Mayor, Day, Caldwell & Keeton, L.L.P.
700 Louisiana, suite 1900
Houston, Texas 77002-2778

Telephone (713) 225-7000
Facsimile (713) 225-7047

December 26, 2000

VIA EMAIL AND
TELECOPIER (202) 942-9651

Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: File No. SR-NASD-99-60

Proposed Rule 2790, Restrictions on the Purchase and Sale of Initial Equity Public Offerings Amendment No. 2

Ladies and Gentlemen:

As you know, on October 15, 1999, NASD Regulation, Inc. ("NASD Regulation") filed proposed Rule 2790, "Trading in Hot Equity Offerings," with the U.S. Securities and Exchange Commission (the "Commission"), which was intended to replace Interpretation No. IM-2110-1, the "Free-Riding and Withholding Interpretation" of NASD Conduct Rule IM-2110 (the "Current Rule"). NASD Regulation subsequently filed minor amendments to Proposed Rule 2790 with the Commission on December 20, 1999, and on January 18, 2000, the Commission published the amended version of proposed Rule 2790 (the "First Proposed Rule") in the Federal Register and requested public comments thereon.

Thereafter, the Commission received numerous comment letters from various interested members of the public, including a letter dated March 8, 2000 from our firm, urging certain revisions to the First Proposed Rule to address numerous problems that the First Proposed Rule would have created. The Commission passed all comments it received on to NASD Regulation, and on October 10, 2000, in response to such comments, NASD Regulation filed a second amendment to proposed Rule 2790 (the "New Proposed Rule"), which made substantial changes to the First Proposed Rule, including changing the name of the proposed rule to "Restrictions on the Purchase and Sale of Initial Equity Public Offerings." While the New Proposed Rule makes substantial revisions to the First Proposed Rule, none of those changes alleviates any of the concerns expressed in our firm's March 8, 2000 letter relating to investment activities of passive investment partnerships, and in fact, some of the changes actually exacerbate those concerns.

Specifically, as we more fully describe below, the New Proposed Rule perversely allows investments in "new issues"¹ under the New Proposed Rule by "restricted persons"² when such persons possess the greatest power to capture disproportionate investments in "new issues" and the greatest incentive to do so for their own benefit, while it severely restricts (and effectively forbids) indirect passive investments by "restricted persons" when such persons have the least power and incentive to gain disproportionate investments in such issues. We believe that the New Proposed Rule thus over- and under-regulates investment activities by securities professionals. In our view, the New Proposed Rule would frustrate the stated policy goal of the Current Rule and First Proposed Rule, which we presume is the same policy goal that informs the New Proposed Rule-namely, protecting the integrity of the public offering process by "(1) ensuring that members make a bona fide public offering of securities at the public offering price; (2) ensuring that members do not withhold securities in a public offering for their own benefit or use such securities to reward certain persons who are in a position to direct future business to the member; and (3) ensuring that industry `insiders,' including members and their associated persons, do not take advantage of their `insiders' position in the industry to purchase hot [or new] issues for their own benefit at the expense of public customers."

In the balance of this letter we discuss our concerns with the application the Proposed New Rule to the investment activities of private investment partnerships ("Passive Investment Partnerships") that invest in other investment partnerships³ ("Active Investment Partnerships"). In the next section of this letter, we discuss how the Current Rule applies to such activities. In the section that then follows, we articulate how the New Proposed Rule severely regulates (and in practice will preclude) indirect investments by Passive Investment Partnerships that have "restricted persons" as partners even though those restricted persons have no practical or legal power to control investments of the Active Investment Partnership in "new issues" and even though NASD member firms ("Members") would have little or no incentive to allocate new issues to the Active Investment Partnership as a result of the Passive Investment Partnership's inconsequential beneficial ownership of the Active Investment Partnership. In the last section before we conclude, we briefly discuss how the New Proposed Rule inexplicably allows a portfolio manager of an Active Investment Partnership-who can direct investments to reward allocations of new issues-to have an unlimited beneficial interest in the new issues so allocated to the Active Investment Partnership. Indirect, passive investments are thus over-regulated with no apparent policy benefit, while direct, active investments of portfolio managers in the accounts over which they have investment authority go unregulated.

I: APPLICATION OF THE CURRENT RULE

A. Background. As explained in our firm's March 8, 2000 letter, our firm represents Passive Investment Partnerships that fall within the definition of a "collective investment account" in both the First Proposed Rule and the New Proposed Rule. Most of these Passive Investment Partnerships are owned in part by persons who are "restricted persons" under Section (a)(11)(D) of the First Proposed Rule and Section (i)(10)(D)(i) of the New Proposed Rule. The restricted persons own, in the aggregate, anywhere from 7% to 70% of the interests in the capital of the Passive Investment Partnerships, but generally less than 10% of such interests.

As we indicated above, these Passive Investment Partnerships do not directly invest in "new issues." Rather, they invest in Active Investment Partnerships, which may invest in new issues from time to time. However, neither the restricted persons who own interests in the Passive Investment Partnerships, nor the Passive Investment Partnerships themselves, are "affiliates" or "associates"⁴ of the managers or general partners of the Active Investment Partnership-or, for that matter, the Active Investment Partnership itself. They have no legal or practical power to influence, much less to direct or veto, any investment that the manager or general partner of the Active Investment Partnership wishes to make. In all cases, the Passive Investment Partnership (and the restricted persons who manage and invest in it) do not even know what investments the managers or general partners of the Active Investment Partnerships have made in any given issue until the end of a quarterly reporting period, and frequently not even then. Moreover, the investment by any given Passive Investment Partnership in an Active Investment Partnership never represents 10% or more of the interests in the capital of the Active Investment Partnership; almost always the interests represent far less than 5% of the total interests in the capital of the Active Investment Partnership. Thus, in a typical case, the restricted persons in the Passive Investment Partnership would have an indirect interest of less than 1% (and most often less than 0.5%) in any given investment, without taking into account the dilutive effects of any special or profits allocations to the managers or general partners of the Active Investment Partnership.⁵

Plainly, even if the manager or general partner of an Active Investment Partnership would turn over the list of partners to a Member who had a new issue to allocate to the Active Investment Partnership-a disclosure that is not routinely or willingly made in our experience-the Passive Investment Partnership and the restricted persons who invest in it do not have sufficiently large economic interests in any given allocation to induce them to "reward" the Member for making an allocation to the Active Investment Partnership.⁶ Even more importantly, since neither the Passive Investment Partnership nor the restricted persons who manage and invest in it have any control over (or even knowledge of) any given investment by the Active Investment Partnership, the Member has no incentive to reward them for investments made by the Active Investment Partnership.

B. Current Rule Does Not Forbid Such Passive Investments. The Current Rule wisely recognizes that the investments of the sort we have described do not harbor the prospect for the abuse that the Current Rule, the First Proposed Rule or New Proposed Rule are intended to combat-namely, disproportionate allocations of new (or hot) issues by Members to investment professionals and others who can reward them with business. To date, these Passive Investment Partnerships⁷ and the restricted persons who invest in them⁸ have been able to rely on Section (b)(5) of the Current Rule (which we will refer to as the "Conditionally Restricted Person Exception"⁹), so that allocations to them will not be limited if:

(i) the restricted persons in question are finders or certain fiduciaries or, more importantly for our purposes, are senior officers of banks, savings and loans, insurance companies, investment companies, investment advisory firms, institutional accounts or persons in the securities departments of such institutions¹⁰ and certain others ("conditionally restricted persons");

(ii) the securities sold to the conditionally restricted person are sold to them in accordance with the conditionally restricted person's normal investment practice;

(iii) the amount of securities sold to any one conditionally restricted person is insubstantial in amount; and

(iv) the Member's aggregate sales to conditionally restricted persons is insubstantial and not disproportionate in amount as compared to sales to other members of the public.

Each one of these conditions must be met in order for the Conditionally Restricted Person Exception to apply, and these conditions collectively address in the context of investments by Passive Investment Partnerships the concerns that led to the promulgation of the Current Rule, First Proposed Rule and New Proposed Rule. First, the scope of the exception is narrowly tailored to cover only certain persons, none of whom are broker/dealers or their dependents. Second, the exception tests for the indicia of reward: the investment by the account in which the conditionally restricted person invests must not be out of the ordinary (normal investment practice) and the investment itself must be insubstantial. Finally, the allocation to those covered by the exception must be so insubstantial as not to affect the bona fide public offering nature of the hot (now new) issue. The type of investment practices that we described above with respect to Passive Investment Partnerships certainly met not only the letter, but also the spirit, of the Conditionally Restricted Person Exception.

II: APPLICATION OF THE NEW PROPOSED RULE TO PASSIVE INVESTMENT PARTNERSHIPS

A. New Proposed Rule Unjustifiably Eliminates Exception. As discussed above, the Conditionally Restricted Person Exception more than adequately addressed the concerns that led to the promulgation of the Current Rule, the First Proposed Rule and the New Proposed Rule, particularly with respect to Passive Investment Partnerships. Yet the First Proposed Rule and the Second Proposed Rule would eliminate the Conditionally Restricted Person Exception, even as applied to the Passive Investment Partnerships that we described above. The only rationale NASD Regulation offered for its decision to eliminate the Conditionally Restricted Person Exception is that many of the persons treated as conditionally restricted under the Current Rule could be in a position to direct business to a Member, a characteristic which NASD Regulation does not believe can be offset by other countervailing characteristics "such as `normal investment practice.'" We believe that NASD Regulation has taken far too limited a view of the Current Rule; after all, as we discussed above, "investment history" is but one of a number of criteria that must be satisfied to lay claim to the benefit of the Conditionally Restricted Person Exception. Nor does NASD Regulation offer any evidence that Passive Investment Partnerships have created any of the problems that prompted it to propose the First Proposed Rule or the New Proposed Rule. Rather, it appears that all passive investments of senior officers and investment professionals associated with certain institutions will be severely limited merely because they can direct investments, even though the passive investment activity itself is not of the type that would prompt a "reward" or induce them to direct investment business. In essence, the First Proposed Rule and New Proposed Rule offer a dramatically new regulatory scheme for Passive Investment Partnerships merely because of the status of the conditionally restricted persons, even though that status has not been shown, in fact, to lead to abusive investment activity and even though persons having that status do not have the incentives to alter their investment behavior.

B. The New Proposed Rule Sweeps Far More Broadly Than Is Warranted. The New Proposed Rule abolishes the Conditionally Restricted Person Exception and replaces it with a flat, bright-line 5% rule pursuant to which new issues may be sold to a collective investment account beneficially owned in part by restricted persons, provided that such restricted persons in aggregate own less than 5% of such account. The New Proposed Rule further restricts purchases by restricted persons by providing that no restricted person included within the 5% limitation may manage or otherwise direct investments in the collective investment account and that no such restricted person who is a natural person may receive, on a pro rata basis, one hundred (100) or more shares of any new issue (all such restrictions collectively, the "5% Rule").

What makes the 5% Rule particularly harsh is the scope of beneficial interests included for purposes of the 5% limitation under the New Proposed Rule, for as we understand the 5% Rule, the beneficial interests of all restricted persons with any beneficial interest, whether direct or indirect, in a collective investment account that desires to purchase a new issue are aggregated for purposes of determining whether the collective investment account is eligible to purchase new issues under the 5% Rule. Thus, consider the example where a restricted person has a 10% interest in Fund A, Fund A has a 10% interest in Fund B and Fund B has a 10% interest in Fund C. If Fund C desires to purchase a new issue, such restricted person will be deemed to have a 0.10% (10% x 10% x 10%) interest in Fund C, and such 0.10% interest will be aggregated with the interests of all other restricted persons in Fund C for purposes of determining whether Fund C is eligible to purchase new issues under the 5% Rule.

If this correctly illustrates the application of the 5% Rule, we believe the scope of beneficial interests included under the 5% Rule, and thus, the scope of persons covered by the 5% Rule, is far wider than necessary to curtail the kind of activity that led to the adoption of the Current Rule, the First Proposed Rule and the New Proposed Rule. Consider, for example, the typical investment activity of Passive Investment Partnerships that we referenced above. As we mentioned previously, these Passive Investment Partnerships hold less than 10% of the Active Investment Partnership (the collective investment account for the initial application of the 5% Rule), and the conditionally restricted persons will own 5%-70% of the interests in the capital of the Passive Investment Partnership, but most often 10% or less of the such interests in capital. As we understand the 5% Rule in application, the 10% of less than a 10% investment in the Active Partnership-or slightly less than 1%--will be counted, meaning that the Active Partnership has only 4% left to be allocated to other restricted persons.

All conditionally restricted persons are thus lumped together and cordoned off, even if their investment takes the form of a highly restricted interest that, as we argued above, eliminates the possibility for rewards or disproportionate allocation that the Current Rule, the First Proposed Rule and New Proposed Rule were supposedly designed to prevent. Again, we note that the Passive Investment Partnerships about which we write do not directly invest in "new issues;" neither the conditionally restricted persons who own interests in the Passive Investment Partnerships, nor the Passive Investment Partnerships themselves, are "affiliates" or "associates" of the managers or general partners of the Active Investment Partnership or the Active Investment Partnership itself; they have no legal or practical power to influence any investment that the manager or general partner of the Active Investment Partnership wishes to make; the Passive Investment Partnership (and the restricted persons who manage and invest in it) do not even know what investments the managers or general partners make at the time of such investments; and the investment by any given Passive Investment Partnership in an Active Investment Partnership never represents 10% or more of the interests in the capital of the Active Investment Partnership. Obviously, in such circumstances, the remote and limited interests of the conditionally restricted person and the incentives of the Member are far too attenuated to warrant a conclusion that the restricted person will direct investments to a Member, or that a Member will allocate a new issue to an Active Investment Partnership because of the tangential investment by the conditionally restricted person.¹¹

Yet, even with all of these restrictions, under the proposed 5% Rule the interests of conditionally restricted persons the Passive Investment Partnership must be lumped together with interests of other conditionally restricted persons. In the discussion of the 5% Rule contained in the comments to the New Proposed Rule, NASD Regulation acknowledges that several commenters urged that the original formulation of the 5% Rule contained in the First Proposed Rule be revised to provide a passive investor exemption. In summarily rejecting such suggestions, the only rationale offered by NASD Regulation is that, "a passive investor exemption would allow restricted persons to circumvent the purposes of the rule by having such purchases made on their behalf by a portfolio manager."

The problem with this rationale is that it presupposes the ability of the restricted persons to direct the investment decisions of the portfolio manager. As we have discussed several times above, we do not see how the conditionally restricted persons investing in the Passive Investment Partnerships described above would have that power. We are not aware of one partnership agreement or other organizational document of an Active Investment Partnership that confers such power. Indeed, those documents generally give the managers or general partners of the Active Investment Partnership broad investment discretion. Moreover, participation in the business operations by the Passive Investment Partnership could very well expose the partnership or its partners to certain liabilities or obligations. Further, the interests of the Passive Investment Partnership, and certainly of the conditionally restricted persons, that we described above are not of the size or nature that would be sufficient to raise any presumption of control or influence under other regulations of the Securities Exchange Commission or NASD.¹²

Even more to the point, this rationale assumes that the restricted persons with a remote interest through a Passive Investment Partnership would want to benefit not only themselves but every other partner in the Passive Investment Partnership and Active Investment Partnership. The Member that intends to benefit the conditionally restricted person in a Passive Investment Partnership would be providing its "reward"-that is, an allocation of a new issue-to an Active Investment Partnership in which the Passive Investment Partnership has, by our definition above, less than a 10% interest. Thus, 90% of the reward benefit goes other partners. Moreover, the conditionally restricted persons in the Passive Investment Partnerships we describe above do not have 100% of the interests in the Passive Investment Partnerships, so the reward is further diluted.

Finally, the rationale presumes that the restricted person would direct the future securities business of the institution of which he or she is an officer or employee in order to gain less (and generally substantially less) than 10% of the reward that the Member is providing by the allocation to the Active Investment Partnership. No fewer or less important fiduciary duties would be violated in such an instance than would be violated by the hedge fund manager referenced in Wilkie Farr & Gallagher's January 28, 2000 letter to Jonathan G. Katz of the Commission and cited by NASD Regulation in the comments to the New Proposed Rule to support NASD Regulation's exemption for portfolio managers. As the Wilkie Farr letter noted, fiduciary duties prevent a hedge fund manager from profiting from new issues personally at the expense of hedge fund investors. By the same reasoning, similar, if not identical fiduciary duties, would prevent a conditionally restricted person from directing investments on behalf of his or her employer (e.g. an insurance company or bank) in order to profit personally through the Passive Investment Partnership. The restricted person would have to violate the fiduciary duties he or she owes to the entity he or she works for or is associated with, thereby risking his or her career as a securities professional. This seems to be an extremely high risk to undertake for a relatively modest potential gain.

We therefore, respectfully submit that the 5% Rule sweeps far too broadly by regulating investment activity that demonstrably poses none of the mischief that the New Proposed Rule is designed to regulate.

C. The New Proposed Rule Allows Investment Professionals To Benefit Directly from Allocations of New Issues Where They Can Reward or Be Rewarded by Members. Even as the New Proposed Rule severely restricts the ability of conditionally restricted persons indirectly to participate in new issue investments over which they have no control and limited economic interests, the New Proposed Rule greatly relaxes the regulation of investments by portfolio managers. Under the New Proposed Rule, a "portfolio manager" is a "person who has the authority to buy or sell securities for a bank, savings and loan institution, insurance company, investment company, investment advisor, or collective investment account." Such persons are generally considered to be "restricted persons" for purposes of application of the 5% Rule except "with respect to a beneficial interest in the bank, savings and loan institution, insurance company investment company, or collective investment account over which such person has investment authority." Thus, oddly, the managers and general partners of an Active Investment Partnership have no effective limitation on the size of their interests in the Active Investment Partnership, even though they are making decisions to invest the Active Investment Partnership's funds in various investments brought to them by a Member and even though the Member has great incentive to reward the manager or general partner for those investments. So, the New Proposed Rule restricts passive investments already highly restricted by the very nature of such investments, and yet at the same time, it carves out of the definition of "restricted person" and thus, out of the scope of application of the 5% Rule, the one group of (otherwise) restricted persons-namely portfolio managers-in the one circumstance in which such persons have the greatest incentive to direct investments to, and reap direct rewards from, Members.

Suffice it to say that we are not advocating greater regulation for portfolio managers than the Current Rule imposes. But certainly we cannot see how the articulated purposes of the New Propose Rule are served by wholly exempting the interests of persons in collective investment accounts in which they have a beneficial interest and over which they have direct investment authority, while greatly regulating truly passive investment accounts. At a minimum, the same legal and contractual limitations that prompted NASD Regulation to exempt the interests of portfolio managers from regulation clearly apply (and with greater force) to the activities of conditionally restricted persons who invest through a Passive Investment Partnership.

III: THE NEW PROPOSED RULE SHOULD BE REVISED SO THAT IT ADDRESSES THE MISCHIEF THAT IT IS INTENDED TO REGULATE

A. Overview. We thus believe that the New Proposed Rule oddly does not regulate circumstances where an investment professional has the greatest ability, as well as the greatest incentive, to direct investments and receive rewards, even as it severely regulates circumstances where such power and incentive are lacking. Whatever the merits of the portfolio manager exception, we respectfully submit that, at a minimum, the New Proposed Rule should be revised to remove the interests held by conditionally restricted persons in Passive Investment Partnerships from any computation used to calculate limitations on investments where the circumstances demonstrate that the Member will not be making an allocation of new issues to reward investment decisions by the conditionally restricted person. Specifically, we believe that the New Proposed Rule should reincorporate the Conditionally Restricted Person Exception or, alternatively, incorporate a new passive investor test to eliminate regulation of activity that does not pose the prospect for the evils that the New Proposed Rule ostensibly is designed to regulate.

B. Retain the Conditionally Restricted Person Exception. For the reasons that we discussed in Section I.B. above, we believe that, as applied to the activities of Passive Investment Partnerships, the Conditionally Restricted Person Exception already contains sufficient safeguards against abuses that the Current Rule, the First Proposed Rule and the New Proposed Rule were fashioned to prevent. Only certain restricted persons may claim the benefit of the exception, the investments must be historically normal and insubstantial, and the allocations to the conditionally restricted persons must be insubstantial. Nothing we have read in the various proposing releases has suggested that these restrictions have proven inadequate to the task of preventing disproportionate allocations or improper reward behavior insofar as Passive Investment Partnerships are concerned. Indeed, as we state in Section II.B., we understand that the Current Rule is being revised because of the theoretical possibility that a conditionally restricted person might be tempted to reward a Member through the investment activities in which the conditionally restricted person engages outside of collective investment account as to which an allocation of a new issue is made. However, the Current Rule contains several limitations that make the prospect of the reward that a conditionally restricted person will receive too minimal and too attenuated to stimulate the investments that the reward supposedly would attract. Certainly that is especially true in the context of Passive Investment Partnership investment activities, as we more fully describe above. Accordingly, we urge that the Conditionally Restricted Person Exception be retained with respect the participation of Passive Investment Partnerships in Active Investment Partnerships.

C. Narrow the New Proposed Rule to Regulate the Mischief That the Rule Is Intended to Prevent. While the foregoing approach has the virtue of simplicity, we would be the first to acknowledge that it lacks the benefits of a bright line test. Of course, having no bright line test is better than having a test that proscribes or regulates behavior that poses no articulated regulatory harm. That said, we can readily envision several tests that would limit the kinds of investment behavior that would create the possibility for abuse that the New Proposed Rule is intended to prevent, would provide bright lines for the regulated and the regulator and would carve out investment activity that should not be subject to the New Proposed Rule.

We suggested one possible approach in our March 8, 2000 letter. Specifically, under our prior proposal (as adapted for the New Proposed Rule), the New Proposed Rule would be modified to provide that: (i) in applying the 5% Rule, only the beneficial interest of restricted persons who are direct owners or "affiliates" of the collective investment account that directly purchases the New Issue (the "Purchaser Collective Investment Account"¹³) would be included within the 5% limitation; (ii) to the extent that any direct owner or the Purchaser Collective Investment Account is itself a collective investment account (an "Owner Collective Investment Account"¹⁴) but is not itself a restricted person, the beneficial interest of its restricted person owners would only be included when such Owner Collective Investment Account is an "affiliate" of the Purchaser Collective Investment Account; and (iii) the less-than-100-share limitation would only apply with respect to restricted persons whose beneficial interests must be included within the 5% limitation pursuant to (i) or (ii). For these purposes, a person or entity should be deemed to be an "affiliate" of the Purchaser Collective Investment Account only where such person or entity owns 10% or more of the Purchaser Collective Investment Account or otherwise has the power to control the operations or investment decisions of the Purchaser Collective Investment Account.¹⁵

What we propose, of course, is nothing more than a passive investor exemption. The rationale for such an exemption is straightforward: without control over the investment decisions of the Purchaser Collective Investment Account by the restricted persons whose interests are in question, the chances that an effective "rewards" system of the type the 5% Rule is intended to prevent between Members and such restricted persons are too remote to warrant or justify regulation. In this regard, we note that under our proposed passive investor exemption, the maximum beneficial interest any one restricted person could have in a Purchaser Collective Investment Account's allocation of a New Issue would be just under 10%. In order to get to that figure, the restricted person would have to own 100% of the beneficial interest in an Owner Collective Investment Account that had a beneficial interest of just under 10% in the Purchaser Collective Investment Account. While this might be possible, far more common would be Owner Collective Investment Accounts with multiple owners and smaller beneficial interests in Purchaser Collective Investment Accounts, so that the beneficial interest of any one restricted person owner in a Purchaser Collective Investment Account's allocation of a new issue would be substantially less than 10%.¹⁶

Moreover, while the potential gain from such a reward is thus so small as to be unlikely to induce directed investments, the Member cannot be assured that any reward will reach its intended beneficiary. First and foremost, the Member would need to overcome the barrier of anonymity. To reward effectively, the Member must be able to identify the Owner Collective Investment Accounts in which the intended restricted person beneficiary has a beneficial interest, as well as the Purchaser Collective Investment Accounts in which such Owner Collective Investment Accounts have a beneficial interest. However, generally, a Member selling new issues will not know the identity of the owners of a Purchaser Collective Investment Account, let alone the identity of the owners of any Owner Collective Investment Accounts. Thus, in the absence of affirmative collusion between the Member and the intended restricted person beneficiary pursuant to which such restricted person discloses his or her portfolio to the Member, any success the Member may have in skewing its allocation of a new issue in favor of accounts in which such restricted person has a beneficial interest would likely be due to pure chance.

Even if the anonymity barrier can be overcome, whether through collusion, chance or otherwise, the restricted person must still be able to steer future business to the Member in return for the Member allocating new issues to accounts in which the restricted person has a beneficial interest in order for the reward system to work. Clearly under the circumstances in which our proposed exemption would apply, the restricted person could not direct future business of the Purchaser Collective Investment Account to the Member, for if the restricted person is in a position to do so, he or she would be deemed to be an "affiliate" of the Purchaser Collective Investment Account, in which case our proposed exemption would not apply to the restricted person. In addition, for the reasons that we stated elsewhere as to the Conditionally Restricted Person Exception, the restricted person is not likely to perceive an allocation as a "reward" if he or she must forfeit over 90% of the "reward" to others. And, as we noted above, the restricted person must be driven to capture less than 10% of the reward in violation of his or her fiduciary duties and at great risk to his or her continued participation in the securities business.¹⁷

Nevertheless, even if the anonymity barrier can be overcome, whether through collusion, chance or otherwise, and even if the restricted person is willing to risk his or her career as a securities professional by violating the fiduciary duties he or she owes to the entity he or she works for or is associated with, the Purchaser Collective Investment Account must still actually purchase the New Issues it is offered by the Member in order for the rewards system to work. However, as noted above, under the circumstances in which our proposed exemption would apply, the restricted person has no ability to control the investment decisions of the Purchaser Collective Investment Account. Under such circumstances, there is no guarantee that a Purchaser Collective Investment Account will actually purchase the new issues offered to it by the Member. Thus, even if the Member and the restricted person are willing to collude, and even if the restricted person is willing to risk his or her career as a securities professional, the ultimate success of a rewards system would still depend on the investment decisions of an entity over which neither the Member nor the restricted person has any control.

IV: CONCLUSION

In light of what we argue above, we respectfully urge that the New Proposed Rule not be approved in its current form, for it regulates investment behavior by Passive Investment Partnerships posing no threat to the policy supporting the rule. We believe that the Conditionally Restricted Person Exception in the Current Rule as applied to Passive Investment Partnerships adequately addresses any potential for abuses of the sort that the New Proposed Rule is intended to regulate. Alternatively we believe that an exception narrowly tailored to address such abuses along the lines that we have proposed should be incorporated into the New Proposed Rule. Certainly it strains credulity to suggest that a passive investor exemption as described above would pose any greater risk of abuse to the public offering process than the portfolio manager carve out in the New Proposed Rule. In any event, we suggest that either the current Conditionally Restricted Person Exception or a specially crafted passive investor exception from the coverage of the 5% Rule as we have suggested above addresses all of the concerns that have been advanced as supporting the adoption of the New Proposed Rule, but without the over-inclusion characteristic of the New Proposed Rule.

Please contact Jeff C. Dodd (713-225-7726) or George Jones (713-225-7736) of this firm with any questions you may have with respect to this letter. We thank you in advance for your consideration of our comments.

Sincerely,

MAYOR, DAY, CALDWELL & KEETON, L.L.P.

Footnotes