December 20, 2004
Comments of Feldman Weinstein LLP to File No. SR-NASD-2004-022
The proposed amendments to Rule 2710 relating to shelf offerings address a problem that has not been shown to exist, and they will severely impact the cost of capital for precisely those public issuers least able to afford it.
The proposed amendments will
Increase the cost of capital for all non-exempted issuers, and most severely impact the cost of capital for the roughly 4,000 issuers on the OTCBB.
Penalize investors, over whom the NASDR has no jurisdiction, by making their exit strategies from private investments both less certain and more costly.
Create an expensive paperwork and compliance burden, which does not seem justified, on every brokerage firm and market maker, in search of what we expect will prove to be at most a handful of problematic broker-dealers.
Inundate the NASDRs Corporate Financing Department with filings, which they have not shown the budget or capability of handling. We believe these amendments should not take effect before the NASDR shows the SEC that its ARC system is fully operational and can handle the large number of filings per day, perhaps even more than 100 daily. NASDRs technology record with CobraDesk has been frustrating at best. There is no reason to expect the ARC system to be any better, and given the scope of the rule, without automated clearance, compliance with the rule will functionally close off the opportunity to access the capital markets for issuers with market capitalizations below 150,000,000. Further, NASDRs proposed automated 24 hour turnaround should be reduced to a maximum of 15 minutes so bona fide trades can be executed while the market is still where the selling shareholder intends to sell. If the ARC system is truly automated, 15 minutes should be more than enough time for NASDR to process the submission.
In a typical Commission rulemaking, the staff presents at least anecdotal evidence of a problem before suggesting remedies. In this case, we do not believe NASDR has presented any evidence that member broker-dealers are circumventing the compensation guidelines of Rule 2710 by somehow disguising public offerings as private placements followed by resale registration statements under Rule 415.
Further, by defining every resale of shares off of a resale registration statement as a distribution, the proposed amendments directly contradict the Commissions own stated rationale for adopting Regulation M in place of the antiquated Rule 10b-6, threatening to undo settled law now more than 10 years old. In adopting Regulation M, the Commission stated:
Under Regulation M, each takedown off of a shelf is to be individually examined to determine whether such offering constitutes a distribution i.e., whether it satisfies the magnitude of the offering and the special selling efforts and selling methods criteria of a distribution.
As the Commission noted in the adopting release, under prior Rule 10b-6, the overall size of the shelf registration, and not the individual takedown, was the relevant criteria. We do not believe anything has changed in the market to cause this wholesale reversion to the old Rule 10b-6 way of thinking. While this commenter would not strongly object if the proposed amendments were applied to all primary offerings by issuers, subject to retention of the Market Transactions Exemption, the adverse effects of the proposed amendments will be felt most strongly in the situation of resale registrations for selling shareholders.
It is virtually unknown for purchasers in a private placement for a smaller issuer to engage an underwriter or other agent on a collective basis to actually make a fixed-price distribution of their resale shares. Typically, each holder simply calls his broker when he is prepared to sell. Such sales are made into the open market and are made at the best available price under the full panoply of the Commissions and the SROs trade-through rules and codes of fair practice. It is frequently the case that the broker approached by the selling shareholder does not even know that a sell order consists of registered-for-resale shares until the customer delivers the securities with a prospectus and instructions to re-deliver the prospectus. Thus, under the proposed rules, the broker, acting either as agent or market-maker, may inadvertently fail to comply because it has no idea that the rule is even implicated. The brokerage business is so competitive, particularly for institutional business, that we believe no further price regulation of that business is needed under Rule 2710.
It is an uncommon situation for one broker-dealer to act as placement agent for a private placement, then as a market maker in the stock and then as the selling broker for the selling shareholder. If that is NASDRs concern, NASDR can either ban one firm from acting in all three capacities in the context of a private placement, or it can require that a broker-dealer acting in all three capacities within a six-month period file under Rule 2710 for approval of its aggregated compensation. There is no justification for requiring apparently purposeless filings by broker-dealers who are either unknowing or passive participants in other peoples investment trading or exit strategies. The costs of this paperwork burden will invariably fall to the issuers. These are the very issuers that NASDR is supposedly trying to protect through the very existence of Rule 2710, both through direct contractual reimbursement requirements and through worse transaction terms in capital raising transactions from investors. The investors now will have to price in the risk that they will be unable to take advantage of market opportunities to sell their securities because their brokers have not submitted a filing under Rule 2710 in order to receive their relatively small brokerage commission.
We believe the proposed Market Transactions Exemption, while perhaps making sense in the context of primary distributions by issuers, is far too limited to be of any practical use for selling shareholders. Institutional investors today routinely transact trades of 10 of an issuers daily trading volume over the course of a trading day, and no special selling efforts or methods are required for one brokerage firm to execute trades of such magnitude. We are particularly concerned that the Market Transactions Exemption will not apply at all to OTC Bulletin Board or Pink Sheet stocks, notwithstanding that these issuers will necessarily have an effective registration statement on file with the Commission at the time in question. The mechanical difficulties for basic trade execution which the proposed rule will create for all resale trades literally risks the end of any attractiveness of the OTCBB, by effectively eliminating its issuers ability to raise equity capital. We assume it is not the intent of the Commission or the NASDR to shut down the OTCBB. The Commissions last significant reform of the trading process, the adoption of Regulation SHO, has already succeeded in dramatically raising the effective cost of capital for low-priced and nonbankable issuers. This current proposal, by making any exit from a private placement for an OTCBB company, other than via Rule 144, problematic, will further increase the cost of capital for these issuers, damaging the issuers, their existing shareholders, and their employees. By increasing the execution cost for disposition trades of larger Nasdaq and exchange-listed issuers through the overly-restrictive definition of Market Transactions, the proposed rule will materially increase the cost of capital for these issuers as well.
Without conceding that NASDRs purported concerns underlying this rule are legitimate, if they are concerned that member firms are receiving excessive compensation from public offerings disguised as multi-stage private transactions, this concern can be dealt with without adversely impacting investors and issuers, over whom NASDR has no jurisdiction.
The definition of Takedown in proposed Rule 2710a13 should NOT include any transaction for the account of a selling shareholder unless such transaction is pursuant to a written agreement or oral agreement which provides for costs to the selling shareholder in excess of standard brokerage commissions for agency transactions or markup policies with respect to principal transactions.
The definition of Market Transactions in 2710b10B should eliminate clause ii requirement that security be listed on Nasdaq or an exchange entirely. Clause iiia. should raise the threshold to 20 of ADTV from 2.
All of the Commissions and NASDRs concerns are addressed by the requirement that the sale be unsolicited and the requirements of clause iv that there be no agreement with respect to such sale.
The NASDR already has its markup/markdown rules to address broker compensation for principal transactions IM-2440, and Rule 2440 with respect to reasonable brokerage commission for agency transactions, although in this day and age of on-line trading and prime brokerage for institutional accounts, the brokerage business is so competitive that there should not be regulatory concerns on this matter.
Further, the definition of Market Transactions could be shaped to provide that only if the broker had acted as placement agent for the offering for which securities were registered for resale on the shelf registration in question, then any underwriting compensation as otherwise defined in Rule 2710 within the prior six months would be aggregated with the principal markup and/or brokerage commission to determine if overall compensation was excessive. This way, NASDRs purported concern would be addressed, and innocent bystanders, such as brokers acting on customer orders, would not be hurt in the cross-fire.
For most broker-dealers, the costs of compliance simply in legal fees to make a CobraDesk filing, will outweigh their possible market maker spread or agency commission, which will lead to even less competitive markets for what are already the least-liquid stocks in the public marketplace, with fewer brokers willing to handle such trades. This will lead to added volatility and added opportunities for market manipulation by those still willing to participate.
Instead of this ill-considered proposal, the Commission should direct NASDR to come up with an automated, expedited process for clearing primary shelf distributions. NASDRs 2001 proposal for notice-only filings by underwriters and agents in primary shelf takedowns is the correct direction. NASDR has such a vast array of functionally unreviewable sanctions against its member firms that we believe strongly that it does not need to pre-review every shelf offering to protect issuers.