Nine Years After—SEC Approves NASD Mark-Up Guidance for Debt Securities

Nine Years After—SEC Approves NASD Mark-Up Guidance for Debt Securities

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On April 16, 2007, the Securities and Exchange Commission (SEC, Commission) approved a proposal by the National Association of Securities Dealers (NASD) to adopt a new interpretation regarding mark-ups and mark-downs in debt transactions.1 Approval of the new interpretation—coming almost nine years after the SEC first published an NASD proposal for a debt mark-up interpretation—occurs amidst substantial controversy and uncertainty regarding the application of the NASD’s mark-up standards to transactions in debt securities. Given the NASD’s decision not to provide further guidance on certain aspects of the proposal, it appears that some degree of uncertainty may persist. Nevertheless, the Approval Order affords some measure of regulatory relief by including a significant exemption for transactions with certain institutional customers in non-investment grade debt securities.2

The NASD is expected to publish a Notice to Members no later than 60 days after SEC approval of the proposal (i.e., by June 15). The Notice to Members is expected to announce an effective date of 30 days after its publication.3 Accordingly, we expect the new interpretation to become effective on or before July 15, 2007.

I. Background

NASD Rule 2440 requires that members charge customers fair prices and commissions. Interpretive Material 2440 (IM-2440) provides guidance regarding what constitutes a fair mark-up or mark-down for purposes of the rule. Under IM-2440, also called the Mark-Up Policy or 5% Policy, it is a violation of both Rule 2440 and Rule 2110 (Standards of Commercial Honor and Principles of Trade) “for a member to enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security or to charge a commission which is not reasonable.” The Mark-Up Policy applies to over-the-counter transactions in both equity and debt securities. Its application in the debt markets, however, has been a topic of considerable confusion and controversy—particularly in regards to how a debt security’s “prevailing market price” should be determined in the absence of an actively traded market for the security. The new interpretation aims to provide some clarity regarding how mark-ups and mark-downs on debt securities should be evaluated.

The NASD filed the initial version of the recently approved proposal in September 2003,4 against the background of earlier, unsuccessful attempts to clarify how the Mark-Up Policy should be applied in the debt markets.5 After five amendments, two comment periods, and two letters from the NASD in response to comments, the proposal adds a new interpretation under Rule 2440 applicable to transactions in debt securities.6 Interpretive Material 2440-2, also referred to as the Additional Mark-Up Policy For Transactions in Debt Securities, Except Municipal Securities (Interpretation or IM-2440-2), will supplement existing IM-2440 by addressing how “prevailing market price” should be determined in the markets for debt securities. Specifically, the Interpretation makes prevailing market price presumptively equivalent to the broker-dealer’s contemporaneous cost of obtaining (or proceeds from selling) the security. This presumption may be overcome in limited circumstances. In addition, the Interpretation includes an exemption from Rule 2440 and its interpretations for transactions with certain institutional customers in non-investment grade debt securities. The Mark-Up Policy will be renumbered as IM-2440-1 and remain generally applicable to transactions in debt securities.7

II. Framework for Analysis under the New Debt Mark-Up Policy

A. The Contemporaneous Cost Presumption

The Interpretation starts with the premise that when a dealer is not acting as a market maker, the mark-up or mark-down of a debt security must be evaluated in relation to the security’s prevailing market price. There is a presumption that the prevailing market price is the dealer’s contemporaneous cost of obtaining the security (in the case of a sale to a customer) or proceeds from selling the security (in the case of a purchase from a customer).8 A “contemporaneous” transaction is one that “occurs close enough in time to the subject transaction that it would reasonably be expected to reflect the current market price for the security.”9

B. Overcoming the Presumption

The Interpretation limits the circumstances in which the contemporaneous cost presumption may be rebutted. Specifically, other evidence of prevailing market price will be considered only if (a) the member has engaged in no contemporaneous transactions, or (b) the member can demonstrate that, in the particular circumstances, its contemporaneous transactions are not indicative of prevailing market price.10

The member may be able to overcome the presumption if an event occurred after the member’s contemporaneous transactions. Events that may be used to rebut the presumption include a change in interest rates to a degree that reasonably would affect debt security pricing, a significant change in the security’s credit quality, or the distribution of news that affects the perceived value of the security.11 News must be broadly disseminated to be used to overcome the presumption, although the practical application of this requirement to news affecting or relating to small issuers with a limited group of debt holders remains unclear (e.g., a bankrupt supplier with no outstanding equity holders and only a handful of holders of its total outstanding debt securities).12

Once the presumption has been overcome, due to either a lack of contemporaneous transactions or a qualifying event after any contemporaneous transactions, a series of factors may be considered to determine prevailing market price.

C. The Hierarchy of Pricing Information

If the presumption has been overcome, the next step is to consider three types of pricing information, which the NASD refers to as the Pricing Hierarchy. These factors must be considered in order, with each subsequent factor becoming relevant only if the preceding factor is not available. The factors in the Pricing Hierarchy are:

  1. Prices of contemporaneous inter-dealer transactions in the security
  2. Prices of contemporaneous dealer transactions in the same security with institutional accounts with which any dealer regularly effects transactions in the security
  3. For actively traded securities, contemporaneous bid or offer quotations in the security through any inter-dealer mechanism through which transactions generally occur at displayed quotations13

D. Analysis of “Similar” Securities

If none of the factors in the Pricing Hierarchy is available, member firms must consider a non-exclusive list of four factors involving “similar” securities:

  1. Prices of contemporaneous inter-dealer transactions in a similar security, or prices of contemporaneous dealer transactions in a similar security with institutional accounts with which any dealer regularly effects transactions in the similar security
  2. Yields calculated from prices of contemporaneous inter-dealer transactions in similar securities
  3. Yields calculated from prices of contemporaneous dealer transactions in a similar security with institutional accounts with which any dealer regularly effects transactions in the similar security
  4. Yields calculated from validated contemporaneous inter-dealer quotations in similar securities14

In this context, a similar security “should be sufficiently similar to the subject security that it would serve as a reasonable alternative investment to the investor.”15 According to the Interpretation, it should be possible to estimate a market yield for the subject security from the yield of the similar security. For a security with several components, the price or yield of each component must be considered.16 Other securities generally will not be sufficiently similar to a debt security whose value and pricing are “based substantially on” and “highly dependent on” the particular circumstances of the issuer.17

E. Economic Models

Finally, if pricing and yield information regarding similar securities is also unavailable, pricing or yield derived from economic models may be considered—if the models take into account appropriate factors (e.g., credit quality, interest rates, industry sector, time to maturity, call provisions and other embedded options, coupon rate, and face value) and consider all applicable pricing terms and conventions.18 The Interpretation makes clear the NASD’s expectation that records of economic models relied upon to price debt securities transactions may be requested by examination staff.

III. Exclusion of Certain Transactions with Institutional Customers

The Interpretation includes a significant exemption from Rule 2440 and the Mark-Up Policy for transactions with certain institutional customers in non-investment grade debt securities. The NASD has accomplished this exemption by excluding “qualified institutional buyers” (QIBs) from the definition of “customer” as that term is used in Rule 2440 and its interpretive materials when a transaction involves a non-investment grade debt security.19

In order for a transaction with an institutional customer to be excluded, each of the following conditions must be satisfied:

A. The institutional customer must be a “qualified institutional buyer,” as that term is defined in Rule 144A under the Securities Act of 1933.

In general terms, a QIB is a registered dealer or any of certain specified types of entities—acting for its own account or for the accounts of other QIBs — that owns and invests, on a discretionary basis, at least $100 million in securities of issuers with which the dealer or entity is not affiliated. The term also includes a registered dealer acting in a riskless principal transaction on behalf of a QIB, as well as any entity—acting for its own account or for the accounts of other QIBs—in which all equity owners are QIBs.20

B. The member firm buying or selling to the institutional customer must conclude that (a) the QIB is capable of evaluating independently the investment risk involved in the transaction, and (b) the QIB is in fact exercising such independent judgment in deciding to enter into the transaction.

The Interpretation directs member firms to use the institutional suitability standards set forth in NASD IM-2310-3 (Suitability Obligations to Institutional Customers) to make these determinations. Accordingly, under the Interpretation, a member firm may rely on the same two factors to fulfill its suitability and fair pricing obligations to an institutional customer meeting the definition of QIB.21

C. The transaction must involve a non-investment grade debt security, as defined in the Interpretation.

In order for a security to be non-investment grade debt for purposes of the Interpretation, one of the following circumstances must exist:

(1) A nationally recognized statistical rating organization (NRSRO) has assigned the security a rating lower than one of the four highest generic rating categories22 (e.g., below BBB or Baa); or

(2) For a security that no NRSRO has rated, either:

a. The dealer has analyzed the security as non-investment grade, retains credit evaluation documentation, and demonstrates to the NASD (using credit evaluation or other demonstrable criteria) that the security’s credit quality is in fact equivalent to a non-investment grade debt security; or

b. The security initially was offered and sold and continues to be offered and sold pursuant to an exemption from registration under the Securities Act of 1933.23

Some commenters expressed concern that the QIB exemption is too limited and should apply to a broader range of securities transactions. The NASD declined to expand the exemption, but “committed to monitor how the market adjusts to the use of differentiated regulation for QIBs in relation to mark-ups.”24 The NASD did not explain how it intends to monitor “how the market adjusts to this significant change in employing differentiated regulation in the case of mark-up rules with respect to QIBs.”25 In view of the NASD’s reluctance to adopt a QIB exemption in the first instance and refusal to apply it on a broader basis, it is unlikely we will see any expansion of this approach in the near term.

Member firms intending to rely on the exemption when it takes effect should be mindful that the anti-fraud provisions of the Exchange Act and the best execution provisions of the NASD rules continue to have general applicability to all securities transactions, and that trading that is suggestive of customer abuse may remain subject to challenge under those rules notwithstanding the exemption.26

IV. Some Outstanding Issues

The Interpretation provides some clarity regarding application of the Mark-Up Policy to transactions in debt securities. The NASD’s willingness to embrace a limited institutional exemption is significant and marks a welcome accommodation of the views expressed by both the dealer and asset management communities. Certain questions and concerns remain, however. For example, some uncertainty remains regarding when a member firm is a “market maker” for purposes of the Interpretation and therefore not subject to the contemporaneous cost presumption. Although the NASD has acknowledged that market makers exist in the debt markets,27 the scope of the market maker concept in the debt markets is unclear.28 The NASD has declined to provide an interpretation of the definition of market maker for the debt-markets, choosing instead to rely on the Exchange Act definition of the term.29

As a result, the Interpretation, coupled with the Commission’s Approval Order, perpetuates the difficulty dealers will encounter in handling block-size transactions. In the equity markets, as the Commission acknowledges,30 a market maker can purchase a block of stock at a discount to the market and sell out the position at a mark-up based on the offer side of the market.31 The situation is dramatically different in the debt context.

For debt securities, both the Commission and the NASD acknowledge—as the statute demands they must—that a dealer that meets the standards of Section 3(a)(38) would qualify as a market maker32 and, thereby, be eligible to charge mark-ups based on the offer side of the market. Unfortunately, however, the Commission, without citation to any authority, announces that “merely because the dealer takes risk positions or devotes substantial capital to provide liquidity” it is not necessarily a market maker.33 In this regard, the Commission did not address what additional steps a dealer might take to meet the “holding out” standard of Section 3(a)(38), nor did the Commission address the commenters’ point that the statutory definition of the term market maker includes acting as a “block positioner.”34 Accordingly, a debt dealer acting as a market maker for all practical purposes nevertheless will be treated as a mere dealer who “must use contemporaneous cost or other prices as provided in the [] Interpretation.”35

In announcing this result, the Commission rejected, as had the NASD, requests for a “block-size exemption”36 and only acknowledged, but did not approve, a request that block discounts and premiums be taken into consideration in determining contemporaneous cost.37 The Commission's decision to hold block trades in debt securities to such a different standard from block trades in equity securities was based on the NASD's “significant investor protection concerns,”38 which apparently the Commission determined were “reasonabl[e].”39 Neither the Commission nor the NASD set forth these concerns or provided either a competitive or cost-benefit analysis of them.

While unstated, the Commission and the NASD appear to be suggesting that it is a “significant investor protection concern” if a dealer, who does not meet the NASD's reading of Section 3(a)(38), buys a block of securities in the wholesale market and re-sells those securities in the retail market at prices greater than a certain percentage of the purchase price.40 The record of this nine-year rulemaking proceeding does not answer whether this is an important concern or the correct policy result, especially in light of the de facto different approach in equities. Be that as it may, however, on a going-forward basis, dealers will either (a) have to take additional steps to evidence their market maker status in order to capture the spread following a block transaction, or (b) expect smaller returns on block trades in debt securities.

V. Conclusion

The Interpretation has the potential to alter significantly broker-dealers’ risks and policies in this area—especially for those able to rely upon the exemption for certain transactions with QIBs in non-investment grade debt securities. It will have a significant effect on the NASD’s enforcement program under Rule 2440. In light of the NASD’s recent investigations and settlements involving trades with institutional customers in distressed debt securities,41 it will be of particular interest to observe how the NASD effects the transition to the policies reflected in the newly approved interpretive material.

As discussed above, the Interpretation and the Approval Order fail to provide reassuring guidance regarding market maker status for purposes of mark-ups in debt securities. Accordingly, dealers that approve transactions in whole or in part because of a bona fide belief that the desk was acting as a market maker—whether by acting as a block positioner, providing quotations in the manner described by Exchange Act Section 3(a)(38), “or otherwise,”—should take steps to build a comprehensive record and prepare to respond to a skeptical examination staff.

Finally, and perhaps most significantly, the Interpretation’s continuing heavy emphasis on a check-the-box “Hierarchy” and a lengthy series of formalistic, prescriptive considerations seems to have strayed far from the principles-based notions otherwise animating Commission action affecting domestic capital market formation and regulation.42 When domestic dealers—unlike their London-based counterparts—find themselves potentially visited with enforcement threats over prices offered to an exclusively institutional customer base in designer (and unregistered) structured securities, it may be time to question whether the Commission—or the Congress—needs to re-examine whether this form of pricing regulation in fact benefits markets or investors.


For more information on this or other securities matters, please contact the authors listed above.

1 Securities Exchange Act Rel. No. 55,638 (Apr. 16, 2007) (Approval Order), available at http://www.sec.gov/rules/sro/nasd/2007/34-55638.pdf.

2 The SEC’s Division of Market Regulation issued the Approval Order pursuant to delegated authority. For this reason, any aggrieved party may seek Commission review of the Approval Order. 17 C.F.R. 201.430(a). An aggrieved party that wishes to seek Commission review must file a written notice of intention to petition for review within 15 days of the Approval Order’s publication in the Federal Register, and the petition to review must be filed within 5 days of the notice of intention to petition for review. 17 C.F.R. 201.430(b). A party to whom actual notice of the action is provided, or on whom notice of the action is served, has 5 days from actual notice or service of notice, whichever is earlier, to file a notice of intention to petition for review. Id. The Commission’s review of such orders is discretionary. 17 C.F.R. 201.431(b)(2).

3 Amendment No. 5 to Proposed Rule Change, File No. SR-NASD-2003-141, at 12. This and other filings related to the proposal are available on the NASD’s website, www.nasd.com.

4 Additional Mark-Up Policy for Transactions in Debt Securities, SR-NASD-2003-141 (Sept. 16, 2003).

5See Notice of Filing of Proposed Rule Change and Amendment Nos. 1 and 2 by the National Association of Securities Dealers, Inc., Relating to the Application of NASD’s Mark-Up Policy to Transactions in Government and Other Debt Securities, Securities Exchange Act Rel. No. 40,511 (Sept. 30, 1998), 63 Fed. Reg. 54,169 (Oct. 8, 1998); NASD Notice to Members 94-62 (Aug. 1994).

6 The second comment period followed the Commission’s publication of Amendment No. 5 to the proposal.

7 Following the SEC’s initial publication of the proposal, the NASD responded to comments in October 2005 and addressed some of the concerns raised by commenters in subsequent amendments in October and November 2005. Response to Comments on Additional Mark-Up Policy for Transactions in Debt Securities, File No. SR-NASD-2003-141 (Oct. 4, 2005) (2005 NASD Response to Comments); Amendment Nos. 1 and 2 to File No. SR-NASD-2003-141.
The NASD’s fifth amendment superseded prior versions of the proposal and was published for comment in November 2006. Notice of Filing of Amendment Nos. 3, 4, and 5 to a Proposed Rule Change Relating to Additional Mark-Up Policy for Transactions in Debt Securities, Except Municipal Securities, Securities Exchange Act Rel. No. 54,799 (Nov. 21, 2006), 71 Fed. Reg. 68,856 (Nov. 28, 2006). (Proposing Release). The NASD responded to comments on January 12, 2007. Second Response to Comments on Additional Mark-Up Policy for Transactions in Debt Securities, File No. SR-NASD-2003-141 (Jan. 12, 2007) (2007 NASD Response to Comments).
For a description of the Proposed Interpretation prior to Amendment No. 5, as well as a broader overview of mark-ups, see Brandon Becker, Todd Wiench, and Julia Lee, Mark-Ups and Recent Developments in Best Execution, SIA Compliance & Legal Division Fall Compliance Seminar (Nov. 13, 2006) (discussing the Proposed Interpretation at pages 31-36). For a discussion of the changes made in Amendment No. 5, see Brandon Becker, Paul R. Eckert, Bruce H. Newman, Todd E. Wiench, and Christie Farris Öberg, NASD Amends Proposed Debt Mark-Up Policy to Exclude Certain Transactions with Institutional Customers, Banking & Fin. Services Pol’y Rep., Vol. 26 No. 2., p. 3 (Feb. 2007); NASD Amends Proposed Debt Mark-Up Policy to Exclude Certain Transactions with Institutional Customers, WilmerHale Securities Briefing Series (Nov. 2006), available at www.wilmerhale.com.

8 IM-2440-2(b)(1).

9 IM-2440-2(b)(3). The NASD has stated, however, that contemporaneous cost or proceeds would not be a reliable basis for determining prevailing market price if the member’s contemporaneous transaction violated NASD Rule 2320 (Best Execution and Interpositioning), because the rule violation would indicate that the transaction price was not the result of market forces. Approval Order at 4, n. 16.

10 IM-2440-2(b)(2).

11 IM-2440-2(b)(4).

12 For example, “news” affecting some companies may be found only in specialty journals or in subscription, web-based publications likely to be read by potential investors but not by the public generally. This is particularly true for some structured debt securities which may change in value based on “news” bearing on prepayment rates or the perceived worth of the underlying assets.

13 IM-2440-2(b)(5).

14 IM-2440-2(b)(6).

15 IM-2440-2(c)(1).

16Id. The Interpretation provides a non-exclusive list of factors that may be considered in determining whether securities are “similar.” These are: credit quality considerations (including, e.g., whether the securities are issued by the same or similar entities, have the same or similar credit ratings, and are supported by guarantees or collateral of similar strength), taking into account recent information of either issuer that is not yet incorporated into credit ratings; the extent to which the securities trade at a similar spread (i.e., the spread over US Treasury securities of a similar duration); general structural characteristics and provisions (e.g., coupon, maturity, duration, complexity or uniqueness of the structure, callability, the likelihood that the security will be called, tendered, or exchanged, and other embedded options); and technical factors (e.g., size of the issue, float and recent turnover of the issue, and legal restrictions on transferability). IM-2440-2(c)(2).

17 IM-2440-2(c)(3). Such circumstances may include “creditworthiness and the ability and willingness of the issuer to meet the specific obligations of the security.” Id.

18 IM-2440-2(b)(7).

19 IM-2440-2(b)(9).

20 For the complete definition of QIB, which contains a number of provisions specific to particular categories of QIBs (e.g., registered investment companies and banks), see Securities Act of 1933, Rule 144A(a)(1).

21 The QIB standard, however, is more restrictive than the suitability rule’s requirements for what is an “institutional customer.” Under IM-2310-3, an institutional customer includes any entity other than a natural person, although the interpretation also states that its guidance “is more appropriately applied” to entities that hold or manage at least $10 million in securities investments.

22 Specifically, the Interpretation states that (a) if rated by only one NRSRO, the rating must be lower than one of the four highest generic rating categories, or (b) if rated by more than one NRSRO, the rating “by any of the NRSROs” must be lower than one of the four highest generic rating categories. IM-2440-2(b)(9) (emphasis added).

 

23 Notably, the exemption encompasses securities based on their exemption from registration only if they also are unrated (although such securities are within the exemption’s scope if they have received non-investment grade ratings). As a result, the exemption will not apply to structured products that, although sold in private placements, are rated investment grade. In response to comments on its amended proposal, the NASD has declined to broaden the exemption to encompass all exempt transactions with QIBs, regardless of the security's rating. The NASD also rejected a commenter's request that the exemption apply to all transactions with QIBs in securitized products that are rated investment grade. 2007 NASD Response to Comments, at 2.

24 Approval Order, at 18.

Approval Order, at 18.Notably, the exemption encompasses securities based on their exemption from registration only if they also are unrated (although such securities are within the exemption’s scope if they have received non-investment grade ratings). As a result, the exemption will not apply to structured products that, although sold in private placements, are rated investment grade. In response to comments on its amended proposal, the NASD has declined to broaden the exemption to encompass all exempt transactions with QIBs, regardless of the security's rating. The NASD also rejected a commenter's request that the exemption apply to all transactions with QIBs in securitized products that are rated investment grade. 2007 NASD Response to Comments, at 2.

 

25 2007 NASD Response to Comments, at 3.

26 For an overview of liability for excessive mark-ups under Exchange Act Section 10(b) and Rule 10b-5, see Becker et al., supra, at 4-7. See also, e.g., NASD Rule 2110 (Standards of Commercial Honor and Principles of Trade); NASD Rule 2120 (Use of Manipulative, Deceptive or Other Fraudulent Devices); NASD Rule 2320 (Best Execution and Interpositioning).

27See 2005 NASD Response to Comments, at 5 n. 17 (“NASD continues to embrace the concept of market makers in the debt markets.”). In fact, a past proposal relating to mark-ups in debt securities would have provided a definition of market maker. See Notice of Filing of Proposed Rule Change and Amendments Nos. 1 and 2 by the National Association of Securities Dealers, Inc., Relating to the Application of NASD’s Mark-Up Policy to Transactions in Government and Other Debt Securities, Exchange Act. Rel. No. 40,511 (Sept. 30, 1998), 63 Fed. Reg. 54,169 (Oct. 8, 1998) (“In the debt securities markets, a market maker is a dealer who, with respect to a particular security, furnishes bona fide competitive bid and offer quotations on request and is ready, willing, and able to effect transactions in reasonable quantities at his or her quoted prices with other brokers or dealers.”). With respect to its proposed definition, the proposing release stated: “This language recognizes that dealers in debt markets may act effectively as market makers in a group of securities without publishing continuous two-sided quotations for each security within the group.” Id.

28 For a discussion of market maker status in the debt markets, see Becker et al., supra, at 36.

29 Proposing Release, 71 Fed. Reg. at 68,859 n. 19 (stating that the standards in Exchange Act Section 3(a)(38) will apply).

30See, e.g., In re Raymond James, Exchange Act Rel. No. 38,893 (Aug. 1, 1997) (“We have held that, unlike other dealers, a market maker in an active competitive market may use the bid or offer-side of the market (as appropriate and if validated) for determining the prevailing market price.”); In re Strategic Res. Mgmt., Inc., Exchange Act Rel. No. 36,618 (Dec. 21, 1995) (concluding that a market maker purchasing securities at a discount may base its mark-up on available quotations).

31 In other words, if the market is, for example, 10 to 10.50 and a market maker purchases stock at 9.70, the market maker can sell the stock at a price of 10.70 without fear of a mark-up violation.

32 Approval Order, at 16 n. 56, 18 n. 60. Section 3(a)(38) of the Exchange Act defines the term “market maker” as “any specialist permitted to act as a dealer, any dealer acting in the capacity of block positioner, and any dealer who, with respect to a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his own account on a regular or continuous basis.” 15 U.S.C. § 78c(a)(38).

33 Approval Order, at 18 n. 60.

34See id. (briefly discussing the statute without any mention of the “block positioner” concept, referring without analysis to the statute’s “legal requirements,” and citing the statute’s “holding out” standard). See also 2005 NASD Response to Comments, at 4-5 (referring without analysis to the “additional requirements” of the statute). Several commenters argued that acting as a block positioner brings a dealer within the statutory definition of market maker. See Letter from William C. Caccamise, Banc of America Securities LLC, to Jonathan G. Katz, SEC, at 5 (Apr. 14, 2005), available at http://www.sec.gov/rules/sro/nasd/nasd2003141/wccaccamise8744.pdf; Letter from Micah S. Green and Michele C. David, Bond Market Association, to Jonathan G. Katz, SEC, at 11 (Apr. 5, 2005), available at http://www.sec.gov/rules/sro/nasd/nasd2003141/mdavid040505.pdf;

35 Approval Order, at 15 n. 50.

36 Approval Order, at 15.

37 Approval Order, at 14 n. 49.

38 Approval Order, at 15 n. 50.

39 Approval Order, at 18 n. 59.

40See 2007 NASD Response to Comments, at 3 (stating that allowing transaction size to overcome the contemporaneous cost presumption “would allow dealers to purchase large institutional-sized positions and resell them in small retail-sized transactions without reference to its contemporaneous costs, a practice that raises significant investor protection concerns”). Cf. Zero-Coupon Securities Release, Securities Exchange Act Rel. No. 24,368 (Apr. 21, 1987), 52 Fed. Reg. 15,575 (Apr. 29, 1987) (discussing different standards for determining “prevailing market price” based on whether the dealer is a market maker, and stating that contemporaneous cost generally is the best indicator of prevailing market price when the dealer is not a market maker). Although the NASD’s guideline speaks in terms of 5 percent, because guidance suggests that debt mark-ups should be less than equity mark-ups, NASD staff have suggested that 4 percent is the guideline for debt. This analysis, however, assumes that all debt is the same and does not recognize that some debt trades more like equity.

41See, e.g., NASD Letters of Acceptance, Waiver, and Consent with Deutsche Bank Securities, Inc., Miller Tabak Roberts Securities LLC, Citigroup Global Markets Inc., and Goldman Sachs & Co. (July 28, 2004).

42 Chairman Cox has said, “We’re trying to simplify things. From the forms issuers must file, to the accounting standards they use—the SEC is waging an all-out war on complexity.” Christopher Cox, SEC Chairman, Giving Investors the Information They Need, In a Form They Can Use, Keynote Address to the 39th Annual Securities Regulation Seminar, L.A., CA, Oct. 20, 2006, available athttp://www.sec.gov/news/speech/2006/spch102006cc.htm. In other contexts, Chairman Cox has emphasized the importance of efficiency, cost-benefit analysis, and adapting regulation to new developments. See, e.g., Christopher Cox, SEC Chairman, Opening Statement on Eliminating the Short Sale 'Tick Test', Christopher Cox, SEC Chairman, Washington, DC, Nov. 28, 2006, available athttp://www.sec.gov/news/speech/2006/spch120406ccc-10a.htm (discussing proposed repeal of short sale tick test in light of empirical evidence); Statement at News Conference Announcing NYSE-NASD Regulatory Merger, Washington, DC, Nov. 28, 2006, available athttp://www.sec.gov/news/speech/2006/spch112806cc.htm (stating, with respect to the regulatory merger of the NASD and NYSE, “As regulators, our mission is to serve and protect investors with the most efficient, fair, and forward-thinking system of regulation possible. The time has come to put an end to the duplication, conflicts, regulatory costs and competing rules that we all live with today.”).
Mary Schapiro, too, has emphasized the need for regulators to adapt to changes in the capital markets. She has expressed her belief that “we can move in [the Financial Services Authority’s] direction” and increase reliance on principles-based regulatory guidance:

We must be more sophisticated in understanding and accommodating different business models without compromising investor protection.

Part of that means losing the blinders of “one size fits all” rulemaking. In some areas that argues for a more principles-based approach to regulation; in others it may argue for tiered regulation based on firm size and business model; and in others, a clearer distinction in the rule set between retail and institutional investors.

. . . At NASD, we are no stranger to principles-based regulation. Our just and equitable principles of trade and suitability rules are good examples. But we continue to look to where perhaps we can do better.

Mary L. Schapiro, Chairman and CEO, NASD, Remarks at SIFMA Compliance & Legal Division’s 38th Annual Seminar, Phoenix, AZ, Mar. 26, 2007, available athttp://www.nasd.com/PressRoom/SpeechesTestimony/MaryL.Schapiro/NASDW_018865.

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