a period of three years, the first two years in an easily

accessible place, consistent with the requirement of Exchange Act Rule

17a-4(f). The required information must be kept for any offering

registered under the Securities Act, conducted pursuant to Regulation A

134 thereunder, or where the aggregate proceeds exceed $5 million.

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\134\ 17 CFR 230.251 et seq.

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While several commenters opposed the disclosure, notification, and

recordkeeping requirements proposed in Rule 104, particularly with

respect to aftermarket activities, the Commission continues to believe

that these provisions are an appropriate and effective means to monitor

developments in aftermarket activities. Nevertheless, the Commission

appreciates commenters' concerns that these provisions may require the

implementation of new internal systems and procedures for underwriters

and syndicate members. To accommodate possible revisions to broker-

dealers' systems and procedures, the Commission has determined to delay

the effectiveness of the recordkeeping requirements pertaining to

syndicate covering transactions and penalty bids contained in Rule 17a-

2 until April 1, 1997. The disclosure and notification requirements,

which are contained in Rule 104 and pertain to stabilizing

transactions, syndicate cover transactions, and penalty bids, will

become effective on the same date as the other provisions of Regulation

M.

F. Rule 105--Short Sales in Connection With an Offering

The Commission is adopting Rule 105 to replace Rule 10b-21. Rule

105, like Rule 10b-21, prohibits certain short sales from being covered

with securities obtained from an underwriter, broker, or dealer who is

participating in an offering. Rule 105 is intended to prevent

manipulative short selling prior to a public offering by short sellers

who cover their short positions by purchasing securities in the

offering, thus largely avoiding exposure to market risk. Such short

sales could result in a lower offering price and reduce an issuer's

proceeds. Rule 105 differs from Rule 10b-21 because it covers only

those short sales effected in the period commencing five business days

prior to the offering's pricing and ending with such pricing, rather

than the potentially much longer period of Rule 10b-21, which commenced

with the filing of a registration statement or Form 1-A.135

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\135\ 17 CFR 239.90.

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In its comment letter, the NASD expressed strong support for Rule

10b-21 and recommended that th

This text is long and has been trimmed here. Open the source document for the complete record.