
[Federal Register: May 13, 2009 (Volume 74, Number 91)]
[Notices]               
[Page 22600-22611]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13my09-95]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59880; File No. SR-FINRA-2007-009]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change and Amendment 
No. 1 Thereto To Modernize and Simplify NASD Rule 2720

May 7, 2009.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on September 6, 2007, Financial Industry 
Regulatory Authority, Inc. (``FINRA'') (f/k/a National Association of 
Securities Dealers, Inc. (``NASD'')) filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission''), and amended on May 1, 
2009,\3\ the proposed rule change as described in Items I, II, and III 
below, which Items have been substantially prepared by FINRA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ This Amendment No. 1 to SR-FINRA-2007-009 replaces and 
supersedes the original filing submitted on September 6, 2007, 
except with regard to Exhibit 2 (NASD Notice to Members 06-52 and 
comments received in response to NASD Notice to Members 06-52).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to modernize and simplify NASD Rule 2720 
(Distributions of Securities of Members and Affiliates--Conflicts of 
Interest) (``Rule

[[Page 22601]]

2720'' or ``Rule''), which governs public offerings of securities in 
which a member with a conflict of interest participates, and make 
corresponding changes to FINRA Rule 5110 (Corporate Financing Rule) 
(``Rule 5110'').
    Amendment No. 1 to SR-FINRA-2007-009 makes certain changes to the 
original filing of September 6, 2007 to address the Commission staff's 
comments. The proposed rule change replaces and supersedes the proposed 
rule change filed on September 6, 2007 in its entirety, except with 
regard to Exhibit 2, NASD Notice to Members 06-52 and comments received 
in response to NASD Notice to Members 06-52.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA 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. FINRA 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

1. Purpose
    Rule 2720 governs public offerings of securities issued by 
participating members or their affiliates, public offerings in which a 
member or any of its associated persons or affiliates has a conflict of 
interest, and public offerings that result in a member becoming a 
public company. The Rule regulates the potential conflicts of interest 
that exist with respect to the pricing of such offerings and the 
conduct of due diligence when a member participates in such offerings.
    In September 2006, FINRA published NASD Notice to Members 06-52 
requesting comment on proposed amendments to Rule 2720 (the ``original 
proposal''). FINRA received two comment letters that generally 
supported the proposal and recognized the need to modernize the 
Rule.\4\ However, in response to the comments received, FINRA staff 
made certain revisions to the original proposal in its September 6, 
2007 filing with the Commission. In order to address Commission staff's 
comments, FINRA filed Amendment No. 1 to SR-FINRA-2007-009 on May 1, 
2009.
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    \4\ Letter from the Securities Industry and Financial Markets 
Association, dated November 1, 2006 (the ``SIFMA Letter''); and 
Letter from the American Bar Association, dated December 4, 2006 
(the ``ABA Letter'').
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    The proposed rule change would replace the current Rule in its 
entirety with proposed Rule 2720 entitled ``Public Offerings of 
Securities With Conflicts of Interest.'' Some of the more significant 
amendments that FINRA is proposing in this proposed rule change are to: 
(1) Exempt from the filing and qualified independent underwriter 
(``QIU'') requirements public offerings of investment grade rated 
securities, public offerings of securities that have a bona fide public 
market, and public offerings in which the member primarily responsible 
for managing the offering does not have a conflict of interest and can 
meet the disciplinary history requirements for a QIU; (2) Amend the 
definition of ``conflict of interest'' to include public offerings in 
which at least five percent of the offering proceeds are directed to a 
participating member or its affiliates; (3) Modify the Rule's 
disclosure requirements to provide more prominent disclosure of 
conflicts of interest in the offering documents; and (4) Amend the 
Rule's provisions regarding the use of a QIU to focus on the QIU's due 
diligence responsibilities and eliminate the requirement that the QIU 
render a pricing opinion. In addition, the proposed rule change would 
amend the QIU qualification requirements to focus on the experience of 
the firm rather than its board of directors, prohibit a member from 
acting as a QIU if it would receive more than five percent of the 
proceeds of an offering, and lengthen from five to ten years the amount 
of time that a person involved in due diligence in a supervisory 
capacity must have a clean disciplinary history. These and the other 
proposed amendments are discussed in greater detail below.
a. Proposed Rule 2720 Generally
    Proposed Rule 2720(a) provides that no member that has a conflict 
of interest may participate in a public offering unless the offering 
meets one of the exemptions set forth in paragraph (a)(1) or a QIU 
participates in the offering pursuant to paragraph (a)(2).
b. Offerings Exempt From the QIU and Filing Requirements Under 
Paragraph (a)(1)
    First, FINRA is proposing an exemption from the QIU and filing 
requirements for public offerings in which the member primarily 
responsible for managing the offering (e.g., the book-running lead 
manager or lead placement agent) does not have a conflict of interest, 
is not an affiliate of a member that has a conflict of interest, and 
can meet the disciplinary history requirements for a QIU under proposed 
paragraph (f)(12)(E).\5\ FINRA staff believes that a QIU should not be 
required for such offerings because the book-running lead manager or 
lead placement agent (or member acting in a similar capacity), which 
does not have conflict of interest, would be expected to perform the 
necessary due diligence that would otherwise be required of a QIU.\6\
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    \5\ See proposed Rule 2720(a)(1)(A).
    \6\ All syndicate members have due diligence responsibility, but 
the book-runner(s) in a firm commitment offering and the lead 
placement agent(s) in a best efforts offering typically hire outside 
counsel to help members meet their due diligence obligations.
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    In response to comments on the original proposal,\7\ FINRA has 
amended this provision to clarify that it would apply to public 
offerings in which there are joint books or that are best efforts 
offerings. However, where there are two or more co-lead managers or co-
lead placement agents that have equal responsibilities with regard to 
due diligence, each would need to be free of conflicts of interest. Due 
to the important role a book-runner or dealer-manager can be expected 
to play in the due diligence process in an offering, even if that 
responsibility is shared equally with other members, the Rule's QIU 
provisions would apply and the offering would have to be filed for 
review if any book-runner or dealer-manager has a conflict.
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    \7\ SIFMA Letter.
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    Second, FINRA is proposing an exemption from the QIU and filing 
requirements for public offerings of securities that have a bona fide 
public market.\8\ The current Rule exempts public offerings of 
securities for which there is a ``bona fide independent market'' from 
Rule 2720's QIU requirement, but not the filing requirement.\9\ The 
proposed rule change

[[Page 22602]]

would replace the term ``bona fide independent market'' with ``bona 
fide public market,'' which is defined in proposed Rule 2720(f)(3) in 
accordance with the numerical standards set forth in SEC's Regulation 
M.\10\ Specifically, ``bona fide public market'' is defined in the 
proposal as a market for a security issued by a company that has been 
reporting under the Exchange Act for at least 90 days, is current in 
its reporting requirements and whose securities are listed on a 
national securities exchange with an average daily trading volume of at 
least $1 million, provided that the issuer's common equity securities 
have a public float value of at least $150 million. One commenter 
expressed strong support for the proposed definition of ``bona fide 
public market.'' \11\
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    \8\ See proposed Rule 2720(a)(1)(B).
    \9\ ``Bona fide independent market'' is defined in current Rule 
2720(b)(3) as a market in a security that is listed on a national 
securities exchange or Nasdaq with a market price of $5 per share, 
aggregate trading volume of 500,000 shares over 90 days and a public 
float of 5 million shares.
    \10\ 17 CFR 242.100 to 105.
    \11\ ABA Letter.
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    Third, FINRA is proposing to exempt from the filing requirement, 
and to retain the existing exemption from the QIU requirement for, 
public offerings of investment grade rated securities and securities in 
the same series that have equal rights and obligations as investment 
grade rated securities.\12\ In response to comments on the original 
proposal,\13\ FINRA has proposed to define ``investment grade rated'' 
in proposed Rule 2720(f)(8) to refer to securities that are rated by a 
nationally recognized statistical rating organization in one of its 
four highest generic rating categories. This definition is consistent 
with the definition proposed by FINRA in SR-NASD-2004-022 relating to 
the filing requirements and the regulation of public offerings of 
securities registered with the Commission and offered by members 
pursuant to Securities Act Rule 415 (the ``proposed shelf 
amendments'').\14\
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    \12\ See proposed Rule 2720(a)(1)(C). Thus, proposed Rule 
2720(a)(1)(C) would apply to public offerings of securities that 
have not received an individual rating, but are of the same class or 
series and are considered ``pari passu'' with other investment grade 
rated securities issued by the same company.
    \13\ ABA Letter.
    \14\ See Exchange Act Release No. 50749 (November 29, 2004), 69 
FR 70735 (December 7, 2004) (notice of filing of SR-NASD-2004-022) 
and Amendment No. 5 (filed on August 31, 2007), available at http://
www.finra.org/Industry/Regulation/RuleFilings/2004/P036671.
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    The three types of public offerings enumerated in paragraphs 
(a)(1)(A) through (a)(1)(C) of proposed Rule 2720 would not be subject 
to the QIU requirements of the proposed Rule and, by operation of 
proposed Rule 2720(d), they would not be subject to the filing 
requirements of Rule 5110 (formerly NASD Rule 2710).\15\ They would be, 
however, subject to the other provisions of proposed Rule 2720, e.g., 
the escrow and discretionary account requirements in paragraphs (b) and 
(c) respectively, if applicable. Additionally, these public offerings 
would be subject to certain disclosure requirements. Proposed Rule 
2720(a)(1) would require prominent disclosure of the nature of the 
conflict of interest in the prospectus, offering circular or similar 
document for the public offering.
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    \15\ On September 11, 2008, the Commission approved proposed 
rule change SR-FINRA-2008-039, in which FINRA proposed, among other 
things, to adopt NASD Rule 2710 as Rule 5110 in the Consolidated 
FINRA Rulebook. See Exchange Act Release No. 58514 (September 11, 
2008), 73 FR 54190 (September 18, 2008). SR-FINRA-2008-039 was 
implemented on December 15, 2008. See Regulatory Notice 08-57 
(October 2008).
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    In response to the original proposal, one commenter requested 
clarification regarding the ``prominent disclosure'' requirement in the 
proposed Rule.\16\ Proposed Rule 2720(f)(10) provides a description of 
how a member may make ``prominent disclosure'' for purposes of 
paragraphs (a)(1) and (a)(2)(B). Specifically, a member could make the 
notation ``(Conflicts of Interest)'' following the listing of the Plan 
of Distribution in the Table of Contents section required in Item 502 
of SEC Regulation S-K, and provide such disclosures in the Plan of 
Distribution section required in Item 508 and any Prospectus Summary 
section required in Item 503 of SEC Regulation S-K. For offering 
documents not subject to SEC Regulation S-K, ``prominent disclosure'' 
could be made by providing disclosure on the front page of the offering 
document that a conflict exists, with a cross-reference to the 
discussion within the offering document and in the summary of the 
offering document if one is included. These methods of disclosure would 
be considered a non-exclusive safe harbor for effecting ``prominent 
disclosure,'' and FINRA would consider alternative--but equally 
prominent--disclosures on a case-by-case basis.
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    \16\ ABA Letter.
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c. Offerings in Which a QIU Must Participate Under Paragraph (a)(2)
    If a member with a conflict of interest participates in a public 
offering that does not meet the conditions of proposed Rule 2720(a)(1), 
then proposed Rule 2720(a)(2)(A) would require that a QIU participate 
in the preparation of the registration statement and the prospectus, 
offering circular or similar document and exercise the usual standards 
of ``due diligence'' with respect thereto.\17\
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    \17\ The requisite qualifications of a QIU are set forth in the 
definition of ``qualified independent underwriter'' in proposed Rule 
2720(f)(12), which is discussed in greater detail below.
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    Like proposed Rule 2720(a)(1), proposed Rule 2720(a)(2)(B) would 
require ``prominent disclosure,'' as defined in proposed Rule 
2720(f)(10), in the prospectus, offering circular or similar document 
of the nature of the conflict of interest. In addition, proposed Rule 
2720(a)(2)(B) would require disclosure of the name of the member acting 
as QIU and a brief statement regarding the role and responsibilities of 
the QIU. The disclosure requirements contained in current Rule 2720(d) 
require that, among other things, the offering documents expressly 
state that the member acting as QIU (if one is required for the 
offering) is assuming its responsibilities in pricing the offering and 
conducting due diligence. In response to commenters' concerns that such 
a statement potentially could give rise to liability on the part of the 
QIU,\18\ FINRA is proposing to replace this disclosure requirement with 
a more general statement about the role and responsibilities of a QIU.
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    \18\ ABA Letter; SIFMA Letter.
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    A public offering in which a QIU participates pursuant to proposed 
paragraph (a)(2) would continue to be subject to the filing 
requirements of Rule 5110.\19\ Additionally, as in the Rule currently, 
a public offering in which a QIU participates would be required to meet 
proposed Rule 2720's escrow and discretionary account requirements, if 
applicable.
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    \19\ See proposed Rule 2720(d).
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    Current Rule 2720 requires that a QIU provide an opinion that the 
price at which equity securities are offered to the public is no 
higher, or the yield for debt securities is no lower, than that 
recommended by the QIU. The proposed rule change would eliminate the 
requirement that a QIU provide a pricing opinion. FINRA staff is 
unaware of instances where QIUs have made recommendations that were 
inconsistent with pricing decisions by the book-running lead manager or 
lead placement agent. In addition, FINRA staff believes that QIU 
pricing opinions in at-the-market offerings are of little to no value. 
Both commenters expressed strong support for eliminating the QIU 
pricing requirement.\20\
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    \20\ ABA Letter; SIFMA Letter.

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[[Page 22603]]

d. Escrow of Proceeds; Net Capital Computation
    Proposed Rule 2720(b)(1) would require that all proceeds from a 
public offering by a member of its securities shall be placed in a duly 
established escrow account and shall not be released therefrom or used 
by the member in any manner until the member has complied with the net 
capital requirements set forth in paragraph (b)(2). This proposed 
provision mirrors current Rule 2720(e).\21\
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    \21\ Members are reminded that additional escrow account 
maintenance and payment requirements may be applicable under 
Exchange Act Rule 15c2-4.
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    The net capital requirements set forth in proposed Rule 2720(b)(2) 
mirror current Rule 2720(e)(2), except that FINRA is proposing to 
replace the reference to Exchange Act Rule 15c3-1(f) with a reference 
in proposed Rule 2720(b)(2) to the alternative standard for calculating 
net capital under Exchange Act Rule 15c3-1(a)(1)(ii).
    In addition, proposed Rule 2720(b)(3) provides that any member 
offering its securities pursuant to this Rule shall disclose in the 
registration statement, offering circular, or similar document a date 
by which the offering is reasonably expected to be completed and the 
terms upon which the proceeds will be released from the escrow account 
described in paragraph (b)(1). This provision mirrors current Rule 
2720(d)(1).
e. Disclosure
    Current Rule 2720(d)(1) requires disclosure in the registration 
statement or offering circular regarding the date the offering will be 
completed and the terms upon which proceeds will be released from the 
escrow account. Current Rule 2720(d)(2) requires disclosure: (1) That 
the offering is being made pursuant to Rule 2720; (2) Relating to the 
member's status in the offering; and (3) Relating to the QIU (if one is 
required).
    The proposed rule change would delete current paragraph (d) of Rule 
2720. As discussed above, the proposal would move the disclosure 
requirements in current paragraph (d)(1) to proposed paragraph (b)(3) 
and establish separate disclosure requirements for public offerings in 
which a QIU participates (proposed Rule 2720(a)(2)(B)) and public 
offerings in which a QIU does not participate (proposed Rule 
2720(a)(1)).
f. Discretionary Accounts
    Proposed Rule 2720(c) provides that, notwithstanding NASD Rule 2510 
(Discretionary Accounts), no member that has a conflict of interest 
would be permitted to sell to a discretionary account any security with 
respect to which the conflict exists, unless the member has received 
specific written approval of the transaction from the account holder 
and retains documentation of the approval in its records. This 
provision differs from current Rule 2720(l), which also places 
limitations on sales to discretionary accounts, in that proposed Rule 
2720(c) would only apply to the sale of securities by the member with 
the conflict of interest. Current Rule 2720(l) limits discretionary 
sales by all firms participating in the offering, even those that do 
not have a conflict of interest. One commenter expressed support for 
limiting this provision to the member that has a conflict.\22\ 
Additionally, FINRA notes that the ``specific written approval'' 
requirement in this provision can be satisfied by an e-mail from the 
customer.
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    \22\ ABA Letter.
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g. Application of Rule 5110
    As noted above, proposed Rule 2720(d) provides that any public 
offering subject to the QIU requirements of paragraph (a)(2) would be 
subject to Rule 5110, whether or not the offering would otherwise be 
exempted from Rule 5110's filing or other requirements. Rule 5110 
generally requires members to file with FINRA public offerings for 
review of the proposed underwriting terms and arrangements. Rule 5110 
contains certain exemptions from the filing requirements for, among 
others, public offerings of the securities of seasoned issuers \23\ and 
offerings of investment grade debt. However, pursuant to current Rule 
2720(m), these exemptions are inapplicable to public offerings that 
fall within the scope of Rule 2720. Thus, for example, while a public 
offering of the securities of a seasoned issuer is normally exempt from 
filing under Rule 5110, if a member participating in the offering has a 
conflict of interest with the seasoned issuer, it must be filed and 
comply with Rule 5110. The proposed rule change would narrow this 
filing requirement to apply only to those public offerings that fall 
within the scope of proposed Rule 2720(a)(2).
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    \23\ The ``seasoned issuer'' filing exemption in Rule 
5110(b)(7)(C) currently exempts offerings registered on Forms S-3 
and F-3 by issuers that meet the standards for those Forms prior to 
October 21, 1992 (i.e., a three-year reporting history and either 
$150 million float or $100 million float and annual trading volume 
of three million shares). The proposed shelf amendments (see supra 
note 14) would preserve the current filing requirements and amend 
the Rule to specifically describe the pre-October 21, 1992 
standards.
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    In response to comments on the original proposal,\24\ FINRA is 
proposing to amend current Rule 5110(b)(7), which lists offerings that 
are exempt from the Rule 5110 filing requirements, to specify that 
documents and information related to the public offerings listed in 
Rule 5110(b)(7) are not required to be filed with FINRA for review, 
unless the public offering is subject to the QIU requirements of Rule 
2720(a)(2). This would clarify that if a public offering listed in Rule 
5110(b)(7) is subject to Rule 2720(a)(1), such offering would not be 
subject to the filing requirements of Rule 5110.
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    \24\ SIFMA Letter.
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h. Requests for Exemption From Rule 2720
    Proposed Rule 2720(e) provides that pursuant to the Rule 9600 
Series, FINRA could in exceptional and unusual circumstances, taking 
into consideration all relevant factors, exempt a member 
unconditionally or on specified terms from any or all of the provisions 
of the proposed Rule that it would deem appropriate. This provision 
mirrors existing Rule 2720(o).
i. Definition of ``Affiliate''
    Proposed Rule 2720(f)(1) defines the term ``affiliate'' as an 
entity that controls, is controlled by or is under common control with 
a member. While current Rule 2720(b)(1) incorporates the ``control'' 
standard in the definition of affiliate, FINRA is proposing instead to 
adopt a separate definition of ``control,'' which is discussed below.
    In response to comments on the original proposal,\25\ FINRA has 
narrowed the proposed definition of ``affiliate'' to apply only where 
an entity controls, is controlled by or is under common control with a 
member. As originally proposed, the definition would have applied where 
an entity was under common control with another entity that controls, 
was controlled by or was under common control with a member.
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    \25\ ABA Letter.
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j. Definition of ``Beneficial Ownership''
    Proposed Rule 2720(f)(2) defines ``beneficial ownership'' as the 
right to the economic benefits of a security. This provision mirrors 
the definition contained in current Rule 2720(b)(2). In NASD Notice to 
Members 06-52, FINRA requested comment on whether Rule 2720 should 
incorporate the definition of ``beneficial ownership'' found in

[[Page 22604]]

Exchange Act Rule 13d-3. That definition includes the right to dispose 
and vote the securities, which would apply to many investment funds. In 
response to comments suggesting that the definition should be confined 
to economic interests in which the member can profit directly,\26\ 
FINRA is proposing to retain the current definition of ``beneficial 
ownership.''
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    \26\ Id.
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k. Definition of ``Common Equity''
    Proposed Rule 2720(f)(4) defines ``common equity'' as the total 
number of shares of common stock outstanding without regard to class, 
whether voting or non-voting, convertible or non-convertible, 
exchangeable or non-exchangeable, redeemable or non-redeemable, as 
reflected on the consolidated financial statements of the company. This 
definition mirrors current Rule 2720(b)(5).
l. Definition of ``Conflict of Interest''
    Proposed Rule 2720(f)(5) would define ``conflict of interest'' to 
mean if, at the time of a member's participation in an entity's public 
offering, any of four conditions applies. The proposed Rule would 
operate much as it does currently. However, the proposed rule change 
would relocate many of the current Rule's substantive concepts to the 
definition of ``conflict of interest.''
    First, pursuant to proposed Rule 2720(f)(5)(A), a conflict of 
interest would exist if the securities are to be issued by the member.
    Second, pursuant to proposed Rule 2720(f)(5)(B), a conflict of 
interest would exist if the issuer controls, is controlled by or is 
under common control with the member or the member's associated 
persons. ``Control'' is defined in proposed Rule 2720(f)(6) and is 
discussed below.
    Third, pursuant to proposed Rule 2720(f)(5)(C), a conflict of 
interest would exist where at least five percent of the net offering 
proceeds, not including underwriting compensation, are intended to be 
either used to reduce or retire the balance of a loan or credit 
facility extended by the member, its affiliates, and its associated 
persons (in the aggregate) or otherwise directed to the member, its 
affiliates, and associated persons (in the aggregate). In response to 
comments on the original proposal,\27\ FINRA has amended the proposed 
definition to clarify that the proceeds are net of underwriting 
compensation.
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    \27\ SIFMA Letter.
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    Currently, Rule 5110(h) requires public offerings in which ten 
percent or more of the offering proceeds (not including the 
underwriting discount) will be paid to participating members to comply 
with Rule 2720's QIU requirements. Pursuant to this proposed rule 
change, FINRA is proposing to delete Rule 5110(h) and move the proceeds 
requirement to Rule 2720 by defining ``conflict of interest'' to 
include a member's participation in a public offering where proceeds 
are directed to the member. Although the threshold for proceeds 
directed to a member is being lowered from ten percent to five percent, 
the new threshold would apply to each participating member individually 
(including the member's affiliates and its associated persons), not on 
an aggregate basis for all participating members, as is currently the 
case. Thus, for example, a conflict of interest would exist where a 
member received five percent of the proceeds, but not where two 
unaffiliated members each received three percent of the proceeds.
    Fourth, pursuant to proposed Rule 2720(f)(5)(D), a conflict of 
interest would exist if, as a result of the public offering and any 
transactions contemplated at the time of the public offering, the 
member will be an affiliate of the issuer, the member will become 
publicly owned, or the issuer will become a member or form a broker-
dealer subsidiary.
    In response to comments on the original proposal,\28\ FINRA is 
clarifying that for purposes of Rule 2720, ``participation in a public 
offering'' has the same meaning as in Rule 5110. Rule 5110(a)(5) 
provides that ``participation or participating in a public offering'' 
means:
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    \28\ Id.

    Participation in the preparation of the offering or other 
documents, participation in the distribution of the offering on an 
underwritten, non-underwritten, or any other basis, furnishing of 
customer and/or broker lists for solicitation, or participation in 
any advisory or consulting capacity to the issuer related to the 
offering, but not the preparation of an appraisal in a savings and 
loan conversion or a bank offering or the preparation of a fairness 
opinion pursuant to [Exchange Act] Rule 13e-3.\29\
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    \29\ Rule 5110(a)(5). Pursuant to the proposed shelf amendments 
(see supra note 14), this definition in former NASD Rule 2710 (which 
has since been moved to the Consolidated FINRA Rulebook as Rule 
5110) would be amended to specify participation in the distribution 
of the offering on an ``underwritten, non-underwritten, principal, 
agency or any other basis'' and to include ``participation in a 
shelf takedown.''
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m. Definition of ``Control''
    As noted above, under the current Rule, the control standard is 
incorporated in the definition of ``affiliate.'' The proposal would 
define ``control'' as any of: (1) Beneficial ownership of ten percent 
or more of the outstanding common equity of an entity, including any 
right to receive such securities within 60 days of the member's 
participation in the public offering; \30\ (2) The right to ten percent 
or more of the distributable profits or losses of an entity that is a 
partnership, including any right to receive an interest in such 
distributable profits or losses within 60 days of the member's 
participation in the public offering; \31\ (3) Beneficial ownership of 
ten percent or more of the outstanding subordinated debt of an entity, 
including any right to receive such subordinated debt within 60 days of 
the member's participation in the public offering; \32\ (4) Beneficial 
ownership of ten percent or more of the outstanding preferred equity of 
an entity, including any right to receive such preferred equity within 
60 days of the member's participation in the public offering; \33\ or 
(5) The power to direct or cause the direction of the management or 
policies of an entity.\34\ FINRA believes it is important in 
subparagraph (i) to include entities other than corporations in order 
to expressly include conflicts that may arise in connection with the 
offerings of, for example, trusts.
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    \30\ Proposed Rule 2720(f)(6)(A)(i). The term ``beneficial 
ownership'' is defined in proposed paragraph (f)(2). In response to 
a comment by Commission staff, FINRA is clarifying that the use of 
the term ``beneficial ownership'' in proposed paragraph (f)(6) is a 
more narrow interpretation of the term as compared to the definition 
in proposed paragraph (f)(2), owing to the numerical thresholds 
imposed by proposed paragraph (f)(6).
    \31\ Proposed Rule 2720(f)(6)(A)(ii).
    \32\ Proposed Rule 2720(f)(6)(A)(iii).
    \33\ Proposed Rule 2720(f)(6)(A)(iv).
    \34\ Proposed Rule 2720(f)(6)(A)(v).
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    FINRA had originally proposed that the definition of control would 
eliminate ownership of subordinated debt and preferred equity as a 
basis for a conflict of interest.\35\ However, in response to comments 
from Commission staff, FINRA is now proposing to include beneficial 
ownership of ten percent or more of the outstanding common equity 
(which is defined expressly to include non-voting stock), subordinated 
debt or preferred equity in the proposed definition of control. Thus, 
for example, ``control'' could derive from the restrictive covenants 
typically found in debt indentures, preferred rights to dividends given 
to holders of non-voting common or preferred stock or special voting 
rights given to certain classes of (generally) non-voting stock. FINRA 
is specifically requesting comment on whether such

[[Page 22605]]

forms of ownership give rise to a conflict of interest and should be 
included in the proposed Rule.
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    \35\ See current Rule 2720(b)(7)(A) and (C).
---------------------------------------------------------------------------

    The proposed definition of control includes not only shares 
beneficially owned by a participating member, but also the right to 
receive such securities within 60 days of the member's participation in 
the public offering. In its original filing of September 6, 2007, FINRA 
proposed that for purposes of this provision, 60 days would be from the 
effective date of the offering. However, in Amendment No. 1, FINRA 
revised the proposed rule text to provide that the relevant time frame 
is ``within 60 days of the member's participation in the public 
offering.'' \36\ This would ensure that the Rule properly applies to 
takedowns from an effective shelf registration. FINRA believes that the 
determination of control should be when the member participates in an 
offering, not the date that a registration statement for the offering 
is declared effective.
---------------------------------------------------------------------------

    \36\ For purposes of Rule 2720, ``participation in a public 
offering'' has the same meaning as in Rule 5110(a)(5). See supra for 
further discussion of the definition of the term ``participation in 
a public offering.''
---------------------------------------------------------------------------

    Thus, under the proposed rule change, warrants or rights for voting 
securities that are exercisable within 60 days of the member's 
participation in the public offering would be included in the 
calculation of voting securities when determining whether control 
exists. In response to comments on the original proposal, FINRA is 
clarifying that in calculating the percentage beneficial ownership, it 
is appropriate to include the potential ownership of shares in both the 
numerator and denominator.\37\ FINRA does not believe, however, that 
this calculation should include securities that could be received by 
all investors. Rather, the calculation would be limited to warrants or 
rights that are exercisable within 60 days and received by the 
participating member only and would not include warrants or rights held 
by other investors.
---------------------------------------------------------------------------

    \37\ See ABA Letter (requesting that FINRA clarify whether the 
amount of securities to be received by a member and any other person 
within 60 days of the offering will be included in the denominator 
in order to calculate the member's total ownership interest in the 
issuer's securities).
---------------------------------------------------------------------------

n. Definition of ``Entity''
    Currently, Rule 2720 does not contain a definition of ``entity.'' 
Pursuant to proposed Rule 2720(f)(7), an ``entity'' would be defined, 
for purposes of the definitions of affiliate, conflict of interest and 
control under the Rule, as ``a company, corporation, partnership, 
trust, sole proprietorship, association or organized group of 
persons.''
    The proposed definition would expressly exclude: (1) An investment 
company registered under the Investment Company Act of 1940; \38\ (2) A 
``separate account'' as defined in Section 2(a)(37) of the Investment 
Company Act of 1940; \39\ (3) A ``real estate investment trust'' as 
defined in Section 856 of the Internal Revenue Code; \40\ and (4) A 
``direct participation program'' as defined in NASD Rule 2810.\41\ 
These exclusions are substantially similar to the exemptions from the 
``conflict of interest'' provisions contained in current Rule 
2720(b)(7)(D). In response to comments on the original proposal,\42\ 
FINRA revised the proposed definition of ``conflict of interest'' to 
apply only to a public offering of an ``entity.''
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    \38\ Proposed Rule 2720(f)(7)(B)(i).
    \39\ Proposed Rule 2720(f)(7)(B)(ii).
    \40\ Proposed Rule 2720(f)(7)(B)(iii).
    \41\ Proposed Rule 2720(f)(7)(B)(iv).
    \42\ SIFMA Letter.
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o. Definition of ``Preferred Equity''
    Proposed Rule 2720(f)(9) defines the term ``preferred equity'' as 
the aggregate capital invested by all persons in the preferred 
securities outstanding without regard to class, whether voting or non-
voting, convertible or non-convertible, exchangeable or non-
exchangeable, redeemable or non-redeemable, as reflected on the 
consolidated financial statements of the company. This definition 
mirrors current Rule 2720(b)(12).
p. Definition of ``Public Offering''
    Proposed Rule 2720(f)(11) is substantively similar to the 
definition of ``public offering'' in current Rule 2720(b)(14) and would 
define the term as any primary or secondary offering of securities made 
pursuant to a registration statement or offering circular including 
exchange offers, rights offerings, offerings made pursuant to a merger 
or acquisition and all other securities offerings of any kind 
whatsoever. The proposed definition excludes from its scope any 
offering made pursuant to an exemption from registration under Sections 
4(1), 4(2) or 4(6) of the Securities Act of 1933 (``Securities 
Act''),\43\ Securities Act Rule 504, if the securities are ``restricted 
securities'' under Securities Act Rule 144(a)(3), Securities Act Rule 
505, or Securities Act Rule 506, and Securities Act Rule 144A or 
Regulation S. FINRA currently does not interpret an offering made 
pursuant to Regulation S to be within the scope of a ``public 
offering'' under this Rule and as such, is proposing also to exclude 
these offerings from the definition. Additionally, in response to 
comments on the original proposal,\44\ FINRA has amended the proposed 
definition of ``public offering'' to expressly exclude exempted 
securities as defined in Section 3(a)(12) of the Exchange Act,\45\ as 
in the current Rule.
---------------------------------------------------------------------------

    \43\ 15 U.S.C. 77d(1), (2), and (6).
    \44\ ABA Letter.
    \45\ 15 U.S.C. 78c(a)(12).
---------------------------------------------------------------------------

    One commenter suggested that the proposed Rule should provide an 
express exclusion for offerings made pursuant to SEC Rule 144A.\46\ 
FINRA agrees and has added an express exclusion for offerings under SEC 
Rule 144A. FINRA also notes that it currently does not interpret an 
offering made pursuant to SEC Rule 144A to be within the scope of 
either Rule 5110 or Rule 2720.
---------------------------------------------------------------------------

    \46\ ABA Letter.
---------------------------------------------------------------------------

q. Definition of ``Qualified Independent Underwriter''
    Proposed Rule 2720(f)(12) defines the term ``qualified independent 
underwriter'' as a member that meets the certain conditions. First, the 
member must not have a conflict of interest and must not be an 
affiliate of any member that has a conflict of interest.\47\ The Rule 
currently does not disqualify or prohibit a QIU from receiving proceeds 
from an offering. The proposed rule change would prohibit a QIU from 
receiving more than five percent of the offering proceeds because the 
receipt of such proceeds would disqualify a member from acting as a QIU 
because it would fall within the proposed definition of ``conflict of 
interest.''
---------------------------------------------------------------------------

    \47\ Proposed Rule 2720(f)(12)(A).
---------------------------------------------------------------------------

    The second condition for being considered a QIU in the proposed 
Rule is the member cannot beneficially own, as of the date of the 
member's participation in the public offering, more than five percent 
of the class of securities that would give rise to a conflict of 
interest, including any right to receive any such securities 
exercisable within 60 days.\48\ Current Rule 2720(b)(15)(E) prohibits a 
member from acting as a QIU if it is an affiliate of the issuer or if 
it beneficially owns at least five percent of the equity, subordinated 
debt or partnership interest of the issuer. The proposed rule change 
would maintain these prohibitions.
---------------------------------------------------------------------------

    \48\ Proposed Rule 2720(f)(12)(B).
---------------------------------------------------------------------------

    Third, the member must have agreed, in acting as a QIU, to 
undertake the legal responsibilities and liabilities of an underwriter 
under the Securities Act,

[[Page 22606]]

specifically including those inherent in Section 11 thereof.\49\ The 
proposed provision mirrors current Rule 2720(b)(15)(F).
---------------------------------------------------------------------------

    \49\ Proposed Rule 2720(f)(12)(C).
---------------------------------------------------------------------------

    Fourth, the member must have served as underwriter in at least 
three public offerings of a similar size and type during the three-year 
period immediately preceding the filing of the registration statement 
or the date of first sale in an offering for which there is no 
registration statement.\50\ This requirement will be deemed satisfied 
if, during the past three years, the member, with respect to a proposed 
public offering of debt securities, has acted as sole underwriter or 
book-running lead or co-manager of at least three public offerings of 
debt securities each with gross proceeds of not less than 25% of the 
anticipated gross proceeds of the proposed offering. With respect to a 
proposed public offering of equity securities, this requirement will be 
deemed satisfied if, during the past three years, the member has acted 
as sole underwriter or book-running lead or co-manager of at least 
three public offerings of equity securities (or of securities 
convertible into equity securities), each with gross proceeds of not 
less than 50% of the anticipated gross proceeds of the proposed 
offering. FINRA is specifically requesting comment on whether the 50% 
threshold should be lowered if an equity offering is particularly large 
(e.g., over $1 billion). The proposed requirements are similar those 
set forth in current Rule 2720(b)(15)(C). The proposal would, however, 
shorten the relevant period from five to three years and would impose, 
as discussed above, the requirement that a QIU must have acted as a 
managing underwriter in at least three similar offerings during that 
time.
---------------------------------------------------------------------------

    \50\ Proposed Rule 2720(f)(12)(D).
---------------------------------------------------------------------------

    Additionally, Rule 2720(b)(15)(B) currently permits a member to 
serve as a QIU only if the member is a sole proprietorship and the sole 
proprietor has been actively engaged in the investment banking or 
securities business for the five-year period immediately preceding the 
filing of the registration statement, or is a corporation or 
partnership and a majority of its board of directors or general 
partners has been similarly engaged in the investment banking or 
securities business. The proposed rule change would eliminate the 
requirement regarding board or partner experience, since FINRA staff 
believes that the experience of the firm is more relevant.
    The final condition for being considered a QIU in the proposed Rule 
is that the member's associated persons in a supervisory capacity who 
are responsible for organizing, structuring or performing due diligence 
with respect to corporate public offerings of securities cannot have 
certain criminal or disciplinary histories.\51\ These associated 
persons cannot have been convicted within ten years prior to the filing 
of the registration statement or the preparation of an offering 
circular in an offering without a registration statement of a violation 
of the anti-fraud provisions of the Federal or State securities laws, 
or any rules or regulations promulgated thereunder, in connection with 
a registered or unregistered offering of securities. These associated 
persons also cannot be subject to any order, judgment, or decree of any 
court of competent jurisdiction entered within ten years prior to the 
filing of the registration statement, or the preparation of an offering 
circular in an offering without a registration statement, permanently 
enjoining or restraining such person from engaging in or continuing any 
conduct or practice in violation of the anti-fraud provisions of the 
Federal or State securities laws, or any rules or regulations 
promulgated thereunder in connection with a registered or unregistered 
offering of securities. Finally, these associated persons cannot have 
been suspended or barred from association with any member by an order 
or decision of the Commission, any State, FINRA or any other self-
regulatory organization within ten years prior to the filing of the 
registration statement, or the preparation of an offering circular in 
an offering without a registration statement, for any conduct or 
practice in violation of the anti-fraud provisions of the Federal or 
State securities laws, or any rules, or regulations promulgated 
thereunder, or the anti-fraud rules of any self-regulatory organization 
in connection with a registered or unregistered offering of securities. 
The Rule currently prohibits an associated person's involvement in the 
due diligence process in a supervisory capacity if that person has been 
subject to certain criminal and disciplinary actions pertaining to the 
offering of securities within five years prior to the filing of the 
registration statement. The proposed rule change, as described above, 
would lengthen this period from five to ten years.
---------------------------------------------------------------------------

    \51\ See proposed Rule 2720(f)(12)(E).
---------------------------------------------------------------------------

r. Definition of ``Registration Statement''
    Proposed Rule 2720(f)(13) defines the term ``registration 
statement'' as a registration statement as defined by Section 2(a)(8) 
of the Securities Act,\52\ notification on Form 1A filed with the 
Commission pursuant to the provisions of Securities Act Rule 252, or 
any other document, by whatever name known, initiating a registration 
or similar process for an issue of securities which is required to be 
filed by the laws or regulations of any Federal or State agency. This 
definition mirrors current Rule 2720(b)(16), except for technical 
changes to correct the references in the current Rule to Securities Act 
Section 2(8) and Securities Act Rule 255.
---------------------------------------------------------------------------

    \52\ 15 U.S.C. 77b(a)(8).
---------------------------------------------------------------------------

s. Definition of ``Subordinated Debt''
    Proposed Rule 2720(f)(14) defines ``subordinated debt'' to include 
debt of an issuer which is expressly subordinate in right of payment to 
(or with a claim on assets subordinate to) any existing or future debt 
of such issuer or all debt that is specified as subordinated at the 
time of issuance. Subordinated debt shall not include short-term debt 
with maturity at issuance of less than one year and secured debt and 
bank debt not specified as subordinated debt at the time of issuance. 
This definition mirrors current Rule 2720(b)(18).
t. Deleted Definitions
    Proposed Rule 2720 does not contain definitions of the following 
terms that appear in current Rule 2720: ``company,'' ``effective 
date,'' ``immediate family,'' ``parent,'' ``person,'' ``public 
director,'' and ``settlement.'' In response to comments on the original 
proposal,\53\ FINRA is proposing to adopt the current definitions of 
``company,'' ``effective date,'' ``immediate family,'' and ``person'' 
as new paragraphs (a)(11) through (14) of Rule 5110 because they are 
used in that rule. Proposed Rule 2720(f) provides that the definitions 
in Rule 5110 are incorporated by reference in Rule 2720.
---------------------------------------------------------------------------

    \53\ ABA Letter.
---------------------------------------------------------------------------

u. Corporate Governance and Periodic Reporting
    Rule 2720 currently includes certain provisions that do not apply 
to the public offering itself and instead require the issuer to adopt 
corporate governance policies relating to an audit committee, public 
directors, and to issue periodic reports to shareholders.\54\ With the 
enactment of the Sarbanes-Oxley Act of 2002 and recent SEC rulemaking 
and interpretive actions, FINRA believes that issuers' periodic 
reporting requirements under the Exchange Act

[[Page 22607]]

have been enhanced and listing standard changes intended to improve 
corporate governance and enhance the role of audit committees have been 
adopted. Accordingly, at this time, FINRA believes that separate Rule 
2720 requirements for corporate governance and periodic reporting are 
unnecessary. One commenter expressed support for eliminating these 
provisions from Rule 2720.\55\
---------------------------------------------------------------------------

    \54\ See current Rule 2720(f), (g), and (h).
    \55\ ABA Letter.
---------------------------------------------------------------------------

v. Intrastate Offerings
    Rule 2720(j) currently requires any member offering its securities 
pursuant to the intrastate offering exemption under the Securities Act 
to include in the offering documents information required in a release 
that the Commission published in 1972. The proposed amendments would 
delete this requirement from Rule 2720. FINRA believes that disclosure 
requirements for unregistered offerings should be addressed in a more 
comprehensive manner by the Commission, the states, or FINRA, and not 
imposed under the narrow scope of Rule 2720 or limited to intrastate 
offerings. One commenter suggested that FINRA should not adopt 
disclosure requirements for intrastate offerings because such offerings 
are subject to the disclosure requirements of the State where the 
securities are offered.\56\
---------------------------------------------------------------------------

    \56\ Id.
---------------------------------------------------------------------------

x. Suitability
    Rule 2720(k) currently requires that every member underwriting an 
issue of its own securities, or securities of an affiliate or company 
with which it has a conflict of interest, that recommends to a customer 
the purchase of a security of such issue must have reasonable grounds 
to believe that the recommendation is suitable for the customer. FINRA 
is not proposing a similar provision in new Rule 2720 because NASD Rule 
2310 already addresses a member's obligations relating to suitability.
    FINRA will announce the implementation date of the proposed rule 
change in a Regulatory Notice to be published no later than 60 days 
following Commission approval. The implementation date will be 30 days 
following publication of the Regulatory Notice announcing Commission 
approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\57\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes that the proposed rule change will 
simplify and modernize Rule 2720, thereby providing greater clarity 
regarding members' obligations and enhancing the regulation of public 
offerings in which members have a conflict of interest.
---------------------------------------------------------------------------

    \57\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The proposed rule change was published for comment in NASD Notice 
to Members 06-52 (September 2006). Two comments were received in 
response to the Notice. A copy of the Notice is attached as Exhibit 2a. 
A list of the comment letters received in response to the Notice is 
attached as Exhibit 2b. Copies of the comment letters received in 
response to the Notice are attached as Exhibit 2c. Those comments that 
have not already been addressed herein are discussed below.\58\
---------------------------------------------------------------------------

    \58\ In addition, FINRA has incorporated some of the commenters' 
non-substantive comments without specifically addressing them 
herein, e.g., comments regarding inconsistent use of the terms 
``entity,'' ``company'' and ``issuer.'' See ABA Letter.
---------------------------------------------------------------------------

Comments on the Scope of Proposed Rule 2720
    Both commenters suggested revising proposed Rule 2720(a)(1) to 
include additional categories of public offerings that would be exempt 
from the QIU and filing requirements by operation of proposed Rule 
2720(d). As discussed in greater detail below, FINRA does not agree 
that the exemptions should be expanded further. FINRA notes that, as 
proposed, the Rule would significantly reduce the number of public 
offerings that must be filed and reviewed by FINRA staff. A public 
offering (that is not an offering of investment grade rated securities 
or securities with a bona fide public market) will be subject to the 
QIU and filing requirements under Rule 2720 only if a member with 
primary responsibility for managing the offering has a conflict of 
interest. As such, FINRA does not believe that it would be appropriate 
to further expand the automatic exemptions under the Rule, as suggested 
by the commenters.
    Specifically, the commenters suggested that paragraph (a)(1) of the 
proposed Rule should include ``well-known seasoned issuers'' or 
``WKSIs.'' \59\ The commenters contend that such a change would be 
consistent with the proposed shelf amendments, which proposes exempt 
all WKSI shelf offerings from the filing requirements of the 
predecessor to Rule 5110.\60\ FINRA does not agree. FINRA believes that 
if a participating member has a conflict of interest, the offering 
should be subject to the QIU and filing requirements, irrespective of 
whether the issuer involved is a WKSI. Today, a WKSI that is not 
required to file under Rule 5110 would nonetheless be required to 
obtain a QIU if it were to receive ten percent of the offering 
proceeds.\61\ In addition, FINRA does not agree that application of 
Rule 2720 to WKSIs would slow the offering process.\62\ Currently, all 
WKSI filings are reviewed and cleared on the same day they are received 
by FINRA's Corporate Financing Department. In connection with the 
proposed shelf amendments, FINRA is developing upgrades to the 
COBRADesk electronic filing system that will implement a new same-day 
automatic review and clearance process for most shelf offerings and all 
WKSI shelf offerings.\63\
---------------------------------------------------------------------------

    \59\ ABA Letter; SIFMA Letter. See also Securities Act Rule 405 
(defining WKSI); Exchange Act Release No. 52056 (July 19, 2005), 70 
FR 44722 (August 3, 2005) (adopting the WKSI definition).
    \60\ ABA Letter; SIFMA Letter. The proposed shelf amendments 
were proposed to amend NASD Rule 2710, which has since been moved to 
the Consolidated FINRA Rulebook as Rule 5110. See supra note 15.
    \61\ See Rule 5110(h) and current Rule 2720(m).
    \62\ SIFMA Letter.
    \63\ See supra note 14.
---------------------------------------------------------------------------

    Similarly, one commenter suggested that public offerings by issuers 
with investment grade rated debt, which are currently exempted by Rule 
5110(b)(7)(A), should be included in proposed Rule 2720(a)(1).\64\ 
FINRA does not agree. The proposed rule change is designed to focus on 
the particular public offering in which a member has a conflict of 
interest. FINRA believes that while it is appropriate to exempt certain 
public offerings from the Rule, it would be inappropriate to exempt an 
entire class of issuers such as WKSIs or all issuers with investment 
grade rated debt. The relevant inquiry is whether the member has a 
conflict of interest with respect to that offering of that security; 
the characteristics of the issuer should not be determinative. As such, 
FINRA also does not agree with the commenter that proposed paragraphs

[[Page 22608]]

(a)(1)(B) and (C) should be amended to refer to the issuer of the 
securities, instead of the securities being offered.\65\
---------------------------------------------------------------------------

    \64\ SIFMA Letter.
    \65\ Id.
---------------------------------------------------------------------------

    One commenter suggested that the exception under proposed Rule 
2720(a)(1)(B) should be available for public offerings of warrants, 
options, convertible debt and convertible preferred securities that are 
exercisable for or convertible into equity securities that meet the 
standard of having a bona fide public market.\66\ FINRA does not 
believe that such an exemption would be appropriate because the 
characteristics of the derivative will not always be the same as the 
underlying security. The existence of a bona fide public market in the 
underlying equity security does not necessarily extend to an offering 
of a derivative on that security.
---------------------------------------------------------------------------

    \66\ ABA Letter.
---------------------------------------------------------------------------

    One commenter also suggested that there should be an exception for 
offerings by banks and other financial institutions that are the 
parents or affiliates of FINRA members of medium-term notes or similar 
securities, the return of which is linked to the performance of a 
particular stock, asset or index.\67\ While an offering of these 
securities that are rated investment grade would be exempted under the 
proposed Rule, FINRA believes that an offering of such securities rated 
below investment grade should continue to be subject to the filing and 
QIU requirements. FINRA believes that an exemption for offerings of 
structured products rated below investment grade would be inconsistent 
with concerns expressed by FINRA about these securities.\68\ However, 
to avoid potential unintended consequences of the proposed Rule, FINRA 
is specifically requesting comment on whether certain other types of 
securities that are registered on a shelf registration statement or 
automatic shelf registration statement should be eligible for the 
exemption from the filing and QIU requirements.
---------------------------------------------------------------------------

    \67\ Id.
    \68\ See NASD Notice to Members 05-59 (September 2005). The 
Notice stated that FINRA is concerned that when members sell 
structured products, they may not be fulfilling their sales practice 
obligations, including the requirement to perform a reasonable-basis 
and customer-specific suitability determination. The Notice also 
raised specific concerns about member sales practice obligations 
when selling these instruments to retail customers. The Notice added 
that structured products have been increasingly targeted at retail 
investors and that FINRA is concerned about the manner in which such 
products are marketed and the types of investors purchasing such 
products.
---------------------------------------------------------------------------

    Both commenters suggested that the reorganizations, mergers and 
acquisition transactions that are currently exempted by Rule 2720(a)(3) 
should be exempted under proposed Rule 2720(a)(1).\69\ FINRA believes 
that unless a reorganization, merger or acquisition would otherwise 
meet the proposed Rule 2720(a)(1) exemptions, it should be subject to 
the QIU and filing requirements. The Rule currently applies to these 
transactions if the member or its parent issues shares or the 
transaction results in the public ownership of a member. Thus, there is 
not currently a blanket exemption for reorganizations, mergers and 
acquisitions.
---------------------------------------------------------------------------

    \69\ ABA Letter; SIFMA Letter.
---------------------------------------------------------------------------

    One commenter also suggested that the proposed Rule should exempt 
all offerings by government entities.\70\ FINRA has proposed to exclude 
certain government entities from the filing requirements of Rule 5110 
pursuant to the proposed shelf amendments.\71\ However, FINRA does not 
agree that all such offerings should be excluded under Rule 2720. If a 
member has a conflict of interest with a government entity (e.g., the 
member will receive at least five percent of the net proceeds of the 
public offering) and the public offering does not otherwise meet the 
Rule 2720(a)(1) exemptions, FINRA believes that the offering documents 
should be filed and reviewed by FINRA staff.
---------------------------------------------------------------------------

    \70\ SIFMA Letter.
    \71\ See supra note 14.
---------------------------------------------------------------------------

    One commenter suggested that offerings of securities exempt from 
registration with the Commission under Section 3(a)(4) of the 
Securities Act of 1933 should be exempt under proposed Rule 2720(a)(1), 
noting that such offerings currently are exempted from the conflict of 
interest provisions of Rule 2720.\72\ While FINRA is not aware of 
member conflicts with non-profit or charitable organizations, in the 
unlikely event that such a conflict does exist, FINRA believes that the 
offering should be filed and reviewed by FINRA staff.
---------------------------------------------------------------------------

    \72\ SIFMA Letter.
---------------------------------------------------------------------------

    This same commenter also suggested that proposed Rule 2720(a)(1) 
should exclude offerings conducted pursuant to the multi-jurisdictional 
disclosure system because they are already subject to regulation under 
the Canadian system.\73\ FINRA does not agree that it should remove 
itself from public offerings in which a FINRA member with a conflict of 
interest is participating, even if such offerings also are subject to 
regulation under the Canadian system.
---------------------------------------------------------------------------

    \73\ Id.
---------------------------------------------------------------------------

    Finally, with respect to proposed Rule 2720(a)(1)(A), one commenter 
suggested amending the provision to apply to any book-running manager, 
including co- or joint book-running managers, such that a QIU would not 
be required if any of the joint book-runners could meet the 
requirements of the Rule.\74\ FINRA does not agree that the provision 
should be expanded in this way. FINRA understands that in some joint 
book offerings, members have been designated as a joint book-runner or 
co-lead manager in return for assistance with the road show or other 
services critical to marketing the offering. In some cases, the member 
designated as a co-lead would not be in the position of supervising due 
diligence for the offering or may not be involved in the due diligence 
at all. FINRA staff does not believe that including a book-runner or 
lead placement agent without a conflict of interest eliminates the 
conflict that exists with respect to the remaining book-runner(s) or 
lead placement agent(s). Therefore, amending the proposed provision as 
the commenter suggests would not fulfill the objective of ensuring 
independent due diligence by a member free of conflicts.
---------------------------------------------------------------------------

    \74\ Id.
---------------------------------------------------------------------------

Comments on Proposed QIU Requirements
    One commenter suggested that the references to ``due diligence'' 
and ``usual standards of due diligence'' should be eliminated from the 
Rule, expressing concern that such references could raise the due 
diligence defense to the level of a regulatory requirement.\75\ The 
requirement that a QIU exercise the usual standards of due diligence 
has been in the Rule for 20 years and FINRA believes that it is an 
appropriate regulatory requirement.\76\ However, as discussed above, in 
response to comments, as well as similar concerns expressed by FINRA's 
Corporate Financing Committee, FINRA has eliminated the proposal to 
require that the offering documents include a statement that the QIU 
has assumed responsibilities for conducting due diligence.
---------------------------------------------------------------------------

    \75\ Id.
    \76\ See, e.g., current Rule 2720(c)(3)(A) and (d)(2).
---------------------------------------------------------------------------

    The commenters also suggested that offerings in which a QIU 
participates should be exempt from the filing requirements of Rule 
5110.\77\ FINRA does not believe that the participation of a QIU in an 
offering sufficiently mitigates the conflicts of interest such that 
FINRA review is no longer necessary. Additionally, pursuant to current 
Rule 2720(m), the Rule 5110

[[Page 22609]]

filing requirements apply to all public offerings subject to Rule 2720, 
including public offerings in which a QIU has participated. Thus, the 
proposed rule change would not expand the current filing requirements.
---------------------------------------------------------------------------

    \77\ ABA Letter; SIFMA Letter.
---------------------------------------------------------------------------

Comments on the Proposed Discretionary Accounts Provision
    One commenter \78\ suggested that the Rule should be revised to 
incorporate the advance authorization procedure in FINRA's Corporate 
Financing Department's exemption letter to Goldman Sachs (the ``Goldman 
Letter'').\79\ The Goldman Letter applies to public offerings of 
straight debt securities, structured notes and straight preferred stock 
issued by Goldman or its affiliates and permits the firm to use an 
advance authorization procedure in lieu of the requirement in Rule 2720 
for prior specific written approval. Specifically, the firm could 
obtain an advance written letter of consent from certain customers with 
discretionary accounts and oral authorization by the customer prior to 
execution of the transaction. FINRA does not believe that Rule 2720 
should expressly incorporate the advance authorization procedure set 
forth in the Goldman Letter. As discussed above, the written 
authorization requirements of this provision can be satisfied by e-
mail, which today may often prove quicker and easier than obtaining 
oral authorization.
---------------------------------------------------------------------------

    \78\ ABA Letter.
    \79\ See letter to Judith G. Belash, Esq., Goldman, Sachs & Co., 
from Joseph Price, NASD, Corporate Financing Department, dated June 
14, 1999, available at http://www.finra.org/Industry/Regulation/
Guidance/ExemptiveLetters/P002617.
---------------------------------------------------------------------------

    Additionally, this commenter suggested that public offerings in 
which proceeds are being directed to a member should be exempted from 
the discretionary account provision.\80\ FINRA does not agree. FINRA 
believes that the receipt of offering proceeds by members and their 
affiliates gives rise to conflicts that are of equal concern in the 
context of sales to a discretionary account.
---------------------------------------------------------------------------

    \80\ ABA Letter.
---------------------------------------------------------------------------

Comments on the Proposed Definition of ``Affiliate''
    One commenter suggested that the definition of ``affiliate'' should 
be structured similar to the current definition as a control standard 
and a presumption of control as a result of management or share 
ownership.\81\ FINRA recognizes that there are other ways to define 
``affiliate.'' However, this commenter has not demonstrated that its 
recommended approach is better than the approach FINRA is proposing.
---------------------------------------------------------------------------

    \81\ Id.
---------------------------------------------------------------------------

Comments on the Proposed Definition of ``Bona Fide Public Market''
    The commenters suggested that the definition of ``bona fide public 
market'' should be amended to apply to equity securities of foreign 
issuers that meet the ``actively traded'' standards of Regulation M and 
are designated offshore securities markets under Rule 902(b).\82\ Upon 
further consideration, FINRA is not proposing to amend the definition 
along these lines. Because securities with a bona fide public market 
are not subject to the QIU or filing requirements, amending the 
definition to apply to securities traded on a foreign market would make 
this exemption too broad.
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    \82\ Id.; SIFMA Letter.
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    One commenter also suggested that the definition should be amended 
to clarify that the issuer--and not the particular security--must have 
a bona fide public market.\83\ FINRA does not agree. As discussed 
above, the focus of this Rule is on the securities being offered and 
not the characteristics of the issuer.
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    \83\ SIFMA Letter.
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Comments on the Proposed Definition of ``Conflict of Interest''
    The commenters suggested that there should be no filing requirement 
for public offerings in which the conflict of interest derives from the 
member's receipt of proceeds.\84\ One commenter asserted that ``NASD 
has historically deemed a conflict of interest based on the receipt of 
offering proceeds by participating members to be a less significant 
conflict than one that is based on the ownership of an issuer's 
securities or management control.'' \85\ FINRA does not agree and 
believes that the conflict deriving from a member's receipt of proceeds 
warrants review and filing of the offering documents. Indeed, FINRA's 
Corporate Financing Committee has identified conflicts resulting from 
proceeds being directed to a member as one of the most important 
conflicts in public offerings today. Pursuant to the proposed rule 
change, all public offerings in which a QIU is involved--including 
those for which a QIU is required because proceeds are being directed 
to a member or its affiliate--must be filed and reviewed by FINRA 
staff.
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    \84\ ABA Letter; SIFMA Letter.
    \85\ ABA Letter.
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    Additionally, both commenters assert that the five percent 
threshold for a member's receipt of offering proceeds is too low.\86\ 
FINRA does not agree and believes that in recognition of the 
significance of proceeds-related conflicts, it is appropriate to lower 
the threshold from ten percent to five percent.
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    \86\ ABA Letter; SIFMA Letter.
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    One commenter suggested that the proposed definition of ``conflict 
of interest'' should exclude transactions by which the issuer will 
become a member or form a broker-dealer subsidiary.\87\ This commenter 
also suggested that the definition be revised to exclude 
reorganizations and restructurings if no material change in the 
ownership of the issuer or participating member is taking place.\88\ 
FINRA does not agree that merely because the corporate governance 
provisions have been deleted from the Rule, a member's participation in 
such offerings no longer creates a conflict of interest. FINRA believes 
that these offerings should be subject to the Rule.
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    \87\ SIFMA Letter.
    \88\ Id.
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    This commenter also suggested that the old formulation in which 
conflicts of interest existed under specific circumstances, rather than 
as a result of a member's participation in public offerings where 
certain conditions apply, should be retained because it was easier for 
members to argue that no conflict actually exists.\89\ FINRA does not 
agree and believes that the proposed definition of ``conflicts of 
interest'' is preferable in that it clearly delineates the scope of the 
Rule.
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    \89\ Id.
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    The commenters suggested that the definition should not apply to 
arms length forward sales contracts and other derivatives where the 
proceeds are used by the issuer to purchase the securities to hedge 
risk in the transactions.\90\ FINRA is requesting further comment on 
this issue and specifically how use of the proceeds by the issuer to 
buy derivatives or other hedging transactions is substantially 
different from other uses of proceeds contemplated by the Rule (e.g., 
to retire debt).
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    \90\ ABA Letter; SIFMA Letter.
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Comments on the Proposed Definition of ``Control''
    One commenter suggested that ``control'' should not be a defined 
term because an entity that is in a control relationship is an 
affiliate and thus, the control concept should remain in the definition 
of ``affiliate.'' \91\ As previously noted, FINRA recognizes that there 
are other ways to approach the definitions

[[Page 22610]]

and standards set forth in this Rule. However, FINRA does not believe 
that the approach the commenter has proposed is preferable to that 
outlined above.
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    \91\ ABA Letter.
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Comments on the Proposed Definition of ``Entity''
    One commenter suggested that the proposed definition of ``entity'' 
be amended to include groups of persons only if they are organized to 
conduct business under the laws of a jurisdiction.\92\ FINRA does not 
agree and believes that more flexibility is needed given that FINRA is 
not proposing to define ``beneficial ownership'' in accordance with 
Exchange Act Rule 13d-3.
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    \92\ Id.
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Comments on the Proposed Definition of ``Public Offering''
    One commenter reiterated its concern, also expressed in response to 
FINRA's proposed shelf amendments, that Rules 5110 and 2720, and NASD 
Rule 2810, should not be extended to any sale of securities (even one 
share) from a registration statement or offering circular, including a 
takedown of securities from a shelf registration statement that does 
not meet the standard of being a ``distribution'' for purposes of 
Regulation M.\93\ The appropriate filing requirements for shelf 
takedowns are addressed in FINRA's response to comments on the proposed 
shelf amendments.
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    \93\ Id.
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Comments on the Proposed Definition of ``QIU''
    One commenter suggested that the disciplinary history lookback 
period should not be extended from five years to ten.\94\ FINRA 
believes that a longer lookback period is consistent with the goal of 
ensuring that a QIU will provide the necessary investor protection in 
public offerings where a member has a conflict of interest. 
Additionally, FINRA notes that a ten-year lookback is consistent with 
the period used to determine whether a person is subject to a statutory 
disqualification.
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    \94\ Id.
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    One commenter suggested that ownership of five percent or more of 
the issuer's securities is too low a threshold for purposes of 
disqualification as a QIU and should be increased to ten percent in 
proposed Rule 2720(f)(12)(B).\95\ FINRA believes that the five percent 
threshold is not too low and in fact considered lowering it to three 
percent.
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    \95\ SIFMA Letter.
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    This commenter also believes that the term ``5% of the class of 
securities that would give rise to a conflict of interest'' contained 
in proposed Rule 2720(f)(12)(B) improperly suggests that the member's 
conflict of interest is with the issuer's securities rather than with 
the issuer and should be replaced with ``5% of the issuer's total 
equity securities.'' \96\ FINRA does not agree. Because the proposed 
Rule addresses conflicts resulting from the receipt of offering 
proceeds by the member, the five percent standard is appropriately 
limited to the class of securities offered.
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    \96\ Id.
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    One commenter suggested that the Rule should permit a prospective 
QIU to demonstrate on a case-by-case basis that it has acquired 
experience within the previous years involving the pricing and due 
diligence functions.\97\ FINRA believes that such an approach would be 
unmanageable and that a bright-line test is necessary.
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    \97\ Id.
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    One commenter suggested that FINRA should eliminate the requirement 
that FINRA members wishing to act as a QIU must qualify on an annual 
basis.\98\ This commenter stated that when a participating member acts 
as a QIU, that member represents by way of prospectus disclosure that 
it is qualified to act and the commenter believes that FINRA should not 
require proof in each case. FINRA notes that there is no annual 
qualification requirement contained in the current or proposed Rule. 
Rather, to streamline the QIU process, FINRA's Corporate Financing 
Department permits members to provide information establishing that 
they meet the QIU qualification requirements in advance of 
participating in a particular public offering and to update this 
information annually. In the course of its review of information in 
connection with a public offering requiring a QIU, FINRA staff 
routinely asks for information that establishes that a member 
identified as a QIU is qualified to participate in that capacity. If a 
member has already provided this information within the last 12 months 
or has done an annual update, the member will not need to provide the 
information in connection with that particular offering.
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    \98\ Id.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2007-009 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2007-009. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). 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, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All

[[Page 22611]]

submissions should refer to File Number SR-FINRA-2007-009 and should be 
submitted on or before June 3, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\99\
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    \99\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-11081 Filed 5-12-09; 8:45 am]

BILLING CODE 8010-01-P
