[Federal Register Volume 59, Number 73 (Friday, April 15, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-9215] [[Page Unknown]] [Federal Register: April 15, 1994] ======================================================================= ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-33899; File No. SR-NASD-94-19] Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by National Association of Securities Dealers, Inc., Relating to Part II, Sections 1, 2, and 3 of Schedule D to the NASD By-Law April 12, 1994. Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ notice is hereby given that on April 6, 1994, the National Association of Securities Dealers, Inc. (``NASD'' or ``Association'') 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 the NASD. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. --------------------------------------------------------------------------- \1\15 U.S.C. 78s(b)(1) (1988). --------------------------------------------------------------------------- I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change Below is the text of the proposed rule change. Proposed new language is italicized Schedule D to the NASD By-Laws, Part II, Qualification Requirements for NASDAQ Securities Sec. 1. Qualification Requirements for Domestic and Canadian Securities The Association, as operator of the NASDAQ System, is entrusted with the authority to preserve and strengthen the quality of and public confidence in its market. The NASDAQ System stands for integrity and ethical business practices in order to enhance investor confidence, thereby contributing to the financial health of the economy and supporting the capital formation process. NASDAQ System issuers, from new public companies to companies of international stature, by being included in the NASDAQ System, are publicly recognized as sharing these important objectives of the NASDAQ System. The Association, therefore, in addition to applying the enumerated criteria set forth in Parts II and III hereof, will exercise broad discretionary authority over the initial and continued inclusion of securities in the NASDAQ System in order to maintain the quality of and public confidence in its market. Under such broad discretion and in addition to its authority under Subsection 3(a) hereof, the Association may deny initial inclusion or apply additional or more stringent criteria for the initial or continued inclusion of particular securities or suspend or terminate the inclusion of particular securities based on any event, condition, or circumstance which exists or occurs that makes initial or continued inclusion of the securities in the NASDAQ System inadvisable or unwarranted in the opinion of the Association, even though the securities meet all enumerated criteria for initial or continued inclusion in the NASDAQ System. [Other provisions of Section 1 remain unchanged] * * * * * Sec 2. Qualification Requirements for Non-Canadian Foreign Securities and American Depository Receipts The Association, as operator of the NASDAQ System is entrusted with the authority to preserve and strengthen the quality of and public confidence in its market. The NASDAQ System stands for integrity and ethical business practices in order to enhance investor confidence, thereby contributing to the financial health of the economy and supporting the capital formation process. NASDAQ System issuers, from new public companies to companies of international stature, by being included in the NASDAQ System, are publicly recognized as sharing these important objectives of the NASDAQ System. The Association, therefore, in addition to applying the enumerated criteria set forth in Parts II and III hereof, will exercise broad discretionary authority over the initial and continued inclusion of securities in the NASDAQ System in order to maintain the quality of and public confidence in its market. Under such broad discretion and in addition to its authority under Subsection 3(a) hereof, the Association may deny initial inclusion or apply additional or more stringent criteria for the initial or continued inclusion of particular securities or suspend or terminate the inclusion of particular securities based on any event, condition, or circumstance which exists or occurs that makes initial or continued inclusion of the securities in the NASDAQ System inadvisable or unwarranted in the opinion of the Association, even though the securities meet all enumerated criteria for initial or continued inclusion in the NASDAQ System. [Other provisions of Section 2 remain unchanged] II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the NASD 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. The NASD 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 Proposed Discretionary Authority Regarding Inclusion of Securities in the Nasdaq System Background Prior Rule Filing Proposal In recent years, the NASD has received an increasing number of applications for inclusion in the Nasdaq System from companies in which an officer, director, controlling shareholder, or other person in a position to influence management decisions has been enjoined, barred or suspended from participation in the securities industry for violations(s) of state or federal securities laws, self-regulatory organizations (``SRO'') rules and regulations, or convicted of any felony involving the purchase or sale of any security arising out of such person's participation in the securities or commodities industry. On a case-by-case basis, the NASD has denied the applications of such issuers for inclusion in the Nasdaq system pursuant to its authority under Part II, Subsection 3(a)(3) of Schedule D where the NASD formed a reasonable belief that enumerated persons connected with the issuer might engage in additional violative conduct contrary to the interests of the investing public. In such cases, the NASD's rationale has been that any adjudicated prior violative conduct raises concerns regarding the continuing potential for conduct in connection with the operation of the company or the market for its securities that would be considered fraudulent and manipulative, contrary to just and equitable principles of trade, or otherwise raise investor protection concerns. The NASD has been concerned that such person(s) may seek to continue their violative conduct in the securities markets through the management, control or influence of publicly-held company. More recently, the NASD has had concerns and denied inclusion in the Nasdaq System if persons in a position of management, control or influence of an issuer are the subject to pending proceedings for violations of state or federal securities laws. As a result of these concerns, the NASD filed with the SEC SR-NASD- 93-32 on June 2, 1993. SR-NASD-93-32 proposed to amend Part II, Section 3(a) to Schedule D by adding new subsection 3(a)(3) to clarify the NASD's authority, on a case-by-case basis, to either deny inclusion or apply additional or more stringent criteria for the initial or continued inclusion of a particular securities, or to suspend or terminate the inclusion of an otherwise qualified security if any officer, director, controlling shareholder, or other person in a position to influence management decisions of the issuer has been: (i) Barred or suspended from participating in the securities industry by the SEC or any self-regulatory organization; (ii) permanently enjoined by order, judgment or decree of any court of competent jurisdiction from participating in the securities industry, or from engaging in or continuing any conduct or practice in connection with the purchase or sale of any security; or (iii) convicted of any felony involving the purchase or sale of any security arising out of such person's participation in the securities or commodities industry.\2\ In response to the SEC's publication for comment of the proposed NASD rule change,\3\ the SEC received one comment letter submitted by members of a Task Force of the American Bar Association (``ABA Task Force'') dated August 30, 1993 (the ``comment letter'').\4\ The comment letter referenced the criteria in the proposed rule change as ``bad boy criteria'' and stated: --------------------------------------------------------------------------- \2\The adoption section 21(d)(2) of the Act, as part of the Remedies Act of 1990, demonstrates congressional concern regarding the potential abuse that may exist where a company i managed by such person(s) with a history of adjudicated violative conduct. Section 21(d)(2) authorizes a federal court to bar or suspend an individual from serving as an officer or director of a public company as a sanction for securities law violations. Thus, Congress recognized that individuals may use public companies to manipulate the equity markets and harm investors. In the first U.S. District Court decision imposing a sanction under section 21(d)(2), the Court also required that all seucrities holdings of the respondents be placed in a voting trust to divest them of any control of any public company. The Court explicitly recognized that ownership of a controlling interest in a public company provides an opportunity for an individual to use a company as a vehicle for future securities violations. SEC v. Drexel Burnham Lambert Incorporated, 1993 WL 496837 (S.D.N.Y.) (December 1, 1993). See, Washington Post, December 2, 1993, at 13, col. #3. \3\Securities Exchange Act Release 32605 (July 9, 1993), 58 FR 38150 (July 15, 1993). \4\See, Amendment No. 2 to SR-NASD-93-32 which includes the NASD's response to all of the comments of the ABA Task Force. --------------------------------------------------------------------------- We generally do not object to specific ``bad boy'' criteria. We believe, however, that such criteria themselves should be subject to standards consistent with the NASD's discretionary authority under existing Subsection 3(a)(3), namely, to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade and to protect investors and the public interest. The ``bad boy'' criteria in proposed Subsection 3(a)(3) standing along would apply to an unduly broad range of vioaltions, some of which would not be appropriate bases for denying initial inclusion or suspension or termination of continued inclusion of the securities of an issuer in the Nasdaq System.\5\ --------------------------------------------------------------------------- \5\Comment letter at 3. --------------------------------------------------------------------------- The comment letter also noted that a number of the ABA members that reviewed the comment letter in draft form strongly preferred that the NASD rely solely on the discretionary standards contained in existing Part II, Section 3(a)(3) of Schedule D to avoid the potential for ``abuse that may derive from the inclusion of specific ``bad boy'' criteria'' in that Section.\6\ In response to the comment letter, the NASD filed on September 29, 1993, Amendment No. 2 to SR-NASD-93-32. In this amendment, the NASD noted it had not intended for the criteria to stand alone without reference to the current requirements set forth in Part II, Section 3(a)(3) of Schedule D. The text of the proposed rule change, therefore, was amended to clarify this issue. --------------------------------------------------------------------------- \6\Id. at n. 7. --------------------------------------------------------------------------- Review of Association's Discretionary Authority The NASD recognized, however, that the ABA Task Force comment letter raised important questions regarding the scope of the NASD's discretionary authority over the inclusion of securities in the Nasdaq System. The NASD, therefore, commenced an additional review of the scope of its discretionary authority under Part II, Section 3(a)(3) of Schedule D and under the Act, and also compared such authority to the rules of the New York Stock Exchange (``NYSE'') and American Stock Exchange (``AMEX'') providing discretionary authority with respect to listings on such exchanges. Section 3(a)(3)--Section 3(a)(3) of Part II to Schedule D (``Section 3(a)(3)'') provides that the Association may, in accordance with Article IX of the NASD's Code of Procedure, apply additional or more stringent criteria for the initial or continued inclusion of particular securities or suspend or terminate the inclusion of an otherwise qualified security if the Association deems it necessary to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, or to protect investors and the public interest.\7\ --------------------------------------------------------------------------- \7\Any denial by the Association of initial or continued inclusion in the Nasdaq System is subject to review by the SEC and the Courts by request of the aggrieved party. --------------------------------------------------------------------------- The NASD has always believed that Section 3(a)(3) provides broad discretionary authority in order to allow the Association to fulfill the statutory policies contained in this Section of Schedule D and in Section 15A(b)(6) of the Act. The policy goals of Section 3(a)(3) to Part II of Schedule D are based on the statutory requirements contained in Section 15A(b)(6) of the Act which requires, in part, that the rules of the Association be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade and to protect investors and the public interest. Identical statutory mandates are imposed on the exchanges pursuant to Section 6(b)(5) of the Act. Compliance by the NASD and exchanges with these statutory mandates is central to the concept of self-regulation. The breadth of the NASD's discretionary authority under Section 3(a)(3) was clearly intended and is necessary to fulfill the regulatory purpose of this Section to Schedule D and Section 15A(b)(6) of the Act. Without such broad discretionary authority to make determinations based on any issuer-related matter, the investor protection and public interest goals contained in Section 3(a)(3) and Section 15A(b)(6) of the Act, would be severely compromised. Limitations on the NASD's authority under Section 3(a)(3) could, in fact, result in circumstances where the NASD would be prevented from excluding an issuer from the Nasdaq System even if the Association deemed such action necessary to protect investors and the public interest. Tassaway Decision--The importance of the NASD's authority to exclude, in general, non-complying securities from the Nasdaq System was addressed by the SEC in In the Matter of Tassaway, Inc.\8\ (``Tassaway''). In Tassaway, the SEC stated: --------------------------------------------------------------------------- \8\Securities Exchange Act Release No. 11291 (Mar. 13, 1975), 45 SEC 706, 6 SEC Docket 427. --------------------------------------------------------------------------- Though exclusion from the system may hurt existing investors, primary emphasis must be placed on the interests of prospective future investors. The latter group is entitled to assume that the securities in the system meet the system's standards. Hence the presence in NASDAQ of non-complying securities could have a serious deceptive effect.\9\ --------------------------------------------------------------------------- \9\Tassaway 45 SEC 706 at 709. See also, In the Matter of ORS Automatic, Inc. 48 SEC 490, 493 (1986) wherein the Commission stated that the policy enunciated in Tassaway with regard to inclusion in the Nasdaq System is equally applicable to the Nasdaq National Market segment of the Nasdaq System. --------------------------------------------------------------------------- The Commission in Tassaway also articulated its review standards regarding the Association's discretionary authority with respect to inclusion criteria in the Nasdaq System. The Commission stated: To the extent that discretion enters into the matter--and it very often does--the discretion in question is the NASD's not ours. Hence, we are not at liberty to substitute our discretion for that of the Association.\10\ --------------------------------------------------------------------------- \10\Id at 710. In a footnote to this statement, the Commission stated that the Nasdaq System's rules, like those of the exchanges do not lend themselves to mechanical and inflexible administration. The Commission noted that this is an area for ``pragmatic business judgments based on a kaleidoscopic variety of factors.'' --------------------------------------------------------------------------- The above statements in Tassaway were made prior to adoption of Section 3(a)(3) to Part II of Schedule D, and, therefore, did not address the NASD's discretion to deny or terminate inclusion in the Nasdaq System pursuant to Section 3(a)(3) to Part II of Schedule D, that authorizes the NASD to use discretion to fulfill the investor protection and public interest standards contained in Section 15A(b)(6) of the Act. The Association believes, however, that the Commission's statements in Tassaway are none-the-less valid with respect to the investor protection, public interest and other policy standards contained in Section 3(a)(3) of Part II to Schedule D and Section 15A(b)(6) of the Act. Relying on the reasoning of Tassaway, the NASD believes that prospective future investors are entitled to assume that the securities in the Nasdaq System are subject to the Association's broad discretionary authority to deny or terminate inclusion when the Association deems it necessary to protect the public interest and the interests of potential future investors and other market participants, to promote just and equitable principles of trade, to prevent fraudulent and manipulative acts and practices, regardless of whether the issuer is in compliance with the inclusion criteria of Schedule D. The Tassaway decision affirms the NASD's long-held position that an issuer's access to the Nasdaq System is not an incontrovertible right but a privilege.\11\ --------------------------------------------------------------------------- \11\In 1957, the Commission stated that the use of the facilities of a national securities exchange by an issuer is a privilege involving important responsibilities under the Act. The Commission noted that when those responsibilities are abused, the integrity of the exchange market is vitiated. In the Matter of Great Sweet Grass Oils Ltd., 37 SEC 683, 698 (1957); aff'd per curiam sub nom. Great Sweet Oils, Ltd. v. SEC, 256 F.2d 893 (D.C. Cir. 1958); see also Kroy Oils, Ltd., 37 SEC 683, 698 (1957). --------------------------------------------------------------------------- Section 11A--The investor protection, public interest and other statutory policies mandated by Section 15A(b)(6) of the Act (which are embodied in Section 3(a)(3) to Part II of Schedule D) were expanded by Congress in the Securities Exchange Act Amendments of 1975 (``1975 Amendments'') through the adoption of Section 11a(a)(1)(A) of the Act (``Section 11A(a)(1)(A)''). As stated in Section 11A(a)(1)(A), ``Congress finds that the securities markets are an important national asset which must be preserved and strengthened.'' The NASD believes that Congress thereby acknowledged that there is a general public interest in strong securities markets that is consistent, yet identifiably separate from the transaction-related investor protection and public interest policies previously addressed under Section 15A(b)(6) of the Act. The NASD believes that the Congressional Joint Statement of the Committee of Conference to the 1975 Amendments emphasized this distinction when stating: The securities markets of the United States are indispensable to the growth and health of this country's and the world's economy. In order to raise the enormous sums of investment capital that will be needed in the years ahead and to assure that capital is properly allocated among competing uses, these markets must continue to operate fairly and efficiently. The increasing tempo and magnitude of the changes are occurring in our domestic and international economy make it clear that the securities markets are due to be tested as never before. Unless these markets adapt and respond to the demands placed upon them, there is a danger that America will lose ground as an international financial center and that the economic, financial and commercial interests of the Nation will suffer. The rapid attainment of a national market system as envisaged by this bill is important, therefore, not simply to provide greater investor protection and bolster investor confidence but also to assure that the country maintains a strong, effective and efficient capital arising and capital allocating system in the years ahead.\12\ --------------------------------------------------------------------------- \12\Introduction to the Joint Explanatory Statement of the Committee of Conference on the amendments of the House to the bill (S. 249), submitted to the House and Senate. See, Federal Securities Laws, Legislative History, (1933-1988) Vol. III at 3128. --------------------------------------------------------------------------- In describing the securities markets of the United States as national assets, Congress envisioned that the NASD and exchanges would be increasingly responsible for advancing this public interest, as well as other statutory obligations. Senator Harrison A. Williams, Jr., during Senate consideration of the 1975 Amendments, specifically addressed the increased role of the self-regulatory organizations as envisioned in the 1975 Amendments when stating: Self-regulation should be preserved in the securities industry, but the self-regulatory organizations must display a greater responsiveness to their statutory obligations and to the need to coordinate their functions and activities.\13\ --------------------------------------------------------------------------- \13\Federal Securities Laws, Legislative History (1933-1988), Vol. III, Item 159 at 2949. --------------------------------------------------------------------------- In addition, Sections 15A(b)(6) and 6(b)(5) of the Act require that the rules of the NASD and the exchanges be designed to perfect the mechanism of a national market system. The rules of the NASD and exchanges are, therefore, required to further all statutory policies underlying a national market system, including the Section 11A(a)(1)(A) policy to preserve and strengthen the securities markets. As the operator of the second largest securities market in the U.S. and the world, the NASD believes that the general legislative intent of the 1975 Amendments and the express findings of Congress set forth in Section 11A(a)(1)(A) of the Act, expand the investor and public interest policies contained in Section 15A(b)(6) of the Act and support the Association's position that it has broad discretionary authority to make issuer inclusion determinations based on broad concerns regarding any event, circumstance or condition in order to protect the Nasdaq System as a national asset. Discretionary Listing Authority of the National Exchanges The NASD also compares its discretionary authority under Section 3(a)(3) to Part II of Schedule D to the discretionary authority contained under comparable rules of the New York Stock Exchange (``NYSE'') and the American Stock Exchange (``AMEX'') (together, the ``national exchanges''). The reason for this comparison is twofold. First, as noted above, the investor protection and public interest mandates imposed on the exchanges pursuant to Section 6(b)(5)\14\ of the Act are identical to the mandates imposed on the Nasdaq System pursuant to Section 15A(b)(6) of the Act. The NASD, therefore, concludes that the discretionary authority to fulfill such identical statutory mandates should be similar. Second, the Commission also expressly stated, in Tassaway, that the governing legal standards of both are the exchanges and the Nasdaq System should be the same. The Commission stated: --------------------------------------------------------------------------- \14\Section 6(b)(5) provides: The rules of the exchange are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers, or to regulate by virtue of any authority conferred by this title matters not related to the purposes of this title or the administration of the exchange. --------------------------------------------------------------------------- So we think this is a suitable occasion on which to state the Standards by which we shall be guided when asked to review the NASD's actions with respect to [the Nasdaq System]. The NASD's role in Nasdaq is the same as that of the organized exchanges with respect to the lists of securities traded on them. It follows that the governing legal standards should also be the same.\15\ --------------------------------------------------------------------------- \15\45 SEC 706 at 709. --------------------------------------------------------------------------- Pursuant to the Commission's determination in Tassaway, the NASD has concluded that the scope of its discretionary authority with respect to listings in the Nasdaq System can be no less than that of the national exchanges. The NASD's review of the exchanges' rules is as follows. AMEX Discretionary Authority--AMEX rules describe their numerical initial listing criteria as ``numerical guidelines'' and the exchange is provided with sole discretion to approve or disapprove a listing application. The AMEX rule states: The approval of an application for the listing of securities is a matter solely within the discretion of the Exchange. To assist companies interested in applying for listing, the Exchange has established certain numerical guidelines, outlined below, which will be considered in evaluating listing eligibility. Other factors which will also be considered include the nature of a company's business, the market for its products, the reputation of its management, its historical record and pattern of growth, its financial integrity, its demonstrated earning power and its future outlook. The fact that an applicant may meet the Exchange's numerical guidelines does not necessarily mean that its application will be approved. On the other hand, an application may be approved even though the company does not meet all of the numerical guidelines.\16\ --------------------------------------------------------------------------- \16\Part 1, section 101 of the Manual. --------------------------------------------------------------------------- The rules of the AMEX regarding continued listing criteria (including their corporate governance criteria) are also stated to be only guidelines that in no way limit or restrict the exchange decision on continued listing or delisting determinations. The first three sections of Part 10 of the AMEX Manual regarding Suspension Delisting provide for such broad discretionary authority.\17\ Section 1001 entitled ``General'' states: --------------------------------------------------------------------------- \17\See, Part 10 entitled `Section and Delisting' of the AMEX Manual and Specifically Subsections 1001, 1002 and 1003 entitled `General'; Policies With Respect to Continued listing; and `Application of Policies' respectively. --------------------------------------------------------------------------- In considering whether a security warrants continued trading and/or listing on the Exchange, many factors are taken into account, such as the degree of investor interest in the company, its prospects for growth, the reputation of its management, the degree of commercial acceptance of its products, and whether its securities have suitable characteristics for auction market trading. Thus, any developments which substantially reduce the size of a company, the nature and scope of its operations, the value or amount of its securities available for the market, or the number of holders of its securities, may occasion a review of continued listing by the Exchange. Moreover, events such as the sale, destruction, loss or abandonment of a substantial portion of its business, the inability to continue its business, steps towards liquidation, or repurchase or redemption of its securities, may also give rise to such a review. Section 1002 entitled ``Policies With Respect to Continued Listing'' first outlines the AMEX's discretionary authority to delist or suspend, and then outlines the AMEX's policy on when it will generally consider suspension or removal. This Section states: The Constitution of the Exchange provides that the Board of Governors may, in its discretion, at any time, and without notice, suspend dealings in, or may remove any security from, listing or unlisted trading privileges. The Exchange, as a matter of policy, will consider the suspension of trading in, or removal from listing or unlisted trading of, any security when in the opinion of the Exchange: (a) the financial condition and/or operating results of the issuer appear to be unsatisfactory; or (b) it appears that the extent of public distribution or the aggregate market value of the security has become so reduced as to make further dealings on the Exchange inadvisable; or (c) the issuer has sold or otherwise disposed of its principal operating assets, or has ceased to be an operating company; or (d) the issuer has filed to comply with its listing agreements with the Exchange; or (e) any other event shall occur or any condition shall exist which makes further dealings on the Exchange unwarranted. While the discretionary authority of the AMEX to list or delist is clearly stated in the first sentence of the above Section 1002, the AMEX strongly emphasizes its discretionary authority in the introductory paragraphs to the following Section 1003 entitled, ``Application of Policies.'' Section 1003 begins as follows: The determination as to whether a security warrants continued trading on the Exchange is not based on any precise mathematical formula. Each case is considered on the basis of all relevant facts and circumstances and in light of the objectives of the Exchanges policies regarding continued listing (See also Sec. 1004). To assist in the application of these policies, the Exchange has adopted certain guidelines, outlined below, under which it will normally give consideration to suspending dealings in, or removing, a security from listing or unlisted trading. However, these guidelines in no way limit or restrict the Exchange in applying its policies regarding continued listing, and the Exchange may at any time, in view of the circumstances in each case, suspend dealings in, or remove, a security from listing or unlisted trading when in its opinion such security is unsuitable for continued trading on the Exchange. Such action will be taken regardless of whether the issuer meets or fails to meet any or all of the guidelines discussed below. Section 1003 also enumerates numerous quantitative and non- quantitative guidelines, including corporate governance criteria. These guidelines include Subsection (e)(iii) that provides that the exchange will normally consider suspending dealings in, or removing from the list, a security ``if the company or its management shall engage in operations which, in the opinion of the exchange, are contrary to the public interest.'' NYSE Discretionary Authority--Unlike the AMEX's ``guidelines,'' the NYSE initial and continued listing requirements are described as ``criteria.'' NYSE rules, however, provide the Exchange with broad discretionary authority to list, suspend or delist securities. Section 1, Subsection 101 of the NYSE Listed Company Manual provides initial numerical listing criteria. In addition, the introductory language of this Section stresses that an NYSE listing must meet more than just the enumerated listing criteria, it must merit the recognition of the NYSE. The Rule specifically states: A listing on the New York Stock Exchange is internationally recognized as signifying that a publicly owned corporation has achieved maturity and front-rank status in its industry--in terms of assets, earnings, and shareholder interests and acceptance. Indeed, the Exchanges's listing standards are designed to assure that every domestic or non-U.S. company whose shares are admitted to trading in the Exchange market merit that recognition. This introductory language is followed by numerical criteria and additional language that provides the NYSE with discretionary authority to ensure that each issuer does ``merit that [international] recognition.'' The Rule states: Aside from the minimum numerical standards listed above, other factors are taken into consideration. The company must be a going concern or be the successor to a going concern. Although the amount of assets and earnings and the aggregate market value are considerations, greater emphasis is placed on such questions as the degree of national interest in the company, the character of the market for its products, its relative stability and position in its industry, and whether or not it is engaged in an expanding industry with prospects for maintaining its position. The Exchange is also concerned with such matters as voting rights of shareholders, voting arrangements and pyramiding of control, and related party transactions. When there is an indication of a lack of public interest in the securities of a company evidenced, for example, by low trading volume on another exchange, lack of dealer interest in the over-the-counter market, unusual geographic concentration of holders of shares, slow growth in the number of shareholders, low rate of transfers, etc., higher distribution standards may apply. In this connection, particular attention will be directed to the number of holders of from 100 to 1,000 shares and the total number of shares in this category. With respect to discretionary authority to delist securities, Section 802.00 of the NYSE Company Manual provides that the NYSE will ``give consideration to delisting a security of a company'' when the company falls below certain numerical and corporate governance related criteria (listed in this Section), or when the NYSE makes certain other ``determinations'' or ``appraisals.'' This NYSE section provides the NYSE with broad discretionary authority by stating: The Exchange is not limited by the criteria set forth above. Rather, it may make an appraisal of, and determine on an individual basis, the suitability for continued listing of an issuer in the light of all pertinent facts whenever it deems such action appropriate, even though a security meets or fails to meet any enumerated criteria. Other factors which may lead to a company's delisting include:The failure of a company to make timely, adequate, and accurate disclosures of information to its shareholders and the investing public. Failure to observe good accounting practices in reporting of earnings and financial position. Other conduct not in keeping with sound public policy. Unsatisfactory financial conditions and/or operating results. Inability to meet current debt obligations or to adequately Finance operations. Abnormally low selling price or volume of trading. Unwarranted use of company funds for the repurchase of its equity securities. Any other event or condition which may exist or occur that makes further dealings or listing of the securities on the Exchange inadvisable or unwarranted in the opinion of the Exchange. Proposed Rule Change In the NASD's review of the rules of the national exchanges, the Association noted an important difference between the language contained in Part II, Section 3(a)(3) of Schedule D and the national exchanges' more extensive rule language that emphasizes each exchanges' broad discretionary authority to make determinations over the listing of securities on their markets. Whereas Section 3(a)(3) of Schedule D relies on investor protection and public interest rule language set forth in Section 15A(b)(6) of the Act, the exchange rules expressly reserve discretionary authority to the respective exchanges without tracking the identical investor protection and public interest rule language of Section 6(b)(5) of the Act. The NASD notes that the AMEX listing rules are emphasized to be only guidelines and Part I, Section 101 of the AMEX Manual provides that the approval of an application for listing is a matter solely within the discretion of the Exchange. In a similar manner, Section 802.00 of the NYSE Company Manual specifically provides the exchange with discretionary authority to determine the suitability of continued listing of an issuer in light of all pertinent facts whenever it deems such action appropriate, even though a security meets or fails to meet any enumerated criteria. Section 802.00 also provides that a company may be delisted based on any other event or condition that may exist or occur that makes dealings or listing of the securities on the NYSE inadvisable or unwarranted in the opinion of the Exchange. The NYSE also utilizes its discretionary authority to maintain high non- quantitative standards for its securities markets by stating, under Section 1, Subsection 101 of the NYSE Company Manual, that a listing on its market is internationally recognized and that its rules are designed to assure that every company admitted to trading on the NYSE merits such recognition. The NASD believes that the exchange rules that reserve to the exchanges discretionary authority over their respective listings, and the NYSE's merit of international recognition standard, reflect the interest of the exchanges' in preserving and strengthening the quality of their markets as a commercial service. The exchanges reservation of discretionary authority over listings is, therefore, intended to improve the quality of its commercial service in order to make the service more attractive to current and future customers (as well as regulate securities transactions). The NASD believes, therefore, as an operator of a securities market that is a commercial service, that its rules should similarly reserve discretionary authority over listings to the Association for the purpose of preserving and strengthening the quality of the Nasdaq System to the benefit of its customers, i.e. present and prospective investors, issuers, brokers, and dealers. Description of Proposed Rule Change The NASD has determined that its rule applicable to the Nasdaq System must clearly and unambiguously reserve discretionary authority to the Association with respect to the initial or continued inclusion of particular securities that is comparable to that of the national exchanges. Such discretionary authority is necessary in order to preserve and strengthen the Nasdaq System as a national asset. The NASD also believes that such discretionary authority over inclusion in the Nasdaq System reflects the natural interest of the NASD, as operator of the market, in preserving and strengthening the quality of the Nasdaq System in order to increase the attractiveness of this market to all customers, i.e. present and prospective investors, issuers and broker/ dealers. In addition, the NASD believes such discretionary authority is necessary in order to ensure that securities which would otherwise be subject to the Penny Stock Rules (discussed below) merit this exemption when entering the Nasdaq System and continue to merit this exemption thereafter. The NASD is, therefore, proposing to amend Sections 1 and 2 of Part II to Schedule D\18\ to add an introduction to each section that states that: (1) the Association, as operator of the Nasdaq System, is entrusted with the authority to preserve and strengthen the quality of and public confidence in its market; (2) the Nasdaq System stands for integrity and ethical business practices in order to enhance investor confidence, thereby contributing to the financial health of the economy, and supporting the capital formation process; and (3) Nasdaq System issuers, from new public companies to companies of international stature, by being included in the Nasdaq System, are publicly recognized as sharing these important objectives of the Nasdaq System. --------------------------------------------------------------------------- \18\The Nasdaq System includes both The Nasdaq SmallCap Market and Nasdaq National Market. Sections 1 and 2 to Part II of Schedule D include the qualification requirements for domestic and Canadian securities and for non-Canadian foreign securities and American Depositary Receipts, respectively. The qualification requirements in Sections 1 and 2 of Part II to Schedule D apply to both the Nasdaq SmallCap Market and the Nasdaq National Market. --------------------------------------------------------------------------- The introduction then sets forth that as a result of the foregoing policy statement, the Association, in addition to applying the enumerated criteria set forth in Parts II and III hereof, will exercise broad discretionary authority over the initial and continued inclusion of securities in the Nasdaq System in order to maintain the quality of and public confidence in its market. Under such board discretion and in addition to its authority under Section 3(a), the introduction states that the Association may deny initial inclusion or apply additional or more stringent criteria for the initial or continued inclusion of particular securities or suspend or terminate the inclusion of particular securities based on any event, condition, or circumstance which exists or occurs that makes initial or continued inclusion of the securities in the Nasdaq System inadvisable or unwarranted in the opinion of the Association, even though the securities meet all enumerated criteria for initial or continued inclusion in the Nasdaq System.\19\ --------------------------------------------------------------------------- \19\Simultaneously, with the filing of this proposal, the NASD is withdrawing SR-NASD-93-32. --------------------------------------------------------------------------- The proposed rule change would provide broad discretionary authority that is separate and distinct from the authority currently provided under Section 3(a)(3) of Part II to Schedule D. Section 3(a)3 would not be deleted under the proposed rule change. The NASD would continue to rely on Section 3(a)(3) when appropriate. The proposed rule change is a single statement of discretionary authority in contrast to the rules of the national exchanges which also include statements of many enumerated factors that may be considered by each exchange in making a determination as to listing, delisting or suspension of a security. The NASD does not intend by proposing such a statement of discretionary authority that the scope of its authority with respect to listings in the Nasdaq System be narrower than the scope of authority of the NYSE and AMEX with respect to listings. To the contrary, the NASD intends, by this proposal, to make clear that its discretionary authority over listings is no less than that of the exchanges. The NASD believes the proposed rule change provides important guidance to investors, issuers and the general public that the NASD is authorized pursuant to the Act to make determinations over inclusion in the Nasdaq System to preserve and strengthen the quality of the Nasdaq System. Penny Stock Sales Practice and Disclosure Rules The NASD believes the proposed rule change will enhance the Association's ability to oversee the initial and continued inclusion of securities that are exempted from the Penny Stock Sales Practice and Disclosure Rules of the Act\20\ (``Penny Stock Rules'') by virtue of inclusion in the Nasdaq System. The NASD believes that the clarity provided by the proposed rule change regarding the NASD's discretionary authority to deny or terminate such securities sends a strong message to those who would consider evading and abusing these statutory provisions. Such guidance enhances the continued vigilance required to ensure that inclusion in the Nasdaq System is not used as a vehicle to avoid compliance with the Penny Stock Rules by the very persons for whom compliance is so essential. --------------------------------------------------------------------------- \20\The Penny Stock Sales Practice and Disclosure Rules of the Act are comprised of Rule 3a51-1 providing definitions of penny stocks and Rules 15g-1 to 15g-6, 15g-8 and 15g-9. In general, the Penny Stock Rules have been enacted to require more stringent regulation of broker/dealers that recommend penny stock transactions to customers. Under Rule 3a51-1 of the Act, Nasdaq System securities are excluded from the scope of the Penny Stock Disclosure Rules, except that Nasdaq SmallCap securities under $5.00 are deemed penny stocks for purposes of Section 15(b)(6) of the Act. --------------------------------------------------------------------------- In a letter from the Securities and Exchange Commission to the President of the NASD, the SEC stated: In providing an exclusion for quotation on the Nasdaq System [from Rule 15c2-6],\21\ the Commission was relying on the NASD's ability to screen issuers and to authorize for quotation only legitimate companies whose quotation on the Nasdaq System would be in the public interest. The Division is concerned that certain promoters may attempt to circumvent the requirements of Rule 15c2-6 by seeking Nasdaq authorization. This situation demands extra caution in authority for quotation securities that otherwise would be subject to Rule 15c2-6. Before authorizing one of these securities, the NASD should assure itself of the bona fides of the company and its past trading market.\22\ --------------------------------------------------------------------------- \21\In August of 1989, the SEC adopted Rule 15c2-6 to address sales practice abuses in low priced over-the-counter (``OTC'') securities which, in general, prohibits a broker-dealer from selling to or effecting the purchase of a ``designated security'' by any person, unless the broker-dealer has approved the purchaser's account for such transactions and received from the purchaser a written agreement to the transaction. The Commission later amended Rule 15c2-6 and redesignated it as Rule 15g-9 of the Act. In the amendment, the Commission also conformed the definition of ``designated security'' in Rule 15c2-6 to the definition of ``penny stock'' in Rule 3a51-1 of the Act, and, with certain exceptions, replaced the transactional exemption under the rule with the exemptions contained in Rule 15g-1 of the Act. See, Securities Exchange Act Release No. 32576 (July 2, 1993), 58 FR 37413 (July 12, 1993). \22\See, January 10, 1990 letter from the Director, SEC Division of Market Regulation the President of the NASD. --------------------------------------------------------------------------- The NASD, therefore, believes the proposed rule change is an indispensable and clear regulatory statement to public customers, issuers and other market participants that the NASD has the broad discretionary authority and will use such discretionary authority to ensure that securities which would otherwise be subject to the Penny Stock Rules merit this exemption when entering the Nasdaq System and continue to merit this exemption thereafter. Proposal To Clarify the NASD Authority To Deny Inclusion of Particular Issuers in the Nasdaq System Under Part II, Section 3(a) of Schedule D Part II, Section 3(a) of Schedule D provides the NASD, under certain circumstances, with authority to apply additional or more stringent criteria for the initial or continued inclusion of particular securities or to suspend or terminate the inclusion of a security otherwise qualified for inclusion in the Nasdaq System. The NASD has for many years interpreted Part II, Section 3(a) as providing the Association with the authority to ``deny inclusion'' of a security in the Nasdaq System. Authority to deny inclusion is inherent in Part II, Section 3(a) otherwise the NASD would be required to include a security in the Nasdaq System in order to terminate the security's inclusion, which procedure was never the intent of the Association. The NASD has determined that its authority to deny inclusion of particular securities in the Nasdaq System in compliance with the enumerated provisions of Part II, Section 3(a) should be expressly stated. The proposed rule change would, therefore, amend Part II, Section 3(a) of Schedule D to clarify such authority. Statutory Authority The NASD believes that the proposed rule change is in furtherance with the purposes of Sections 15A(b)(6) and 11A of the Act in that the proposed rule change provides the Association with discretionary authority to preserve and strengthen the Nasdaq System as a national asset. The NASD believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act which requires that the rules of a national securities association be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general to protect investors and the public interest in that the rule change: (1) Clarifies the NASD's authority to deny inclusion under the criteria under Section 3(a) to Part II to Schedule D; and (2) establishes the NASD's broad discretionary authority under Part II, Sections 1 and 2 of Schedule D to deny initial inclusion or apply additional or more stringent criteria for the initial or continued inclusion of particular securities or suspend or terminate the inclusion of particular securities based on any event, condition, or circumstance which exists or occurs that makes initial or continued inclusion of the securities in the Nasdaq System inadvisable or unwarranted in the opinion of the Association, even though the securities meet all enumerated criteria for initial or continued inclusion in the Nasdaq System. The NASD believes that the proposed rule change is in furtherance of Section 15A(b)(11) of the Act in that clarification of the NASD's authority to deny inclusion of securities under Section 3(a) to Part II of Schedule D, and also providing the Association with board discretion over the initial or continued inclusion of securities in the Nasdaq System under Sections 1 and 2 to Part II of Schedule D, is intended to enhance the ability of the NASD to prevent fictitious and misleading quotations in securities included in the Nasdaq System. The NASD believes that, with respect to securities that are designated in the Nasdaq Small Cap Market, the proposed rule change is in furtherance of the purposes of the Penny Stock Rules adopted under the Act in that the proposed rule change will provide the NASD with authority to ensure that securities which would otherwise be subject to the Penny Stock Rules merit this exemption when entering the Nasdaq System and continue to merit this exemption thereafter. The NASD believes that the proposed rule change is consistent with the purposes of the Act and, to the extent the proposed rule change imposes any burden on competition, the NASD believes that such burden on competition is in furtherance of the purposes of the Act is required by Section 15A(b)(9) of the Act. (B) Self-Regulatory Organization's Statement on Burden on Competition Providing broader discretion to the NASD over the inclusion of securities in the Nasdaq System may result in the denial or termination of certain securities that would otherwise be eligible for inclusion, yet such action does not result in an inappropriate competitive disadvantage to an issuer as there currently exist alternative electronic markets such as the NASD's OTC Bulletin Board which as of December 20, 1993 provides not only real time quotations but last sale trade reporting for companies whose securities are not traded in the Nasdaq System. Furthermore, the securities of the issuers would generally be eligible for inclusion on regional stock exchanges. Moreover, as set forth in Tassaway, the SEC stated that while exclusion from the Nasdaq System may hurt existing investors, the primary emphasis must be placed on the interest of prospective investors and that this latter group is entitled to assume that the securities in the Nasdaq System meet the system's standards. The NASD does not believe, therefore, 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 Written comments were neither solicited nor received in the proposed rule change. The SEC published for comment SR-NASD-93-32, a related proposed rule change,\23\ and received one comment letter from members of the Task Force on Listing Standards of Self-Regulatory Organizations of the Federal Regulation of Securities Committee, Section of Business Law of the American Bar Association (``Task Force''). On September 29, 1993, the NASD responded to the comment letter in Amendment No. 2 to SR-NASD-93-32. The NASD believes it appropriate to respond again to one issue raised in the comment letter as it remains applicable to the proposed rule change. --------------------------------------------------------------------------- \23\Securities Exchange Act Release No. 32605 (July 9, 1993); 58 FR 38150 (July 15, 1993). --------------------------------------------------------------------------- The Task Force recommended that the securities of issuers already included in The Nasdaq System should not be suspended or terminated for ``bad boy'' conduct that is known or disclosed prior to the adoption of the ``bad boy'' criteria contained SR-NASD-93-32 unless there is a change of control or influence or other meaningful change in circumstances with respect to such issuers. The Task Force expanded on this recommendation, in part, by arguing that application of the proposed rule change to all current Nasdaq issuers would be unfair to current security holders who relied on the fact that such securities were included or about to be included in the Nasdaq System. The NASD has reviewed this comment with respect to the proposed rule change and has determined that such a limitation on NASD authority would impose an arbitrary restriction on the NASD's oversight of the Nasdaq System that could undermine public confidence in the Nasdaq System as a securities market and be contrary to interests of retail and institutional investors, issuers, broker/dealers and the public in the Nasdaq System. Any determination to delist an issuer will be made on a case-by-case basis in accordance with Article IX of the NASD's Code of Procedure. 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 reasons 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 NW., 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 in the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the NASD. All submissions should refer to the file number in the caption above and should be submitted by May 2, 1994. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.\24\ --------------------------------------------------------------------------- \24\17 CFR 200.30-3(a)(12) (1993). --------------------------------------------------------------------------- Margaret H. McFarland, Deputy Secretary. [FR Doc. 94-9215 Filed 4-13-94; 9:20 am] BILLING CODE 8010-01-M