Public Securities Association 40 Broad Street New York, NY 10004-2373 (212) 809-7000 or (212) 440-9400 Telecopier: (212) 440-5260 or (212) 440-5261 July 17, 1996 Mr. Jonathan G. Katz Secretary Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Re: Trading Practices Rules Concerning Securities Offerings, File No. S7-11-96 Dear Mr. Katz: The Public Securities Association ("PSA")1 appreciates the opportunity to comment to the Securities and Exchange Commission ("Commission" or "SEC") on new Regulation M as proposed to be adopted in Release No. 34- 37094 (April 11, 1996) (the "Proposing Release"). PSA wishes to praise the Commission and staff on the comprehensive review they have undertaken of the Trading Practices Rules,2 from preparation of the initial concept release in 19943 through the thoughtful and time- consuming effort leading to the Proposing Release. The work of the Commission and staff has resulted in proposed rules of which PSA members are generally strongly supportive. We believe that the rules will eliminate burdensome prohibitions that have inhibited legitimate trading activity before and during distributions of debt securities. PSA also applauds the Commission's moves to codify interpretations of the Trading Practices Rules that previously have been available only through the exemptive, interpretive and no-action letter processes. The discussion herein addresses the provisions of proposed Regulation M that are analogous to current Rule 10b-6 under the Securities Exchange Act of 1934 (the "Act"), focusing on their application to the fixed income markets. In particular, and as discussed more fully below, PSA: ú Strongly supports the Commission's proposal to eliminate the application of distribution restrictions to securities of the "same class and series" as those being distributed, a test that has been extraordinarily difficult to apply in the context of debt securities; ú Strongly supports the continued exclusion of investment grade debt from the securities covered by proposed Regulation M and urges the Commission to make clear that this exclusion includes investment grade asset-backed and mortgage-backed securities;4 ú Proposes that the investment grade debt exclusion also include auction preferred stock, which, like other investment grade securities, trades predominantly on the basis of interest rates and yield; ú Proposes that the exclusion be extended to certain limited classes of distributions involving non-investment grade debt; ú Supports the proposed exemption for Rule 144A securities sold to "qualified institutional buyers" ("QIBs"), and proposes that the exemption be extended to apply to sales to institutional accredited investors where QIBs have committed to purchase a sufficiently large portion of the offering so that they can be deemed to have performed the price discovery function; ú Proposes clarification of the definition of "prospective underwriter" and further proposes that a distribution of debt securities be considered "completed" when substantially all of a participant's portion of the distribution has been sold -- at which time the incentive to manipulate is substantially eliminated; ú Proposes that the factors supporting an exemption of certain "affiliated purchasers" -- that there be information barriers between the distribution participant and the affiliate and that they not act in concert -- be applied to different areas within a single organization as well; and ú Continues to suggest that the Commission give greater consideration to creating a safe harbor (perhaps through a rebuttable presumption) for transactions that comply with Regulation M. In addition, PSA's comments address certain other definitional and specific points. I. General Discussion of Trading Practices Rules Rule 10b-6 is an antimanipulative rule that is intended to prevent participants in a distribution from "artificially conditioning the market for the securities being distributed, and to protect the integrity of the securities trading market as an independent pricing mechanism" (Proposing Release, text following note 6). In its current form, the rule prohibits issuers, underwriters, prospective underwriters and other participants in the distribution -- as well as their "affiliated purchasers" -- from bidding for or purchasing for any account in which they have a beneficial interest, or inducing others to purchase, the securities being distributed, or any security of the same class and series, until they have completed their participation in the distribution. Rule 101 of Regulation M would replace Rule 10b-6 by restricting certain activities by distribution participants and certain affiliates during the so-called "restricted period." It would prohibit such persons from bidding for or purchasing, directly or indirectly, the securities being distributed. "Reference securities," defined as securities "whose price is, or may in the future be, used to determine, in whole or in significant part, the value of a security that is the subject of a distribution," also would be subject to the prohibition, which would continue throughout the "restricted period." As stated in the Proposing Release and discussed more fully below, the new regulation is designed to reduce regulatory burdens through the relaxation of restrictions where either the risk of manipulation appears small or the costs of prophylactic restrictions are disproportionate to the purposes sought to be served. As noted by the Commission, the new rules are intended to reflect the significant developments and innovations that have occurred in the securities markets during recent years, in particular, (a) increased participation by institutional investors, whose market sophistication and bargaining power provide protections against abusive conduct on the "sell-side" of an offering, (b) increased transparency and liquidity in the secondary markets, (c) more sophisticated surveillance techniques by self-regulatory organizations ("SROs"), (d) globalization of the markets and (e) transformation of the capital-raising process. II. Covered and Excepted Securities A. Elimination of "Same Class and Series" The security or securities in distribution as well as any "reference security" are collectively referred to as "covered securities" in the proposed rule. These terms would replace the Rule 10b-6 structure, which prohibits transactions in securities of the "same class and series" as the securities being distributed. The "same class and series" language has been construed broadly to encompass securities that are sufficiently similar in their terms to the security in distribution to "raise the possibility that bids for or purchases of the outstanding security might be utilized to facilitate the distribution, even though there is no inherent mathematical relationship between the prices of the securities." (Concept Release, text accompanying note 84). PSA commends the Commission for the proposed elimination of restrictions on trading in outstanding securities of the same class and series as the new security. As the Commission has recognized, identifying these outstanding securities in the case of distributions of debt securities, for purposes of Rule 10b-6, has been an extraordinarily difficult task. Moreover, as the Commission has recognized, the "same class and series" concept has been overinclusive; the resulting restrictions have led to unduly decreased liquidity for holders of debt securities that had little or no chance of affecting the market for the debt securities in distribution. To ensure that the rule clearly captures the Commission's intent in this regard, PSA suggests that the Commission move to the definition of "covered security" in Rule 100 the language in the Proposing Release to the effect that Rule 101 does not apply to other debt securities of the same issuer unless such other securities are "identical in their principal features." In this connection, it is PSA's understanding that a new debt security would in effect have to represent the reopening of a previous issue in order for it to be considered a "covered security." B. Investment Grade Debt and Asset- Backed Securities The Commission's adoption of exception (xiii) to Rule 10b-6 in 1983 reflected its belief "that it is very difficult, if not impossible, to manipulate the price" of investment grade debt.5 As the Commission observed in proposing the amendment: Investment grade debt securities are generally thought to trade in accordance with a concept of relative value i.e., such securities are to a large degree fungible, so that investors generally evaluate new offerings by looking at comparably rated securities of other issuers. Debt securities that are not of investment grade may pose a greater potential manipulative threat, since those securities tend not to be fungible. Investors are therefore more likely to compare yields of new non-investment grade debt offerings with those of outstanding debt securities of the same issuer. In adopting exception (xiii), the Commission avoided a specific definition of "investment grade." It determined instead to rely on the investment grade categories adopted by each nationally-recognized statistical rating organization ("NRSRO") or, in the absence of such a designation, on the common understanding of the securities industry. In the Concept Release, the Commission referred to exception (xiii) as being "premised on the fungibility of investment grade issues (i.e., that securities with similar terms will trade on rating and yield rather than issuer identification)." PSA strongly supports the continued exception for investment grade debt. Exception (xiii) to Rule 10b- 6 provides certain relief from the rule's requirements in the case of distributions of nonconvertible debt securities or nonconvertible preferred securities. This exception has been carried over to proposed Rule 101 (in subsection (c)(2)). Where both the securities being distributed and the securities to be purchased6 are rated "investment grade" by at least one NRSRO, the exception permits bids for, purchases of or inducements to purchase other nonconvertible debt securities or nonconvertible preferred securities of the issuer -- provided that such activities are not "for the purpose of creating actual, or apparent, active trading in or raising the price of" any security subject to the rule or regulation. In response to Q 6 in the Proposing Release, PSA strongly believes that asset-backed securities ("ABS") should be treated as debt securities for purposes of Regulation M7 -- even though they may be issued in technical terms as equity interests in a trust or similar vehicle. In answer to the Commission's question, PSA does believe that ABS "have the same characteristics, including with respect to trading", as nonconvertible investment grade debt securities of corporate issuers. ABS are essentially fixed income investments, i.e., investments which pay interest and principal at specified times and in specified amounts. Such payments are funded and secured by the underlying assets, but do not necessarily correspond directly to the payments on such underlying assets. Indeed, Congress came to the same conclusion regarding the most prominent ABS, mortgage-related securities, when it determined such securities are much like other corporate securities. Moreover, the Congressional purpose in enacting the Secondary Mortgage Market Enhancement Act of 1984 ("SMMEA") was to broaden the market for mortgage-related securities by removing regulatory barriers that prevented "them from functioning in the market as well as other corporate securities." (Sen. Rep. No. 98-293 at 3). In addition, the Commission itself already has recognized the functional equivalency of mortgage- related securities to other investment grade debt for purposes of the Trading Practices Rules. In commenting on the House bill that led to SMMEA the SEC referred to the bill's concept of "investment grade security" as being the "same concept used in Rule 10b-6 under the 1934 Act to exempt issuers from the trading prohibitions of that Rule." The SEC comments also cited, "[i]n the same vein," the net capital rule's favorable treatment of "nonconvertible debt securities" if they were rated investment grade. (Statement of Commissioner Charles C. Cox, reprinted in id. at 43, 45). Commissioner Cox's statement clearly assumes that the theory of exemption (xiii) -- that investment-grade securities are difficult to manipulate -- should apply to mortgage-related securities. It is impossible to escape the conclusion that both Congress and the Commission assumed during the deliberations on SMMEA that mortgage-related securities were "debt securities" for purposes of Rule 10b-6 and that Congress intended the SEC to treat investment-grade mortgage-related securities for this purpose at least as favorably as investment-grade corporate debt securities. Once mortgage-related securities are treated as "debt securities" for purposes of Rule 10b-6, the same reasoning should apply to other ABS. PSA accordingly strongly requests that the SEC clarify that investment grade ABS are included in the exception for investment grade debt. For this purpose, PSA suggests that the Commission use the definition of ABS contained in General Instruction I.B.5. to Form S-3. C. Auction Preferred Stock PSA also believes that auction preferred stock should be excluded from Rule 101 on the same basis, and for the same reasons, that other preferred stock and investment grade debt have been excluded from the rule. Although the staff early on took the administrative position that auction preferred stock was not intended to be included in the exemption otherwise available for nonconvertible debt and preferred securities, auction preferred stock is now a recognized financing vehicle like any other preferred stock. While the particular timing and process of pricing auction preferred stock may differ from other preferred securities, so long as the auction preferred stock is rated "investment grade" it should be excluded from the rule. Thus, even though the staff may have been uncertain regarding the treatment of auction preferred stock when it was first introduced to the market 20 years ago, this financial innovation should now be recognized as a mature financial instrument eligible for traditional regulatory treatment. In other words, the 1983 rationale for excluding preferred securities (they "generally trade on the basis of their value in relation to comparably-rated offerings of other issues") is equally applicable to auction preferred securities. D. High-Yield Securities PSA recognizes the Commission traditionally has assumed high-yield securities should be treated, for purposes of the Trading Practices Rules, as if they were equity securities. The premise underlying this assumption is that all high-yield securities trade predominantly on the basis of "issuer-specific information." PSA believes proposed Regulation M presents a special opportunity for the Commission to revisit this premise by acknowledging the hybrid nature of high-yield securities and developing a regulatory framework that more fully reflects the fact that the market for and trading of high-yield securities increasingly resemble those of other debt securities, and should be treated as such. The Concept Release did not examine whether the scope of exception (xiii) in Rule 10b-6 was still valid in view of developments in the market for high- yield debt securities since 1983. Nor did it request comment on whether market conditions have developed to the point where exception (xiii) might be extended to at least some high-yield securities.8 The Commission's traditional justification for the prophylactic restrictions of the Trading Practices Rules has been that "manipulative incentives are present during securities distributions." (Proposing Release, text following note 100). More recently, however, the Commission has been willing to look beyond the mere possibility of such incentives. Accordingly, the proposed rules are based on the premise, as stated in the Proposing Release, that trading restrictions should be relaxed "where either the risk of manipulation appears small or the costs of the restrictions are disproportionate to the purposes that they serve." The proposed rules are also based on the related premise that it is difficult to manipulate securities -- at least in a "cost-effective" manner, as the Proposing Release puts it -- if "aberrations in price are likely to be observed and corrected quickly." Such difficulty to manipulate is most likely to be present where securities are regarded as fungible with other securities which meet the $1,000,000 average daily trading volume ("ADTV") test.9 Moreover, the Commission recognizes that any securities distribution that is purchased largely by institutions is subject to an additional safeguard against abusive conduct, i.e., the ability of large and sophisticated investors -- as noted in the Proposing Release -- to observe and identify price aberrations. We believe the sophisticated nature of high- yield market participants, improved transparency and surveillance of the high-yield market, increased reliance on relative-yield pricing of high-yield securities, more extensive credit analysis of high-yield securities, and broader dealer participation in the high- yield market all warrant, separately and collectively, a reevaluation of the treatment of high-yield securities under Regulation M. Accordingly, we describe below a series of proposals that we believe achieve the Commission's twin goals of encouraging liquid capital markets while maintaining necessary investor protection. In offering these proposals, we wish to emphasize our key point -- the Commission should not simply assume that all distributions of high-yield securities should be treated as if they were the same as equity distributions of securities and thus subject to the same risks of manipulation. If the Commission or its staff is willing to reconsider this, in our view, overly broad assumption, we stand ready and would welcome the opportunity to discuss our specific proposals, or any other alternatives, with the Commission. Indeed, it would be unfortunate if after all the work and effort (both by the Commission and the industry), the final product of Regulation M left the treatment of the high-yield market essentially unchanged after 15 years of growth and expansion, especially in view of the evolution of the high-yield market into an important source of capital for American companies. Perhaps most significantly, as the Commission itself recognizes, the market for high-yield securities is dominated by sophisticated, institutional investors who can "fend for themselves."10 The overwhelming majority of high-yield securities is held by insurance companies, mutual funds, and public pension funds.11 PSA believes that the "unwarranted costs on the capital raising process" of "overly broad and unnecessarily rigid" rules greatly outweigh their prophylactic benefit in an institutional marketplace. Given the sophistication of investors in the high yield market, we believe the Commission's objectives of protecting investors and maintaining liquid markets conducive to capital raising can be achieved with more finely- textured rules. Moreover, the composition of the high-yield debt market also is changing and the pricing of such securities is increasingly tied to the underlying yield curve. Indeed, the line between investment-grade and high-yield securities is blurring rapidly as a larger portion of the market consists of large, well-known and improving credits. It was recently reported, for example, that as much as 25% of the $330 billion of outstanding high-yield debt securities consists of so- called "crossover" credits that have one investment- grade and one non-investment-grade rating.12 While one investment-grade rating is sufficient for purposes of exception (xiii), the fact remains that investors' search for higher yields is causing them to engage in more extensive credit analysis of the higher-rated high- yield securities. In this context, we believe the institutional nature of the high-yield market and the fact that high- yield securities increasingly are priced on the basis of their relative position on the underlying yield curve could be appropriately recognized by excluding certain limited classes of distributions from Rule 101.13 PSA believes that, although many debt securities would not be excepted under the proposed investment grade test or the ADTV test, many high-yield securities in fact exhibit characteristics of institutional ownership, liquidity and market following such that they should be excluded from Rule 101. PSA has given considerable thought to the Proposing Release's invitation for the submission of alternative tests and proposes the further exclusions from Rule 101 described below. For example, each of the following classes of distributions could be excluded from Rule 101: Distributions in which (a) the security is priced at a specified number of basis points above a benchmark Treasury instrument (meaning it is more likely that the security has been priced on the basis of relative yield and is thus largely fungible with other securities); (b) participants are contractually obligated (e.g., in an underwriting agreement) to sell the securities in lots of $250,000 or more (this relatively simple test would assure that an underwriter's trading activity during the period of a distribution is the subject of scrutiny by institutional investors whose "market sophistication and bargaining power" should provide protection against abusive conduct);14 (c) the issuer's equity securities meet the $1,000,000 ADTV test;15 (d) a large amount of the issuer's securities is owned by investors unaffiliated with the issuer (e.g., $250,000,000 in market value); or (e) the amount of new securities being distributed is large enough to result in a high degree of liquidity (e.g., $100,000,000). Proposals (c), (d) and (e) reflect situations where it is reasonable to assume that investors also follow closely the issuer's debt securities. PSA therefore proposes that any of these criteria also should provide an independent basis for excluding a distribution from Rule 101. These multiple proposals represent PSA's belief that there must be a method to reflect within Regulation M the maturation of the high-yield market. We are convinced, to use the Commission's 1994 analysis, that most high-yield securities distributions do not "give rise to a readily identifiable incentive to manipulate the market" such that a broad prophylactic rule is necessary. In this spirit, we have proposed a variety of investor sophistication, oversight and market discipline standards to reflect a reasonable first step toward recognition that the market for high-yield securities has developed to a point where across-the- board restrictions are no longer necessary. We look forward to the opportunity to discuss these proposals further with the Commission and its staff. We are prepared to devote the necessary resources to work with the staff to craft an approach that would recognize the evolution of the debt markets while satisfying the Commission's policy goals. E. Definition of "ADTV" As stated above, PSA does not believe that the ADTV test is well-suited to the fixed-income market (Q 2). It therefore believes that the alternate exceptions described above, such as the $250,000 minimum sales standard, should be developed for high yield fixed- income securities (Q 10). PSA notes that a consistent rolling 90-day period would be easier to apply in practice than the non- uniform periods in excess of 90 days that would result from a focus on three full calendar months (Q 12). In this connection, the Proposing Release (text before Q 10) differs from the definition in proposed Rule 100 in that the proposed rule does not permit reliance on actual price and volume data for each day within the period. In addition, PSA questions the relevance in fixed-income markets of a requirement that volume be "reported." Assuming that this requirement means "reported to an SRO," PSA does not understand the rationale of reliance on such reports to the exclusion of other records that demonstrate sufficient trading volume to support an inference of liquidity and therefore of price efficiency. PSA would oppose a requirement that transactions in actively-traded securities be restricted for a brief period -- even one or two hours -- prior to pricing. Such a requirement could prevent an underwriting from being priced at the optimal time (Q 3). III. Rule 144-A-Eligible Offerings PSA strongly supports the exception for sales to QIBs of Rule 144A-eligible securities (Q 36, 37). PSA believes, however, that sales to institutional accredited investors should also be a permitted exception, provided that QIBs commit to purchase a sufficient part of an offering so that QIBs can be considered to have performed the price discovery function. PSA suggests that an appropriate percentage would be 75%.16 IV. Restricted Period The Rule 101 prohibitions are imposed on distribution participants during a so-called "restricted period." The period begins on the later of either a fixed number of days before pricing of the securities being distributed or such time that the person becomes a distribution participant, such as a "prospective underwriter." The period ends upon the person's completion of participation in the distribution. With respect to the beginning of the restricted period, PSA believes that the definition of "prospective underwriter" should be clarified further. Rather than rely on a dealer's expectations, the definition should focus on a bright-line test: whether the issuer has requested bids (Q 20). In this connection, PSA prefers the language in the Proposing Release (text following note 47) to the effect that a person becomes a prospective underwriter only where that person has either itself submitted a bid or the issuer has issued an invitation to bid. PSA also proposes that the Commission consider revising the definition of the term "completion of participation in a distribution," insofar as it applies to distributions of high yield debt securities, where the sophistication of market participants on the "buy" side substantially reduces the ability or incentives to manipulate the price of the security. Under this proposal, an underwriter would be deemed to have completed its participation in a distribution when it has sold substantially all of its participation (for example, 85%). PSA believes that Rule 101 would otherwise unreasonably restrict -- as Rule 10b-6 does now -- an underwriter's bids and purchases (made in order to maintain liquidity for customers who already have purchased the securities being distributed) at a time when "manipulative incentives" have largely dissipated because the underwriter has sold substantially all of its participation and because the purchasers thereof generally have the market sophistication to monitor market activity to detect and deter late-stage attempts at manipulation. V. "Affiliated Purchaser" Rule 101 imposes restrictions on the activities of "affiliated purchasers" of distribution participants as well as the distribution participants themselves. However, if a distribution participant has established, maintained, enforced and reviewed written policies to separate its corporate finance activities conducted in connection with a distribution from the trading operations of its affiliated purchasers, those affiliated purchasers would be exempted from the restrictions. We applaud the Commission for taking the view that Regulation M "should reflect the structural complexity of multi-service financial organizations, the administrative costs incurred by such entities in complying with Rule 10b-6, and the precedents recognizing information barriers as an element of exemptions from Rule 10b-6." (Proposing Release, language accompanying note 48). We strongly support the proposed reliance on "information barriers" in the revised definition of "affiliated purchaser," and the attempt to capture affiliates acting in concert with the distribution participant (Qs 21 and 22) as a basis for omitting the current rule's prohibition of common compensation arrangements (Q 25). In one important respect, however, the exemption exalts form over substance by requiring that the affiliated purchaser be a "separate and distinct organizational entity." PSA requests that the Commission consider expanding the exemption to include areas within an integrated firm where the firm has established, maintained, enforced and reviewed information barriers designed to separate its corporate finance activities from its other activities.17 We note that the Commission considers information barriers to be sufficient by themselves in other important areas of the securities laws -- most notably, for inside information purposes (see Rule 14e-3(b)(2)). This would suggest that where information barriers are in place there should be no need for a "separate and distinct organizational entity" -- whether a legal entity or an administrative entity such as a department or division - - or a prohibition on officer and key employee interlocks (Q 23). PSA also does not believe that an "independent review" needs to be conducted by outside persons (Q 24). It should be sufficient, as stated in the Proposing Release, that the review be conducted by an internal audit or similar group that is in fact independent from -- i.e., does not report to -- the underwriter's corporate financing or trading functions. VI. Other Exceptions A. Odd Lot Exception Rule 101 contains an exception for de minimis transactions that are inadvertent. PSA strongly endorses that exception. PSA believes it would be useful for the rule also to contain an exception similar to an "odd lot" or de minimis exception for bids and purchases that are intentional and not the result of inadvertence (Q 35). Thus, individual bids and purchases in an insubstantial amount in relation to the outstanding securities of the issuer would not tend to promote abuse or manipulation, even if they were intentional. B. Unsolicited Purchases Rule 10b-6 contains an exception (exception (ii)) that PSA believes is widely relied upon in the industry and should be retained (Q 39). The requirement that the customer's offer be unsolicited means that the purchase cannot be planned as part of a manipulative scheme The dealer's ability to execute unsolicited trades will also promote liquidity for investors. VII. Other Matters Exception for Research PSA welcomes the exception in Rule 101 that permits the distribution in the ordinary course of business of research eligible under Rules 138 or 139. The basic purpose of Rules 138 and 139 is to preserve the continuity of research coverage, and Rule 101 should not operate to undermine this purpose. PSA remains troubled, however, by the staff position expressed in the Proposing Release to the effect that the sending by sales personnel of research material to "customers who normally would not receive it in the ordinary course of business" can constitute a solicitation to purchase (text at note 55). In the context of convertible debt or preferred securities, it is not clear whether this statement means that a sales representative cannot send otherwise-eligible research material to a customer during the distribution period without the occurrence of a prohibited "inducement to purchase". Any customer might, in the ordinary course of business, request or be solicited to be placed on a mailing list for a research report, or to be given direction as to how to obtain access to such research (e.g., by being provided with a Firm's internet address where research information might be found). PSA believes that if a customer is not currently on distribution to receive a given category of research which qualifies for an exemption under Rule 138 or 139 of the Securities Act, and if a sales representative mails, sends or otherwise facilitates that customer's obtaining access to the research information once a distribution has commenced, there should be no violation of Rule 101, assuming the report has been prepared and distributed in the ordinary course of business. PSA hereby requests that the SEC clarify that, in connection with the offering of materials exempt under SEC Rules 138 and 139 of the Securities Act, an improper solicitation would occur only when a research report is prepared or distributed outside the ordinary course of business. B. Relationship Between Rules 101 and 102 In view of Rule 102's coverage of affiliates of an issuer and its omission of many of the exceptions included in Rule 101, it is important that the activities of an underwriter that is an affiliate of the issuer be exclusively regulated by Rule 101 and not by Rule 102 (Q 44). Rule 102 should be clarified to make this point explicit. Information barriers between the underwriter and the issuer should not play a role in this area (Q 43) because underwriters and issuers obviously need to communicate regarding a distribution. PSA notes, however, that the potential for abuse in this area is very low because an underwriter's affiliated non- regulated holding company would not itself normally be bidding for or purchasing its debt securities. C. Exception for Transactions Among Underwriters Exception 8(i) covers purchases of securities from an issuer or selling securityholder that are "necessary to conduct the distribution." This phrase creates a new and ambiguous requirement and should be deleted. VIII. Safe Harbor While Rule 10b-6 and proposed Regulation M identify certain conduct that violates the Act's anti- manipulation provisions, neither creates a safe harbor. Conduct that is not specifically proscribed by Rule 10b- 6 or Regulation M may nonetheless be manipulative conduct proscribed by Sections 9(a), 10(b) or 15(c) of the Act or Rule 10b-5 thereunder. PSA believes that the Commission should give greater consideration to creating a safe harbor for transactions that comply with Regulation M, possibly by means of a rebuttable presumption that any distribution participant that acts in accordance with Regulation M should be presumed not to have violated Rule 10b-5 or any of Sections 9(a), 10(b) or 15(c). This would create greater certainty in the marketplace and for market participants as to which transactions are and are not acceptable, thereby promoting market efficiency. IX. Conclusion PSA appreciates this opportunity to provide its views to the Commission. If it would be helpful to the staff and the Commission, we would be most willing to make PSA staff and member firm personnel available to meet and discuss any of the points raised in this letter. Please address any questions or requests for additional information to either of the undersigned at 212/440-9400, or to our special counsel, Joseph McLaughlin of Brown & Wood, at 212/839-5312. Very truly yours, Paul Saltzman Sarah M. Starkweather Senior Vice President and Vice President and General Counsel Associate General Counsel cc: The Honorable Arthur Levitt, Chairman, Securities and Exchange Commission The Honorable Steven M.H. Wallman, Commissioner The Honorable Norman S. Johnson, Commissioner The Honorable Isaac Hunt, Jr., Commissioner Michael E. Schlein, Chief of Staff, Office of the Chairman Richard Lindsey, Director, Division of Market Regulation Robert L.D. Colby, Deputy Director, Division of Market Regulation Larry E. Bergman, Associate Director, Division of Market Regulation Nancy J. Sanow, Assistant Director, Office of Trading Practices Brian J. Lane, Director, Division of Corporation Finance sms/katz4.doc/7/17/96 _______________________________ 1 PSA is the bond market trade association, representing approximately 275 securities firms and banks that underwrite, trade and sell debt securities, both domestically and internationally. Among PSA's members are many of the underwriters that participate in the initial distribution of corporate debt securities, including investment grade and non-investment grade corporate debt securities as well as mortgage and other asset-backed securities. More information about PSA is available on PSA's Internet home page at http://www.psa.com. This letter was prepared in consultation with the Executive Committee, the High Yield Debt Committee and the Legal Advisory Working Group of PSA's Corporate Bond Division. 2 For purposes of this letter, Rules 10b-6, 10b-7, 10b-8 and 10b-21 are referred to collectively as the Trading Practices Rules. 3 Release No. 34-33924 (Apr. 19, 1994) (the "Concept Release"). 4 For purposes of this letter, references to "debt securities" include preferred stock except where the context otherwise requires. 5 Release No. 34-19565 (Mar. 4, 1983) (adopted), Release No. 34-18528 (Mar. 3, 1982) (proposed). 6 The reference to "purchased" should presumably be read to include all "transactions" as that term is used in exception (xii), i.e., all bids, purchases or inducements. 7 In this connection, PSA notes that many other commentators similarly have recommended an exemption for ABS. See Letter from Hardwick Simmons, President and Chief Executive Officer, Prudential Securities, to Chairman Levitt, SEC, dated June 13, 1996; Letter from Richard E. Gutman, Chairman, Committee on Securities Regulation of the Business Law Section of the New York State Bar Association, to Jonathan Katz, Secretary, SEC, dated June 14, 1996; Letter from Robert F. Price, Chairman, Federal Regulation Committee, Securities Industry Association, to Jonathan G. Katz, Secretary, SEC, dated September 12, 1994; Letter from Ralph L. Pellecchio, Principal, Morgan Stanley, to Jonathan G. Katz, Secretary, SEC, dated September 15, 1994. 8 It did, however, inquire as to the circumstances in which "the price of or trading activity in an outstanding bond [would be] likely to be relevant in evaluating a debt security of the same issuer." (Question 1.22). 9 The average daily trading volume ("ADTV") test measures the reported trading volume of the security in question during the preceding three full calendar months. Transactions in securities having an ADTV in excess of $1 million are excepted from Rule 101 as proposed. 10 We recognize, of course, the Commission's view that even large investors deserve the protections of the anti-fraud provisions, but that is not the question presented by Regulation M. Since Regulation M is a prophylactic rule, we believe the Proposing Release correctly asks whether regulatory burdens can be relaxed where the risk of manipulation appears small or the costs of prophylactic restrictions are disproportionate to the purposes to be served. 11 Capital Access Corporation, a consulting, market research and data resources company serving the fixed income market, estimates that the total high yield debt market at year end 1995 was $300 billion, and that approximately $265 billion, or 88%, of the market at that time was held by insurance companies, mutual funds and public pension funds. 12 "'Crossover' Bonds Meet Strong Demand." The Wall Street Journal, June 6, 1996. 13 In any event, subject to the proviso which is always applicable to activities carried out during distributions, that such activities not be "for the purpose of creating actual, or apparent, active trading in or raising the price of" any security subject to the rule or regulation. 14 The focus here would be on customers' making investment decisions (for their own account or for persons for whom they act with discretion) to purchase securities having a purchase price of $250,000 or more. "Authorized denominations" would be irrelevant for two reasons: (i) they are hard to enforce in a book-entry environment, and (ii) they have nothing to do with the size of an order, i.e., an investment decision. The Commission previously has recognized that purchases of options on exempted securities with an underlying principal value of $250,000 or more may be sufficiently large to warrant exclusion from regulation. See Exchange Act Rule 3a12-7. 15 In this regard, PSA notes that an ADTV test, while potentially very helpful for the equity markets, is ill- suited to identify those high-yield securities that should be excluded from Rule 101. First, the recapture of volume data is more difficult for debt securities than for equity securities. Second, a new issue of a high-yield security would not have a 90-day trading history until (in most cases) long after the distribution had terminated. Third, a focus on trading volume ignores the role of institutional participation in the offering as an independent protection against manipulation. 16 We note that at least one other commentator has made a similar observation, although he proposes a lower percentage for the QIB portion of the offering. Letter from Richard E. Gutman, Chairman, Committee on Securities Regulation of the Business Law Section of the New York State Bar Association, to Jonathan Katz, Secretary, SEC, dated June 14, 1996. PSA would support any percentage which the Commission deems reasonable. 17 We note that many other commentators have made a similar observation. See Letter from Phillip M. Colebatch, Chief Financial Officer, and Peter Derendinger, General Counsel, CS Holding, to Jonathan Katz, Secretary, SEC dated June 24, 1996; Letter from Mohan V. Phansalkar, Vice President and Associate General Counsel, Trust Company of the West, to Jonathan Katz, Secretary, SEC, dated June 13, 1996; Letter from Ronald T. Carman, Senior Vice President and Associate General Counsel, Dean Witter Reynolds, Inc., to Jonathan Katz, Secretary, SEC, dated June 20, 1996; Letter from Hardwick Simmons, President and Chief Executive Officer, Prudential Securities, to Chairman Levitt, SEC, dated June 13, 1996.