United States: SEC Approves Change to NASD Rule 2790 Relating to Business Development Companies, Real Estate Investment Trusts and Direct Participation Programs

In August 2005, the SEC approved proposed changes to NASD Rule 2790 to exclude business development companies, real estate investment trusts and direct participation programs1 from the definition of "new issue" securities offerings.

Once this rule change becomes effective, underwriters involved in an initial public offering ("IPO") by a business development company, a real estate investment trust or a direct participation program will not be required to obtain "IPO certifications" from their clients prior to selling them shares in the IPO. The SEC releases describing the rule change are available at http://www.sec.gov/rules/sro/nasd/34-52209.pdf and http://www.sec.gov/rules/sro/nasd/34-52209a.pdf.

NASD Rule 2790 generally prohibits NASD member firms from selling a "new issue," as defined in NASD Rule 2790(i)(9), to an account in which a "restricted person" has a beneficial interest. "Restricted persons" include most broker-dealers and their personnel and most owners and affiliates of a broker-dealer, and certain institutional account portfolio managers. NASD Rule 2790 is intended to protect the integrity of the public offering process by:

• Ensuring that NASD members make bona fide public offerings of securities at the offering price so that industry insiders, including NASD members and their associated persons, do not take advantage of their "insider" position to purchase new issues for their own benefit at the expense of public customers; and

• Ensuring that members do not withhold securities in a public offering in order to use such securities to direct compensation in a manner that is not consistent with the public interest and fair dealing, or to reward persons who are in a position to direct future business to members.

In order to ensure compliance with NASD Rule 2790, an NASD member is required to obtain a representation from an account holder, or the person authorized to represent the beneficial owners of the account, that the account is eligible to purchase securities of a "new issue" in compliance with the rule (such certification is typically referred to as an "IPO certification"). The IPO certification must be obtained within 12 months prior to the sale and must be in writing.

In excluding business development companies, real estate investment trusts and direct participation programs from the definition of "new issue" under NASD Rule 2790, the SEC and the NASD determined that "including such offerings within the scope of NASD Rule 2790 would do little to further the purposes of the rule."² Specifically, the SEC and NASD concluded that "these products historically commence trading at their public offering price and premiums, if any, tend to be very small."³

The NASD will announce the effective date of this rule change in a Notice to Members to be published no later than 60 days following SEC approval. The effective date will be no more than 30 days following publication of the Notice to Members announcing the SEC’s approval of these changes. Thus far, the effective date has not been published.

© 2005 Sutherland Asbill & Brennan LLP. All Rights Reserved.

This article is for informational purposes and is not intended to constitute legal advice.