[12942]
December 18, 2000
TO: SEC RULES COMMITTEE No. 133-00
CLOSED-END INVESTMENT COMPANY COMMITTEE No. 34-00
EQUITY MARKETS ADVISORY COMMITTEE No. 63-00
UNIT INVESTMENT TRUST COMMITTEE No. 30-00
INVESTMENT ADVISERS COMMITTEE No. 25-00
RE: NASD AMENDS PROPOSED RULE CHANGE RELATING TO TRADING IN HOT
EQUITY OFFERINGS
The National Association of Securities Dealers (“NASD”), through its wholly owned
subsidiary, NASD Regulation (“NASDR”), has filed with the Securities and Exchange
Commission Amendment No. 2 to a proposed rule change to establish a new rule relating to the
purchase and sale of initial equity public offerings.1 The new rule would replace the current
Free-Riding and Withholding Interpretation, IM-2110-1 (“Interpretation”). The amendment is
in response to comments received on the original proposal.2 Amendment No. 2 is attached and
the most significant aspects of the amendment are summarized below. Comments on
Amendment No. 2 are due to the SEC no later than December 26.
Scope of Proposed Rule
The original proposal defined the term “hot issue” with reference to a threshold
premium. In particular, a hot issue would be defined as any security that is part of a public
offering if the volume weighted price during the first five minutes of trading in the secondary
market is five percent or more above the public offering price. Based on comments received on
the original proposal, NASDR has amended the proposed rule change to restrict the purchase
and sale of all initial equity public offerings, not just those that open above a certain premium.
The Proposing Release states that this approach is both easier to understand and avoids many
of the complexities associated with canceling and reallocating the sale of an IPO to a non-
restricted person in the event that an offering unexpectedly becomes a hot issue. As a result of
1 Securities Exchange Act Release No. 43627 (November 28, 2000), 65 FR 76316 (December 6, 2000) (“Proposing
Release”).
2 See Memorandum to Closed-End Investment Company Committee No. 3-00, Equity Markets Advisory Committee
No. 3-00, Investment Advisers Committee No. 4-00, and SEC Rules Committee No. 11-00, dated January 19, 2000.
2the proposal to apply the proposed rule change to all IPOs, NASDR also is proposing to exempt
all secondary offerings.
In addition, in order to address issues relating to an offering where there is insufficient
investor demand, NASDR is proposing to add provisions to address circumstances where
purchases by restricted persons are necessary for the successful completion of an offering. For
example, the proposed rule change would exempt offerings of closed-end investment
companies, as defined under Section 5(a)(2) of the Investment Company Act, from the scope of
the rule. The Proposing Release states that applying the proposed rule change to closed-end
funds does not further the purposes of the rule and may impair the ability of closed-end funds
to obtain capital.3
Finally, the proposed rule change continues to expressly exempt investment companies
registered under the Investment Company Act from the categories of persons to whom member
firms would be prohibited from selling new issues. The proposed rule also would exempt
persons associated with “limited business broker/dealers” from the categories of restricted
persons. A limited business broker-dealer includes a broker-dealer whose authorization to
engage in the securities business is limited solely to the purchase and sale of investment
company securities.
Portfolio Managers
The original proposal also recommended a more function-oriented approach in
determining who would be considered restricted persons under the rule by treating as
restricted persons only those employees or other persons who supervise, or whose activities
directly or indirectly involve or are related to, the buying or selling of securities for a bank,
savings and loan institution, insurance company, investment company, investment advisor, or
collective investment account. In addition, the original proposal would create an exemption
from the rule for a collective investment account that is beneficially owned in part by restricted
persons, provided that these restricted persons in the aggregate own less than five percent of
the account.
In response to comments on the proposed rule change that the five percent figure was
too low and that investors generally expect portfolio managers to make significant investments
in accounts they manage to better align their interests with those of investors, Amendment No.
2 treats a portfolio manager and certain members of his or her immediate family as restricted
persons, other than with respect to a beneficial interest in the bank, savings and loan institution,
insurance company, investment company, investment adviser, or collective investment account,
over which such person has investment authority. Amendment No. 2 therefore permits a
portfolio manager to invest in IPOs through a fund he or she manages. Under Amendment No.
2, however, a portfolio manager may not purchase IPOs for his or her personal accounts.
Ari Burstein
Associate Counsel
Attachment
3 The proposal also would exempt all debt securities, public offerings of investment grade asset-backed securities as
defined in SEC Form S-3, convertible securities, and preferred securities from the rule’s coverage.
3Attachment (in .pdf format)