Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the National Association of Securities Dealers, Inc., Relating to the Valuation of Illiquid Direct Participation Program and Real Estate Investment Trust Securities on Customer Account Statements

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38451; File No. SR-NASD-97-12]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the National Association of Securities Dealers, Inc.,

Relating to the Valuation of Illiquid Direct Participation Program and

Real Estate Investment Trust Securities on Customer Account Statements

March 27, 1997.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on February

21, 1997, NASD Regulation, Inc. (``NASD Regulation'') filed with the

Securities and Exchange Commission (``SEC'' or ``Commission'') the

proposed rule change as described in Items I, II and III below, which

Items have been prepared by NASD Regulation. The Commission is

publishing this notice to solicit comments on the proposed rule change

from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

NASD Regulation proposes to amend Rule 2340, ``Customer Account

Statements,'' of the Conduct Rules of the National Association of

Securities Dealers, Inc. (``NASD'' or ``Association'') to require

general securities members to provide estimated values for direct

participation program (``DPP'') \1\ securities and real estate

investment trust (``REIT'') securities on customer account statements

under certain circumstances. Below is the text of the proposed rule

change. Proposed new language is italicized and proposed deletions are

bracketed.

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\1\ Paragraph (a)(4) of NASD Rule 2810, ``Direct Participation

Programs,'' defines a DPP as ``a program which provides for flow-

through tax consequences regardless of the structure of the legal

entity or vehicle for distribution including, but not limited to,

oil and gas programs, real estate programs, agricultural programs,

cattle programs, condominium securities, Subchapter S corporate

offerings and all other programs of a similar nature. . . .''

According to NASD Regulation, this definition would cover most

limited partnerships and specifically excludes real estate

investment trusts.

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Rule 2340 Customer Account Statements

(a) General

Each general securities member shall, with a frequency of not less

than once every calendar quarter, send a statement of account

(``statement'') containing a description of any securities positions,

money balances, or account activity to each customer whose account had

a security position, money balance or account activity during the

period since the last such statement was sent to the customer.

(b) DPP/REIT Securities

(1) If a member participated in the public offering of any direct

participation program (DPP) or real estate investment trust (REIT)

securities (as these terms are defined below) and an estimated value of

DPP or REIT securities is available pursuant to subparagraphs (3)(A)

(ii) or (iii), the member shall list the DPP and/or REIT securities on

the statement with an estimated value; except that the member shall not

include on the account statement an estimated value that the member

believes is inaccurate as of the date of the valuation or is no longer

accurate as a result of a material change in the operations or assets

of the program or trust; or

(2) If the member or an affiliate of the member, acting as a

fiduciary, provides estimated values of DPP and/or REIT securities to

accounts that are subject to Employee Retirement Income Securities Act

(``ERISA'') and Internal Revenue Service (``IRS'') regulations, the

member shall disclose the same valuations on the statements of all

other customers owning such securities.

(3) If DPP and/or REIT securities are listed on the statement with

an estimated value:

(A) such estimated value shall be:

[[Page 15946]]

(i) developed from data which is as of a date no more than 18

months prior to the date the statement is issued; and

(ii) provided by an independent source engaged by the member; and/

or

(iii) provided in an annual report of the DPP or REIT distributed

to investors pursuant to Sections 14(a) or 14(c) of the Act, as

applicable, or a periodic report filed by the DPP or REIT with the

Commission under Sections 13 or 15(d) of the Act; or

(iv) developed by the member, if valuations pursuant to

subparagraphs (ii) and (iii) are not available; and

(B) the member shall segregate DPP and/or REIT securities by

listing them on the statement separately from non-DPP and non-REIT

securities and shall include on the statement:

(i) a brief and easily-understood description of the type of

estimated value provided (e.g., that the value represents an estimate

of the investor's interest in the assets owned by the DPP or REIT or

represents an estimate of the value of the investor's DPP and/or REIT

securities) and its source, and how a customer may obtain a complete

and detailed explanation of the valuation methodology employed; and

(ii) disclosure in close proximity to the listing of DPP and/or

REIT securities that DPP and/or REIT securities are generally illiquid

securities and the estimated value disclosed may not be realizable if

the customer seeks to liquidate the security.

(4) In disclosing on the statement an estimated value of DPP and/or

REIT securities, the member shall not;

(A) aggregate the estimated value of DPP and/or REIT securities

with the value of any other securities in any sub-total on the

statement;

(B) aggregate the estimated value of DPP and/or REIT securities

with the value of any other securities in the total account value

unless the statement includes the total estimated value of DPP and/or

REIT securities and the disclosure required by subparagraph (3)(B)(ii)

in close proximity to the total account value; and

(C) include the original issue price of a DPP or REIT security as

the estimated value (unless valuation of the securities by another

method indicates the same dollar amount as the original issue price).

(5) Notwithstanding subparagraphs (b)(1)-(4), if a retirement

account statement prepared in compliance with ERISA and IRS regulations

includes DPP and/or REIT securities and individual values are not

provided for any of the assets in the account, the member shall

disclose on the statement that DPP and/or REIT securities are generally

illiquid securities.

(6) If the DPP and/or REIT securities are listed on the statement

without a price and without an estimated value, the member shall

segregate the DPP and/or REIT securities by listing them on the

statement separately from non-DPP and non-REIT securities and shall

include on the statement disclosures that: DPP and/or REIT securities

are generally illiquid securities; the value of the security may be

different than its purchase price; and, if applicable, accurate

valuation information is not available.

[(b)] (c) Definitions For purposes of this Rule[,];

(1) the term ``account activity'' shall include, but not be limited

to, purchases, sales, interest credits or debits, charges or credits,

dividend payments, transfer activity, securities receipts or

deliveries, and/or journal entries relating to securities or funds in

the possession or control of the member.

(2) [(c) For purposes of this Rule,] the term ``general securities

member'' shall refer to any member which conducts a general securities

business and is required to calculate its net capital pursuant to the

provisions of SEC Rule 15c3-1(a), except for paragraph (a)(2) and

(a)(3).

Notwithstanding the foregoing definition, a member which does not carry

customer accounts and does not hold customer funds and securities is

exempt from the provisions of this section.

(3) the term ``direct participation program securities'' shall

include equity securities issued by a ``direct participation program''

as defined in Rule 2810 that would be included on a customer's

statement of account even if not held by the member, but does not

include securities on deposit in a registered securities depository and

settled regular way, securities listed on a national securities

exchange or The Nasdaq Stock Market, or any program registered as a

commodity pool with the Commodity Futures Trading Commission.

(4) the term ``real estate investment trust securities'' shall

include equity securities issued by a real estate investment trust as

defined in Section 856 of the Internal Revenue Code that would be

included on a customer's statement of account even if not held by the

member, but does not include securities on deposit in a registered

securities depository and settled regular way or securities listed on a

national securities exchange or The Nasdaq Stock Market.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, NASD Regulation included

statements concerning the purpose of and basis for the proposed rule

change and discussed any comments it received on the proposed rule

change. The text of these statements may be examined at the places

specified in Item IV below. NASD Regulation has prepared summaries, set

forth in sections (A), (B), and (C) below, of the most significant

aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

(a) Rule 2340 of the NASD Conduct Rules (formerly, Article III,

Section 45 of the NASD Rules of Fair Practice) requires general

securities members to provide account statements to customers on at

least a quarterly basis.\2\ The account statement must contain a

description of any securities position, money balances or account

activity in the accounts since the prior account statements were sent.

Under NASD Rule 2340, ``account activity'' includes, but is not limited

to, purchases, sales, interest credits or debits, charges or credits,

dividend payments, transfer activity, securities receipts or

deliveries, and/or journal entries relating to securities or funds in

the possession or control of the member.

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\2\ ``General securities member'' refers to any member which

conducts a general securities business and is required to calculate

its net capital pursuant to the provisions of SEC Rule 15c3-1(a),

except for paragraphs (a)(2) and (a)(3). However, a member which

does not carry customer accounts and does not hold customer funds

and securities is exempt from the provisions of NASD Rule 2340.

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Background

By letter dated March 9, 1994, the Subcommittee on

Telecommunications and Finance of the U.S. House of Representatives

(``House Subcommittee''), expressed to the NASD (as well as the SEC,

the National Association of State Securities Administrators, and the

Investment Program Association) its concern regarding the information

provided to customers on account statements regarding the current value

of non-publicly traded partnership securities.\3\

[[Page 15947]]

The correspondence noted that the partnerships that are the subject of

their concern do not trade on a regular basis and, thus, regular market

quotes are not available. The House Subcommittee urged that investors

in non-publicly traded partnerships should be provided information on

the performance of their investments and expressed concern that there

may be serious shortcomings in current valuation reporting with respect

to such securities.

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\3\ See Letter from the Honorable Edward J. Markey, Chairman,

and the Honorable Jack Fields, Ranking Republican Member, House

Subcommittee, Committee on Energy and Commerce, U.S. House of

Representatives, to Joseph R. Hardiman, President and Chief

Executive Officer, NASD, dated March 9, 1994.

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In addition, on June 14, 1994, the NASD received correspondence

from the Division of Market Regulation (``Division'') of the Commission

requesting the NASD's views on whether it would be appropriate for

self-regulatory organizations to require that members make certain

disclosures on customer account statements.\4\ Specifically, the June

14 Letter asks for the NASD's views regarding whether it would be

appropriate for self-regulatory organizations to require broker-dealers

to make the following disclosures on customer account statements: (i)

there is no liquid market for most limited partnership interests; (ii)

the values reported on account statements, if any, may not reflect the

values at which customers can liquidate their positions; and (iii) if a

value is reported, the source of the value, a short description of the

methodology used to determine the value, and the date the value was

last determined.

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\4\ See Letter from Brandon Becker, Director, Division,

Commission, to Richard G. Ketchum, Executive Vice President and

Chief Operating Officer, NASD, dated June 14, 1994 (``June 14

Letter'').

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By letters dated May 10, 1994, and August 19, 1994, the NASD

expressed concern to Congress and the SEC that there were

inconsistencies in the manner in which members included valuations for

DPP securities on customer account statements and indicated that the

Association was moving forward to examine the need for regulation in

this area.\5\ NASD Regulation has determined to amend NASD Rule 2340 to

provide regulatory guidance to members regarding the disclosure of

values for DPP securities on customer account statements in order to

regulate the manner in which information is provided to investors

regarding the performance of their DPP investment assets.

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\5\ See Letter from Richard G. Ketchum, Executive Vice President

and Chief Operating Officer, NASD, to the Honorable Edward J.

Markey, Chairman, House Subcommittee, Committee on Energy and

Commerce, U.S. House of Representatives, and the Honorable Jack

Fields, Ranking Republican, House Subcommittee, Committee on Energy

and Commerce, U.S. House of Representatives, dated May 10, 1994; and

Letter from Richard G. Ketchum, Executive Vice President and Chief

Operating Officer, NASD, to Brandon Becker, Director, Division,

Commission, dated August 19, 1994.

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In particular, NASD Regulation has been concerned that a

significant number of NASD members continue to carry DPP securities on

customer account statements at the original purchase price. NASD

Regulation believes that this practice needs to be eliminated. In

addition, NASD Regulation proposes to apply the proposed amendment to

NASD Rule 2340 to the securities of certain REITs, which are excluded

from the Association's definition of DPP security in paragraph (a)(4)

of NASD Rule 2810, in order to ensure similarity of treatment under

NASD Rules of the two products.

Description of Proposed Amendments to NASD Rule 2340

Scope and Definitions

NASD Regulation proposes to apply the new requirements in NASD Rule

2340 to DPP securities and REIT securities. The definitions of DPP and

REIT securities proposed in subparagraphs (c)(3) and (4) of NASD Rule

2340 only encompass unlisted DPPs and REITs, since an investment in

listed securities provides investors with some measure of liquidity and

market values. Thus, the definitions exclude securities listed on a

national securities exchange or The Nasdaq Stock Market, as well as

securities that are in a depository and settle regular way. The

definition of DPP securities proposed in subparagraph (c)(3) also

excludes any program registered as a commodity pool, since those

programs generally offer investors a security that is redeemable by the

issuer, at the customer's option at regular intervals and at

ascertainable values.

Requirements to Place Estimated Values on Customer Account Statements

and Guidance on Appropriate Sources of Valuations--Subparagraphs

(b)(1)-(2)

The proposed rule change contains two specific circumstances under

which general securities members are obligated to provide customers

with estimated values for DPP and/or REIT securities in their

customers' accounts.

In the first circumstance, under subparagraph (b)(1) of the

proposed rule change, if a general securities member participated in

the public offering of DPP or REIT securities, then the member must

list the DPP/REIT securities on its customer account statements with

estimated values if such values are available pursuant to subparagraphs

(b)(3)(A) (ii) or (iii) of the proposed rule change. Where a general

securities member participated in the public offering of DPP or REIT

securities, NASD Regulation believes that the member should inform its

customers of the estimated value of the DPP or REIT securities.

Subparagraph (b)(3)(A)(iii) permits a member to include an estimated

value that is contained in an annual report distributed to investors

pursuant to Sections 14(a) or 14(c) of the Act or in a periodic report

filed with the Commission under Sections 13 or 15(d) of the Act.\6\

This provision is intended to address the concern of members regarding

their liability for disclosing an estimated value by permitting the

member to rely on the liabilities under the federal securities laws

that attach to the general partner's or trustee's disclosure.

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\6\ According to the NASD, the reporting requirements of the Act

do not impose a mandatory obligation on general partners or trustees

to provide an estimated value to investors in a periodic report or

in the annual report.

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Subparagraph (b)(3)(A)(ii) permits a member to include an estimated

value provided by an independent source engaged by the member. Thus,

when a member is obligated to include an estimated value for DPP/REIT

securities on customer account statements under subparagraph (b)(1),

the member may include valuations from both an independent source and

an annual/periodic report, if the member determines to do so.

In considering this mandatory obligation, NASD Regulation

determined that there are circumstances where the member should be

required to refrain from using an estimated value that the member

believes is inappropriate. Therefore, proposed subparagraph (b)(1)

provides that a member shall not include an estimated value of the

securities on the account statement if the member believes that the

estimated value was inaccurate as of the date of the valuation or is no

longer accurate due to a material change in the operations or assets of

the program. With respect to the latter phrase, the assets of a real

estate limited partnership would be considered to be impaired, for

example, where the lessee fails to perform under the lease. Similarly,

the sale of a property would be considered a material change because

the sale reduces the value of the program.

In the second circumstance, under subparagraph (b)(2) of the

proposed rule change, if a general securities member or its affiliate

acts as a fiduciary in connection with partnership or trust securities

which are held in retirement accounts and is disclosing individual

[[Page 15948]]

DPP/REIT estimated values to retirement account holders,\7\ then the

member must disclose the same valuations on the statements of all other

customers owning such securities. NASD Regulation believes that when a

member or its affiliate acts as a fiduciary for retirement accounts and

provides individual DPP/REIT security values to its retirement account

customers, other customers of the broker/dealer should receive the same

values being provided to retirement account customers. NASD Regulation

states that the requirement to disclose the ERISA or IRS valuation to

other customers would not conflict with the fiduciary and custodial

obligations imposed by the Department of Labor and the IRS.

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\7\ According to NASD Regulation, the Employee Retirement Income

Securities Act (``ERISA'') and Internal Revenue Service (``IRS'')

regulations require, at least annually, that a retirement account

fiduciary provide to the account holder a statement of the total

value of all the assets in the account.

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However, according to NASD Regulation, neither the Department of

Labor (which administers ERISA regulations) or the IRS (which

administers IRA and other retirement products) specifically requires

fiduciaries to provide individual values for any assets held in the

retirement account. Therefore, if the general securities member acting

as a fiduciary does not provide individual values for the DPP and REIT

securities in the retirement account, proposed new subparagraph (b)(5),

discussed more fully below, provides an exception from the requirement

to disclose individual values for assets held in a retirement

account.\8\

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\8\ The adoption of such an exception does not represent a view

that the proposed requirement to provide individual ERISA/IRA

valuations to other customers of the broker-dealer will discourage

members from providing such individual valuations. To the contrary,

fiduciaries increasingly are providing individual values for each

asset in a retirement account in order to permit the account holder

to make withdrawals where the account holder has reached the age

when ERISA/IRS regulations require annual mandatory withdrawals that

do not exceed a percentage-of-assets limitation.

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Appropriate Source for Estimated Values--Subparagraph (b)(3)(A)

Proposed subparagraph (b)(3)(A) of NASD Rule 2340 requires that,

where DPP and/or REIT securities are listed on a customer account

statement with an estimated value, such values shall be: (1) Provided

by an independent source engaged by the member; or (2) from a valuation

provided in an annual report distributed to investors or in a periodic

report that must be filed with the SEC (discussed more fully above). A

member may use an estimated value from either or both of these sources.

Under proposed subparagraph (b)(3)(A)(iv), a member may develop an

estimated value for the DPP/REIT securities only when a valuation by an

independent source or from an SEC annual or periodic report is not

available.

Subparagraph (b)(3)(A)(i) requires that any value provided must be

developed from data which is as of a date no more than 18 months prior

to the date the customer account statement is issued. NASD Regulation

believes that this requirement is appropriate because an estimated

value, accurate upon its first use on a customer account statement, may

become stale due to length of time or occurrence of subsequent events

(such as the sale of a major asset of the partnership). NASD Regulation

believes that the 18-month standard provides sufficient time for the

member and for an independent valuation source to develop an estimated

value for DPP/REIT securities based on the audited financials contained

in the Form 10-K of the DPP or REIT that is filed by March 30 and is

based on financial statements dated December 31 of the prior year.

Accordingly, the 18-month standard will allow a member to continue

to use a valuation based, for example, on the December 31, 1995,

financials during April, May, and June 1997, while a new estimated

value based on the December 31, 1996, financials is being developed. In

developing an objective standard, NASD Regulation considered whether

investors would be disadvantaged if an event occurred that would render

an estimated value disclosed on customer account statements obsolete

during the 18-month period. As set forth above, it is the

responsibility of the member to not include an estimated value on the

account statement that the member believes was inaccurate at the time

it was developed or is no longer accurate as a result of a material

change in the operations or assets of the program or trust.

Segregation of DPP/REIT Securities--Subparagraphs (b)(3)(B) and (b)(6)

Subparagraph (b)(3)(B) requires that an estimated value provided

for DPP/REIT securities on a customer's account statement be segregated

from other securities into a separate location on the customer account

statement. NASD Regulation believes that investment in non-publicly

traded DPP and REIT securities and the estimated values that may be

disclosed for those securities regarding their performance differ

sufficiently from the prices of other securities that customers will

benefit from having the DPP/REIT securities grouped together. In

addition, NASD Regulation believes that the segregation of these

securities into a separate location on the customer account statement

should also lessen the possibility of misleading customers regarding

the estimated values for DPP/REIT securities since the valuations will

be distinguished from listed securities and accompanied by cautionary

disclosures.

Subparagraph (b)(6) of the proposed rule change provides that DPP/

REIT securities listed on customer account statements without an

estimated value shall also be segregated. Thus, the requirement to

segregate DPP/REIT securities will apply regardless of whether the

security is listed with or without an estimated value.

Disclosure of the Source of the Estimated Value--Subparagraph

(b)(3)(B)(i)

Proposed subparagraph (b)(3)(B)(i) requires members to provide a

brief and easily-understood statement relating to the source of the

estimated value, provided that the member informs the customer of how

to obtain a more complete and detailed explanation of the methodology.

The provision includes two examples of such a brief statement: (1)

``the value represents an estimate of the investor's interest in the

assets owned by the DPP or REIT;'' or (2) ``the value . . . represents

an estimate of the value of the investor's DPP and/or REIT

securities.'' Another example of acceptable disclosure is that the

estimated value is ``an estimate of value provided to (member's name)

by an independent valuation service on an annual basis based on

information available to the service on (date).''

An example of the disclosure a member may use to inform the

customer of how to obtain a more complete explanation of the valuation

methodology is: ``A general description of the methodology used by the

independent valuation service to determine its estimate of value is

available by telephoning (telephone number).''

Disclosure of Nature of DPP/REIT Securities--Subparagraph (b)(3)(B)(ii)

Proposed subparagraph (b)(3)(B)(ii) requires disclosure in close

proximity to the location of the DPP/REIT securities on the account

statement that DPP securities generally are illiquid securities and the

estimated value disclosed may not be realizable if the customer seeks

to liquidate the security. NASD Regulation considers the requisite

disclosure to be sufficiently proximate if it is located on the same

[[Page 15949]]

page where the DPP and/or REIT securities are listed.

Aggregation of Estimated Values for DPP/REIT Securities with the Value

of Other Securities in Sub-Totals and in the Total Account Value--

Subparagraphs (b)(4) (A) and (B)

Proposed subparagraph (b)(4)(A) prohibits a general securities

member who discloses an estimated value for a DPP and/or REIT security

on a customer account statement from aggregating the estimated value of

the DPP/REIT securities with the value of any other securities in any

sub-total on the statement. Proposed subparagraph (b)(4)(B) allows a

member to include the estimated value of the DPP/REIT securities in the

total account value on the statement if the member provides disclosure

in close proximity to the total account value of the sub-total for DPP/

REIT securities and of the illiquid nature of the securities, as

required by subparagraph (b)(3)(B)(ii), as discussed above. NASD

Regulation considers ``close proximity'' to require that the sub-total

for DPP/REIT securities and the cautionary disclosure appear on the

same page as the total account value.

Use of Purchase Price--Subparagraph (b)(4)(C)

Proposed subparagraph (b)(4)(C) prohibits members from using the

original purchase price of a DPP or REIT security on a customer account

statement as the estimated value unless the valuation of the DPP or

REIT by another method indicates the same dollar amount as the original

issue price. Thus, regardless of the mandatory obligations in proposed

subparagraphs (b)(1) and (b)(2) to disclose an estimated value for DPP/

REIT securities under certain circumstances, the member may not use the

original purchase price as the required estimated value (unless the

valuation of the DPP or REIT by another method indicates the same

dollar amount as the original issue price).

Retirement Account Statements With No Individual Values--Subparagraph

(b)(5)

Proposed subparagraph (b)(5) states that if a retirement account

statement prepared in accordance with ERISA and IRS regulations

includes an aggregate value of the assets held in the account, but does

not provide individual values for any of the assets, then the member

must disclose on the account statement only that DPP and/or REIT

securities included in the account are generally illiquid securities.

As a result of the exception provided in subparagraph (b)(5) from

subparagraphs (b) (1)-(4), the member may include the value of DPP/REIT

securities in the total account value. NASD Regulation believes that

since individual values are not provided for any of the assets in the

retirement account, the other provisions that would, in particular,

require disclosures along with the display of the total account value,

are unnecessary.

Required Disclosure for Unpriced Securities--Subparagraph (b)(6)

When a member discloses no valuation for DPP/REIT securities on a

customer account statement, proposed subparagraph (b)(6) requires the

member to segregate the DPP/REIT securities on the account statement

and include disclosures that DPP/REIT securities are generally illiquid

securities, that the value of the security may be different from its

purchase price, and, if applicable, that accurate valuation information

is not available.

Implementation of Proposed Rule Change

In order to provide members (or their service organizations) with

sufficient time to modify their computer systems to comply with the

proposed rule change, NASD Regulation is requesting that the proposed

rule change become effective six months after Commission approval.

During that time, NASD Regulation will issue a Notice to Members

announcing the Commission's approval of the proposed rule change and

the anticipated effective date. In addition, the staff of the Corporate

Financing Department will respond to inquiries by members and their

service organizations regarding compliance with the proposed rule

change. To the extent that interpretive issues arise during this period

that are generally applicable to those members that are subject to the

proposed rule change, the Association will issue a Notice to Members to

clarify for all members the application of the rule change.

(b) NASD Regulation believes that the proposed rule change is

consistent with the provisions of Section 15A(b)(6) of the Act,\9\

which require that the Association adopt and amend its rules to promote

just and equitable principles of trade and generally provide for the

protection of customers and the public interest, in that the proposed

rule change significantly improves disclosure to public customers on

their account statements of information concerning the value and

performance of securities issued by non-publicly traded DPPs and REITs

in which such customers have invested, while providing safeguards for

both member firms and public customers against the publication of

inaccurate, and therefore misleading, values for such securities.

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\9\ 15 U.S.C. Sec. 78o-3.

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(B) Self-Regulatory Organization's Statement on Burden on Competition

NASD Regulation does not believe that the proposed rule change will

result in any burden on competition that is not necessary or

appropriate in furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the

Proposed Rule Change Received From Members, Participants or Others

The proposed rule change was published for comment in Notice to

Members 94-96 (December 1994). Thirty-nine comments were received in

response thereto from 36 commenters. A copy of the Notice to Members is

attached as Exhibit 2 to the rule filing. A copy of the comment letters

received in response thereto are attached as Exhibit 3 to the rule

filing. Thirty of the 36 commentators generally favored NASD

Regulation's effort to provide regulatory guidance regarding the

disclosure of partnership valuations on customer account statements,

although every letter contained suggested revisions. Six commenters

were opposed to the adoption of the proposed rule change.

Notice to Members 94-96 published an original version of the

proposed rule change which required that customer account statements:

1. Segregate DPP securities from other securities on the account

statement;

2. If illiquid DPP securities are listed without a price,

include disclosure that accurate pricing information is not

available because the value of the security is not determinable

until the liquidation of the partnership and no secondary market

exists;

3. If DPP securities are listed with a price:

a. Not aggregate the value of the DPP securities with the value

of any other securities on the statement or include the value of the

DPP securities in the customer account net worth calculation; and

b. Include disclosure of the methodology used for obtaining the

valuation; and

c. Include disclosure that DPP securities generally are illiquid

securities and that the price listed may not be realizable if the

customer seeks to liquidate the security.

Scope and Definitions

NASD Regulation agreed with the views of commenters that the

regulatory concerns surrounding the value of DPP securities should

extend only to unlisted DPPs and REITs, since an investment in Nasdaq

or exchange-listed securities provides investors with some measure of

liquidity and market

[[Page 15950]]

values.\10\ Accordingly, NASD Regulation revised its proposal to adopt

a definition of DPP and REIT securities in new subparagraphs (c) (3)

and (4) of NASD Rule 2340 that excludes securities listed on a national

securities exchange or the Nasdaq Stock Market, as well as securities

that are in a depository and settle regular way. NASD Regulation also

determined to except from the definition of DPP securities any program

registered as a commodity pool, since those programs offer investors a

security that is redeemable by the issuer, at the customer's option at

regular intervals and at ascertainable values.

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\10\ NASD Regulation expanded the proposal published for comment

in Notice to Members 94-96 to include non-publicly traded REIT

securities (which are not included in the Association's definition

of DPP security) in order to ensure similarity of treatment under

NASD Rules for these products.

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Prices versus Estimated Values

NASD Regulation amended the proposal published for comment to

eliminate the word ``price'' and insert the phrase ``estimated value''

throughout the revised rule. Commenters stated that a ``price'' carried

on a customer account statement gives the appearance to the investor

that the security can be liquidated for an amount that is roughly

equivalent to the price set forth on the customer's account statement.

However, except in the case of those DPPs/REITs which are publicly

listed and traded, estimated values of DPP/REIT securities are not

likely to be realizable if a customer seeks to liquidate his or her

investment.

Requirements to Place Estimated Values on Customer Account Statements

and Guidance on Appropriate Sources of Valuations--Subparagraphs (b)

(1) and (2)

The provisions of the proposal published for comment that provide

guidance for the disclosure of DPP securities with an estimated value

on customer account statements received the most comments. The

commenters generally believed that investors should be provided with a

value for their DPP securities. However, they differed as to the value

to be disclosed, with the greatest amount of comment focused on

valuation methodologies (whether net asset value or securitized value)

and their source (i.e., whether generated by the member or obtained

from the general partners or third-party independent evaluators).

NASD Regulation agrees with the sentiment expressed in a majority

of the comment letters and with the views of correspondence received

from the House Subcommittee, i.e., that investors in non-publicly

traded partnerships and trusts should know how their investments are

performing. However, NASD Regulation believes that there are practical

problems to requiring that all members provide disclosure of the

estimated values of all DPP and REIT securities held by their

customers. A member that was not part of the underwriting syndicate for

the initial public offering would not have conducted due diligence.

Therefore, the member would not have the usual ongoing relationship

with the general partner or trust advisor that would permit the member

to assess the reliability and validity of an estimated value provided

by the general partner/trust advisor or any other source. In

particular, when a customer's DPP/REIT securities are transferred to a

broker-dealer after acquiring them through another member, NASD

Regulation determined that it would be an inappropriate burden for the

member to be required to provide estimated values for the many

different partnerships and trusts held by its customers if the member

did not participate in the initial public offering of the DPP or REIT.

NASD Regulation determined that members should be required to

provide customers who have DPP or REIT securities in their general

securities accounts with estimated values under two specific

circumstances: (1) when the member participated in the underwriting of

the initial or, although rare, follow-on public offering of the

partnership or trust securities and had the opportunity to conduct due

diligence and develop a relationship with the sponsor or general

partner; and (2) when the member or its affiliate acts as a fiduciary

in connection with partnership or trust securities which are held in

retirement accounts and are disclosing individual DPP/REIT security

values to retirement account holder.\11\ NASD Regulation has revised

the proposal published for comment in the Notice to Members to reflect

these requirements by adopting new subparagraphs (b)(1) and (b)(2) of

NASD Rule 2340.

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\11\ ERISA and IRS regulations require, at least annually, that

a retirement account fiduciary provide to the account holder a value

for the aggregate of all the assets in the account. However, as

noted in footnote eight, other ERISA/IRS regulations requiring

mandatory annual withdrawals by the account holder place pressure on

a member acting as a fiduciary to provide individual values for each

asset in a retirement account.

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However, to address concerns that the proposed rule change would

require members to provide estimated values for DPP/REIT securities

held in a retirement account, although neither the Department of Labor

(which administers ERISA Regulations) or the IRS (which administers

IRA, and other retirement type products) specifically require

fiduciaries to provide individual values for DPP/REIT securities and

any other assets held in the retirement account, NASD Regulation

proposed new subparagraph (b)(5) to provide an exception from the

requirement to disclose individual values if the member only provides

an aggregate value for the entire retirement account. See discussion

below of subparagraph (b)(5).

Appropriate Source for Estimated Values--Subparagraph (b)(3)(A)

Commenters expressed concern that the proposal published for

comment did not provide guidance on the different sources of an

estimated value considered appropriate by the Association. Accordingly,

NASD Regulation has amended its original proposal to include a

provision in subparagraph (b)(3)(A) of NASD Rule 2340 that will require

the member's estimated value for DPP or REIT securities to be provided

by an independent source engaged by the member, or be from a valuation

in the DPP's or REIT's annual report distributed to investors, or from

a periodic report filed with the SEC by the DPP or REIT. The member may

develop a value for the DPP or REIT only if a valuation by an

independent source or from an annual or SEC periodic report is not

available.

Prohibition on Using Stale Data--Subparagraph (b)(3)(A)(i)

Many commenters stated that an estimated value, accurate upon its

first use on a customer account statement, may become stale or

inaccurate due to lengthy time or subsequent events (such as the sale

of a major asset of the partnership). NASD Regulation agrees that an

estimated value based on stale information eventually becomes

sufficiently misleading to investors to constitute a fraud. Therefore,

NASD Regulation has amended its original proposal to include a

provision in subparagraph (b)(3)(A)(i) of NASD Rule 2340 that will

preclude members from disclosing an estimated value if the financial

statements and other underlying data used to determine that value are

of a date more than 18 months prior to the date the account statement

is issued. In addition, proposed subparagraph (b)(2) provides an

exception to the mandatory requirement that a member that participated

in the

[[Page 15951]]

distribution of a DPP or REIT security provide an estimated value for

such securities on its customers' account statements where the member

believes that the estimated value was inaccurate as of the date of the

valuation or is no longer accurate as a result of a material change in

the operations or assets of the program or trust.

Segregation of DPP/REIT Securities--Subparagraphs (b)(3)(B) and (b)(6)

NASD Regulation considered and ultimately rejected the views of

several commenters who objected to the requirement that DPP and REIT

securities be segregated from other securities into a separate location

on the customer account statement. NASD Regulation believes that

investments in non-publicly traded DPP and REIT securities and the

estimated values which may be disclosed regarding their performance

differ sufficiently from the prices of other securities that customers

will benefit from having the securities grouped together for ease of

presentation and review.

In addition, NASD Regulation believes that the segregation of DPPs

and REITs into a separate location on the customer account statement

should lessen the possibility of misleading customers regarding values

since they will be distinguished from listed securities. NASD

Regulation also determined that the requirement to segregate DPP/REIT

securities should apply regardless of whether the security is listed

with or without an estimated value. Therefore, proposed subparagraphs

(b)(3)(B) and (b)(6) set forth the requirement to segregate DPP and

REIT securities.

Use of Purchase Price--Subparagraph (b)(4)(C)

In response to the correspondence of the SEC, NASD Regulation

amended the proposal published for comment to add a new provision in

subparagraph (b)(4)(C) prohibiting members from using the original

purchase price of a DPP or REIT security on a customer account

statement as the estimated value. NASD Regulation provided additional

language to clarify that the same dollar value of the purchase price

may be used when a valuation methodology results in the estimated value

and purchase price being equivalent.

Required Disclosure for Unpriced Securities--Subparagraph (b)(6)

In response to comments, NASD Regulation amended the proposal

published for comment to require the following disclosure on the

account statement where a member provides no valuation for a DPP or

REIT: that DPP and/or REIT securities generally are illiquid

securities; the value of the security may be different than its

purchase price; and, if applicable, that accurate valuation information

is not available. This disclosure replaces the provision in the

proposal published for comment that would have required a statement

that the value of the DPP security is not available until the

liquidation of the partnership and that no active secondary market

exists.

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reason for so finding or (ii) as to

which the self-regulatory organization consents, the Commission will:

(a) By order approve such proposed rule change, or

(b) Institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed rule change that are filed with

the Commission, and all written communications relating to the proposed

rule change between the Commission and any person, other than those

that may be withheld from the public in accordance with the provisions

of 5 U.S.C. 552, will be available for inspection and copying at the

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

Washington, DC Copies of such filing will also be available for

inspection and copying at the principal office of the NASD. All

submissions should refer to file number SR-NASD-97-12 and should be

submitted by April 24, 1997.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\12\

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\12\ 17 CFR 200.30.-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97-8470 Filed 4-2-97; 8:45 am]

BILLING CODE 8010-01-M