[Federal Register Volume 59, Number 102 (Friday, May 27, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-13039] [[Page Unknown]] [Federal Register: May 27, 1994] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-34092; File No. SR-NASD-92-12, Amendment No. 7] Self-Regulatory Organizations; Notice of Proposed Rule Change by the National Association of Securities Dealers, Inc., Relating to Amendments to the NASD's Proposed Short Sale Rule May 20, 1994. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ notice is hereby given that on May 16, 1994, the National Association of Securities Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities and Exchange Commission (``Commission'' or ``SEC'') 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 The NASD is proposing two amendments to its proposed short sale rule or ``bid test'' applicable to stocks traded on the Nasdaq National MarketSM. First, the NASD proposes to amend the rule to provide that a member may immediately become a qualified market maker in either or both of the stocks involved in a merger or acquisition (``M&A stock(s)''), even if the member was not previously a market maker in either of the stocks. However, if a market maker withdraws on an unexcused basis from any stock in which it was registered pursuant to this subsection within 20 days of so registering, it shall not be designated as a qualified market maker pursuant to this subsection for any subsequent merger or acquisition announced within three months subsequent to such unexcused withdrawal. Second, the NASD proposes to amend Interpretation A under the rule to clarify that short sales effected by a qualified market maker in one M&A stock will be deemed to be bona fide market making activity if they hedge purchases in the other M&A stock made by the market maker during the course of bona fide market making activity. Therefore, the amendment clarifies that such short sales will be exempted under the rule. The NASD also proposes to make other minor amendments to the short sale rule. The text of the proposed rule change is available at the Office of the Secretary of the NASD and at the Commission. 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 In response to concerns raised by several NASD members actively engaged in risk arbitrage, the NASD is proposing two amendments to its proposed short sale rule that are designed to enhance the liquidity of stocks involved in a merger or acquisition.\2\ In essence, the risk arbitrageurs contend that they should be afforded an exemption from the short sale rule because they provide important market liquidity to the marketplace during the period before a merger or acquisition is consummated. Specifically, the risk arbitrageurs maintain that they provide liquidity to security holders in a target company who are unwilling to assume the risk of completion of the merger or acquisition. The risk arbitrageurs also contend that they are more likely to better analyze and understand a merger or acquisition transaction than the market makers who were making markets in the stocks prior to the announcement of the transaction. Thus, the risk artibrageurs maintain that they are better able to price M&A stocks. --------------------------------------------------------------------------- \2\Some of these members also submitted comment letters to the Commission arguing that the NASD's short sale rule should exempt the activities of risk arbitrageurs. See letters to Jonathan G. Katz, Secretary, SEC, from, Michael B. Radest, Vice President, The First Boston Corporation (Oct. 1, 1992); from Mark Lehman, General Counsel, Bear Stearns & Co. (Oct. 2, 1992); from Anson M. Beard, Jr., Morgan Stanley (Oct. 5, 1992); from Peter M. Schoenfeld, Vice Chairman, Wertheim Schroder & Co. (Oct. 5, 1992); and from Bruce C. Hackett and Rodney B. Berens, Managing Directors, Salomon Brothers (Oct. 6, 1992). --------------------------------------------------------------------------- The NASD has worked closely with the risk arbritrageurs to address their concerns and formulate the current amendments to the rule. As a result, the NASD believes the amendments strike a reasonable balance between the needs of risk arbitrageurs to facilitate the liquidity demands of investors in M&A stocks and the NASD's need to implement a meaningful short sale rule for the The Nasdaq Stock MarketSM (``Nasdaq'') that does not contain broad and sweeping exemptions that eviscerate the rule's effectiveness. In addition, as described below, even though the amendments were crafted with the concerns of risk arbitrageurs in mind, they apply to all NASD members. First, the NASD proposes to make it easier for market makers to become qualified market makers in stocks involved in a merger or acquisition. Specifically, under the amendment, once a merger or acquisition is publicly announced, any market maker can immediately become a qualified market maker in either M&A stock pursuant to Section (1)(3)(iii) of the rule, regardless of whether the member previously made a market in either or both of the stocks. Before this amendment, if a market maker did not previously make a market in either of the M&A stocks, it would have had to make a market in each of the stocks for 20 business days before it was eligible to be a qualified market maker in the stocks. In addition, before this amendment, a market maker could immediately become a qualified market maker in an M&A stock only if it was already a qualified market maker in the other M&A stock. Even though this amendment is designed to facilitate the market making activities of risk arbitrageurs, there is no requirement that market makers engage in risk arbitrage if they take advantage of the immediate registration provisions contained in section (1)(3)(iii) of the rule. The NASD believes that allowing members to immediately become qualified market makers in M&A stocks will enable Nasdaq to better satisfy investors' increased liquidity demands resulting from the announcement of a merger or acquisition. In addition, the NASD believes that allowing members to more readily become qualified makers in M&A stocks will help to promote pricing efficiency in these stocks at a time when they are more volatile. Moreover, the NASD believes permitting market makers to immediately become qualified market makers in M&A stocks is consistent with the treatment of market makers in the context of initial public offerings (``IPOs'').\3\ --------------------------------------------------------------------------- \3\For IPOs, a market maker may immediately become a qualified market maker, however, if the market maker withdraws on an unexcused basis from the security within the first 20 days of the offering, it shall not be designated as a qualified market maker on any subsequent IPO for the next ten business days. In contrast to the ten day restriction for unexcused withdrawals from an IPO, the NASD believes a three month restriction is warranted for unexcused withdrawals from an M&A stock because market makers in M&A stocks will be afforded an immediate exemption from the short sale rule even though they had an opportunity to ``earn'' their status as a qualified market maker. In addition, a market maker that immediately becomes a qualified market maker in an M&A stock is allowed to compete on equal footing (i.e., avail themselves of an exemption from the rule) with other market makers who have made a prior and continuous commitment of capital to the market for the particular stock. Thus, notions of fairness dictate that a three month restriction is more appropriate for premature, unexcused withdrawals in an M&A stock. --------------------------------------------------------------------------- In order to deter market makers from entering and withdrawing as qualified market makers in M&A stocks to suit their own pecuniary interests, however, the proposal provides that if a market maker withdraws on an unexcused basis from any M&A stock in which it immediately registered as a qualified market maker within 20 days of so registering, that it shall not be immediately designated as a qualified market maker for any subsequent merger or acquisition announced within three months subsequent to such unexcused withdrawal. Second, the NASD proposes to amend Interpretation A under the rule to provide more guidance to qualified market makers when they hedge purchases in one M&A stock with sales in the other and vice versa. Specifically, under the proposal, if a market maker purchases or reasonably anticipates purchasing an M&A stock during the course of bona fide market making, then short sales in the other M&A stock by the market maker to hedge these purchases will be deemed to be bona fide market making activity; and, therefore, exempt from the bid test. Conversely, if a qualified market maker sells an M&A stock short during the normal course of bona fide market making, the amendment provides that these short sales will not lose their exemption if the market maker later purchases the other M&A stock in a capacity other than normal bona fide market making. In addition, the amended Interpretation clarifies that the amount of stock sold short by a qualified market maker to hedge purchases of the other M&A stock must be reasonably consistent with the exchange ratio specified by the terms of the merger or acquisition. Thus, if the exchange ratio is three shares of the target for one share of the acquiring company, then the purchase of 300 shares of the target's stock would generally be hedged by no more than 100 shares of the acquiring company. The NASD believes that the expanded Interpretation will provide qualified market makers with more certainty when they hedge transactions in one M&A stock with transactions in the other M&A stock. Moreover, the NASD believes that requiring market makers to adhere to the exchange ratios will help to ensure that market makers do not ``over short'' one M&A stock when hedging purchases in the other M&A stock. In addition, the NASD is proposing several minor changes to its short sale rule. First, the NASD proposes to amend Section (c)(7) of the short sale rule to clarify that the exemption from the rule afforded transactions in special international arbitrage accounts is available to non-NASD members as well as NASD members. Second, the NASD proposes to amend Section (k) of its short sale rule and Sections (h) and (i) of its proposed Primary Nasdaq Market Maker rule to reflect recent amendments to the NASD's By-Laws concerning the ability of the NASD's Board of Governors to adopt and amend NASD Rules of Fair Practice without a membership vote.\4\ Lastly the NASD proposes to clarify that the review period for review of market maker performance in each of the Primary Nasdaq Market Maker qualification standards is one month. --------------------------------------------------------------------------- \4\See Securities Exchange Act Release No. 33737 (Mar. 8, 1994), 59 FR 12017 (Mar. 15, 1994). --------------------------------------------------------------------------- The NASD believes the proposed rule change is consistent with Sections 15A(b)(6) and 11A(c)(1)(F) of the Act. Section 15A(b)(6) 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, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, and to remove impediments to and perfect the mechanism of a free and open market. Section 11A(c)(1)(F) assures equal regulation of all markets for qualified securities and all exchange members, brokers, and dealers effecting transactions in such securities. Specifically, as noted in prior filings regarding the NASD's short sale rule, approval of the proposed short sale rule would result in equivalent short sale regulation in the exchange and Nasdaq markets and would work to prevent fraud and manipulation with respect to short sales in the Nasdaq market. Moreover, the NASD believes that allowing market makers to immediately register as qualified market makers in M&A stocks will promote market liquidity and enhance pricing efficiency at a time when they are most needed. In addition, the NASD believes that the three month restriction for premature, unexcused withdrawals in M&A stocks will help to ensure that market makers in M&A stocks do not enter the market merely to use the exemption to the rule to engage in aggressive short selling designed to drive down the price of a security. Finally, the NASD believes the additions to Interpretation A under the rule will provide market makers with more certainty regarding when they are entitled to an exemption from the rule, thereby promoting market efficiency and enhancing the orderliness of the market. With respect to the other proposed amendments discussed in this filing, the NASD believes they will serve to reduce investor confusion concerning the application and operation of the NASD's short sale rule, thereby promoting efficient and fair markets. B. Self-Regulatory Organization's Statement on Burden on Competition The NASD believes that the proposed rule change will not result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others Comments were neither solicited nor received. 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 NASD 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 SR-NASD-92-12 and should be submitted by June 17, 1994. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.\5\ --------------------------------------------------------------------------- \5\17 CFR 200.30-3(a)(12) (1993). --------------------------------------------------------------------------- Margaret H. McFarland, Deputy Secretary. [FR Doc. 94-13039 Filed 5-26-94; 8:45 am] BILLING CODE 8010-01-M