Self-Regulatory Organizations; National Association of Securities Dealers, Inc. (n/k/a Financial Industry Regulatory Authority, Inc.); Notice of Filing of Proposed Rule Change and Amendment Nos. 1, 2, 3 and 4 Relating to the Regulation of Compensation, Fees and Expenses in Public Offerings of Real Estate Investment Trusts and Direct Participation Programs, 5885-5892 [E8-1725]

Download as PDF Federal Register / Vol. 73, No. 21 / Thursday, January 31, 2008 / Notices on net asset value. Expenses of $4,500 incurred in connection with the liquidation were paid by applicant. Filing Date: The application was filed on December 14, 2007. Applicant’s Address: 522 Fifth Ave., New York, NY 10036. BlackRock S&P 500 (R) Protected Equity Fund, Inc. [File No. 811–9479] Summary: Applicant, a closed-end investment company, seeks an order declaring that it has ceased to be an investment company. On November 21, 2007, applicant made a liquidating distribution to its shareholders, based on net asset value. Expenses of $37,425 incurred in connection with the liquidation were paid by BlackRock Advisors, LLC (‘‘BlackRock’’), applicant’s investment adviser. On November 28, 2007, assets of $257,156, representing an amount due to applicant, and an offsetting liability in the same amount, representing monies advanced to applicant for distribution to shareholders by BlackRock, were transferred to BSP Liquidating Trust, resulting in applicant having no assets or liabilities as of that date. Filing Date: The application was filed on December 19, 2007. Applicant’s Address: c/o BlackRock Advisors, LLC, 100 Bellevue Parkway, Wilmington, DE 19809. USAA Mutual Fund, Inc. [File No. 811–2429] USAA Tax Exempt Fund, Inc. [File No. 811–3333] USAA Investment Trust [File No. 811–4019] Summary: Each applicant seeks an order declaring that it has ceased to be an investment company. On July 31, 2006, each applicant transferred its assets to USAA Mutual Funds Trust, based on net asset value. Expenses of $1,680,029, $272,077 and $650,851, respectively, incurred in connection with the reorganizations were paid by each applicant. Filing Dates: The applications were filed on December 14, 2007. Applicants’ Address: 9800 Fredericksburg Rd., A–3–W, San Antonio, TX 78288. Sit Mutual Funds Trust rwilkins on PROD1PC63 with NOTICES [File No. 811–21447] Summary: Applicant seeks an order declaring that it has ceased to be an investment company. On July 31, 2007, applicant transferred its assets to Sit Tax-Free Income Fund, a series of Sit Mutual Funds II, Inc., based on net asset VerDate Aug<31>2005 18:07 Jan 30, 2008 Jkt 214001 value. Expenses of $22,795 incurred in connection with the reorganization were paid by Sit Investment Associates, Inc., applicant’s investment adviser. Filing Dates: The application was filed on November 8, 2007, and amended on January 7, 2008. Applicant’s Address: Sit Mutual Funds, 3300 IDS Center, 80 South 8th St., Minneapolis, MN 55402. Mezzacappa Long/Short Fund, LLC [File No. 811–21469] Summary: Applicant, a closed-end investment company, seeks an order declaring that it has ceased to be an investment company. Applicant is not presently making a public offering of its securities and does not propose to make a public offering. Applicant will continue to engage in its regular business activities and will operate in reliance on section 3(c)(7) of the Act. Filing Dates: The application was filed on November 21, 2007 and amended on December 21, 2007. Applicant’s Address: 630 Fifth Ave., New York, NY 10111. MDT Funds [File No. 811–21141] Summary: Applicant seeks an order declaring that it has ceased to be an investment company. On November 17, 2006 and December 8, 2006, applicant transferred its assets to corresponding series of Federated MDT Series, based on net asset value. Expenses of approximately $1,358,297 incurred in connection with the reorganization were paid by Federated Investors, Inc., the parent of the surviving fund. Filing Dates: The application was filed on November 13, 2007, and amended on December 21, 2007. Applicant’s Address: Federated Investors Tower, 5800 Corporate Dr., Pittsburgh, PA 15237–7010. The Jhaveri Trust [File No. 811–8974] Summary: Applicant seeks an order declaring that it has ceased to be an investment company. Applicant is not currently making a public offering of its securities and does not propose to make a public offering. Applicant has fewer than one hundred beneficial owners and will continue to operate as a private investment vehicle in reliance on section 3(c)(1) of the Act. Filing Dates: The application was filed on December 29, 2006, and amended on March 5, 2007, and January 24, 2008. Applicant’s Address: 27881 Clemens Rd., Westlake, OH 44145. PO 00000 Frm 00097 Fmt 4703 Sfmt 4703 5885 For the Commission, by the Division of Investment Management, pursuant to delegated authority. Florence E. Harmon, Deputy Secretary. [FR Doc. E8–1687 Filed 1–30–08; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–57199; File No. SR–NASD– 2005–114] Self-Regulatory Organizations; National Association of Securities Dealers, Inc. (n/k/a Financial Industry Regulatory Authority, Inc.); Notice of Filing of Proposed Rule Change and Amendment Nos. 1, 2, 3 and 4 Relating to the Regulation of Compensation, Fees and Expenses in Public Offerings of Real Estate Investment Trusts and Direct Participation Programs January 25, 2008. On September 28, 2005, pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 the National Association of Securities Dealers, Inc. (‘‘NASD’’) 3 filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) proposed amendments to NASD Rule 2810. On June 12, 2006, NASD filed Amendment No. 1 to the proposed rule change.4 The proposed rule change was published for comment in the Federal Register on July 17, 2006 (‘‘Original Proposal’’),5 and the Commission received six comments, which are discussed below in section II.6 On April 16, 2007, NASD filed 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 On July 26, 2007, the Commission approved a proposed rule change filed by NASD to amend NASD’s Certificate of Incorporation to reflect its name change to Financial Industry Regulatory Authority, Inc., or FINRA, in connection with the consolidation of the member firm regulatory functions of NASD and NYSE Regulation, Inc. See Exchange Act Release No. 56146 (July 26, 2007), 72 FR 42190 (Aug. 1, 2007). 4 Amendment No. 1 replaced and superseded the original rule filing. 5 See Securities Exchange Act Release No. 54118 (July 10, 2006), 71 FR 40569 (July 17, 2006) (SR– NASD–2005–114). 6 See letters from the Committee on Federal Regulation of Securities of the American Bar Association (Keith F. Higgins), dated Aug. 22, 2006 (‘‘ABA Committee’’); North American Securities Administrators Association (Patricia D. Struck), dated Aug. 11, 2006 (‘‘NASAA’’); Dominion Investor Services, Inc. (Kevin P. Takacs), dated Aug. 7, 2006; Investment Program Association (Rosemarie Thurston), dated Aug. 7, 2006 (‘‘IPA’’); the Securities Division of Office of the Secretary of the Commonwealth of Massachusetts (Bryan Lantagne), dated Aug. 4, 2006 (‘‘Massachusetts Securities Division’’); and Cambridge Legacy Group (Frank Akridge, Jr.), dated Aug. 4, 2006. 2 17 E:\FR\FM\31JAN1.SGM 31JAN1 5886 Federal Register / Vol. 73, No. 21 / Thursday, January 31, 2008 / Notices Amendment No. 2.7 On November 9, 2007, FINRA filed Amendment No. 3.8 On January 2, 2008, FINRA filed Amendment No. 4 to respond to the comments, and to make revisions to the rule change as described in Items I, II, and III below, which Items have been prepared by FINRA. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change FINRA is proposing to amend NASD Rule 2810 to address the regulation of compensation, fees and expenses in public offerings of direct participation programs and real estate investment trusts. Below is the text of the proposed rule change. Proposed new language is in italics; proposed deletions are in brackets. * * * * * rwilkins on PROD1PC63 with NOTICES 2810. Direct Participation Programs (a) No Change. (b) Requirements. (1) Application. No member or person associated with a member shall participate in a public offering of a direct participation program, [or] a limited partnership rollup transaction or, where expressly provided below, a real estate investment trust as defined in Rule 2340(d)(4) (‘‘REIT’’), except in accordance with this paragraph (b), provided however, this paragraph (b) shall not apply to an initial or secondary public offering of or a secondary market transaction in a unit, depositary receipt or other interest in a direct participation program that complies with subparagraph (2)(D). (2) No Change. (3) Disclosure. (A) Prior to participating in a public offering of a direct participation program or REIT, a member or person associated with a member shall have reasonable grounds to believe, based on information made available to him by the sponsor through a prospectus or other materials, that all material facts are adequately and accurately disclosed and provide a basis for evaluating the program. (B) through (C) No Change. (D) Prior to executing a purchase transaction in a direct participation program or a REIT, a member or person associated with a member shall inform the prospective participant of all 7 Amendment No. 2 replaced and superseded Amendment No. 1. 8 Amendment No. 3 replaced and superseded Amendment No. 2. VerDate Aug<31>2005 18:07 Jan 30, 2008 Jkt 214001 pertinent facts relating to the liquidity and marketability of the program or REIT during the term of the investment[;]. Included in the pertinent facts shall be information regarding whether the sponsor has offered prior programs or REITs in which disclosed in the offering materials was a date or time period at which the program or REIT might be liquidated, and whether the prior program(s) or REIT(s) in fact liquidated on or around that date or during the time period. [provided, however, that paragraph (b) shall not apply to an initial or secondary public offering of a secondary market transaction in a unit, depositary receipt or other interest in a direct participation program which complies with subparagraph (2)(D).] (4) Organization and Offering Expenses. (A) No member or person associated with a member shall underwrite or participate in a public offering of a direct participation program or REIT if the organization and offering expenses are not fair and reasonable, taking into consideration all relevant factors. (B) In determining the fairness and reasonableness of organization and offering expenses that are deemed to be in connection with or related to the distribution of the public offering for purposes of subparagraph (A) hereof, the arrangements shall be presumed to be unfair and unreasonable if: (i) Organization and offering expenses, as defined in subparagraph (b)(4)(C), in which a member or an affiliate of a member is a sponsor exceed an amount that equals fifteen percent of the gross proceeds of the offering; [(i)] (ii) The total amount of all items of compensation from whatever source, including offering proceeds and ‘‘trail commissions’’ payable to underwriters, broker/dealers, or affiliates thereof, [which are deemed to be in connection with or related to the distribution of the public offering,] exceeds an amount that equals ten percent of the gross proceeds of the offering [currently effective compensation guidelines for direct participation programs published by the Association];[*] [(ii) Organization and offering expenses paid by a program in which a member or an affiliate of a member is a sponsor exceed currently effective guidelines for such expenses published by the Association;**] (iii) No Change. (iv) Commissions or other compensation are to be paid or awarded either directly or indirectly, to any person engaged by a potential investor for investment advice as an inducement PO 00000 Frm 00098 Fmt 4703 Sfmt 4703 to such advisor to advise the purchaser of interests in a particular program or REIT, unless such person is a registered broker/dealer or a person associated with such a broker/dealer; [or] (v) The program or REIT provides for compensation of an indeterminate nature to be paid to members or persons associated with members for sales of the program [units] or REIT, or for services of any kind rendered in connection with or related to the distribution thereof, including, but not necessarily limited to, the following: a percentage of the management fee, a profit sharing arrangement, brokerage commissions, an[d] over-riding royalty interest, a net profits interest, a percentage of revenues, a reversionary interest, a working interest, a security or right to acquire a security having an indeterminate value, or other similar incentive items; [provided however, that an arrangement which provides for continuing compensation to a member or person associated with a member in connection with a public offering shall not be presumed to be unfair and unreasonable if all of the following conditions are satisfied:] [a. The continuing compensation is to be received only after each investor in the program has received cash distributions from the program aggregating an amount equal to his cash investment plus a six percent cumulative annual return on his adjusted investment;] [b. The continuing compensation is to be calculated as a percentage of program cash distributions;] [c. The amount of continuing compensation does not exceed three percent for each one percentage point that the total of all compensation pursuant to subparagraph (B)(i) received at the time of the offering and at the time any installment payment is made fall below nine percent; provided, however, that in no event shall the amount of continuing compensation exceed 12 percent of program cash distributions; and] [d. If any portion of the continuing compensation is to be derived from the limited partners’ interest in the program cash distributions, the percentage of the continuing compensation shall be no greater than the percentage of program cash distributions to which limited partners are entitled at the time of the payment.] (vi) The program or REIT charges a sales load or commission on securities that are purchased through the reinvestment of dividends, unless the registration statement registering the securities under the Securities Act of 1933 became effective prior to [the E:\FR\FM\31JAN1.SGM 31JAN1 rwilkins on PROD1PC63 with NOTICES Federal Register / Vol. 73, No. 21 / Thursday, January 31, 2008 / Notices effective date of this proposed rule change]; or (vii) The member has received reimbursement for due diligence expenses that are not included in a detailed and itemized invoice, unless the amount of the reimbursement is included in the calculation of underwriting compensation as a nonaccountable expense allowance, which when aggregated with all other such non-accountable expenses, does not exceed three percent of offering proceeds. (C) The organization and offering expenses subject to the limitations in subparagraph (b)(4)(B)(i) above include the following: (i) Issuer expenses, including overhead expenses that are reimbursed or paid for with offering proceeds, which include, but are not limited to, expenses for: a. Assembling, printing and mailing offering materials, processing subscription agreements, generating advertising and sales materials; b. Legal and accounting services provided to the sponsor or issuer; c. Salaries and non-transaction-based compensation paid to employees or agents of the sponsor or issuer for performing services for the sponsor or issuer; d. Transfer agents, escrow holders depositories, engineers and other experts, and e. Registration and qualification of securities under federal and state law, including taxes and fees and NASD fees; (ii) Underwriting compensation, which includes but is not limited to items of compensation listed in Rule 2710(c)(3) including payments: a. To any wholesaling or retailing firm that is engaged in the solicitation, marketing, distribution or sales of the program or REIT securities; b. To any registered representative of a member who receives transactionbased compensation in connection with the offering; c. To any registered representative who is engaged in the solicitation, marketing, distribution or sales of the program or REIT securities, other than one whose functions in connection with the offering are solely and exclusively clerical or ministerial; or d. For training and education meetings, legal services provided to a member in connection with the offering, advertising and sales material generated by the member and contributions to conferences and meetings held by nonaffiliated members for their registered representatives. VerDate Aug<31>2005 18:07 Jan 30, 2008 Jkt 214001 (iii) Due diligence expenses incurred when a member affirmatively discharges its responsibilities to ensure that all material facts pertaining to a program or REIT are adequately and accurately disclosed in the offering document. (D) Notwithstanding subparagraphs (b)(4)(C)(ii)b. and c. above, information may be provided to NASD from which the Corporate Financing Department can readily determine that some portion of a registered representative’s nontransaction based compensation should not be deemed to be underwriting compensation if the registered representative is either: a dual employee of a program or REIT with fewer than ten people engaged in wholesaling; or a dual employee who is one of the top ten highest paid executives based on nontransaction based compensation in any program or REIT. [(C)] (E) All items of compensation paid by the program or REIT directly or indirectly from whatever source to underwriters, brokers/dealers, or affiliates thereof, including, but not limited to, sales commissions, wholesaling fees, due diligence expenses, other underwriter’s expenses, underwriter’s counsel’s fees, securities or rights to acquire securities, rights of first refusal, consulting fees, finder’s fees, investor relations fees, and any other items of compensation for services of any kind or description, which are deemed to be in connection with or related to the public offering, shall be taken into consideration in computing the amount of compensation for purposes of determining compliance with the provisions of subparagraphs (A) and (B). [(D)] (F) The determination of whether compensation paid to underwriters, broker/dealers, or affiliates thereof is in connection with or related to a public offering, for purposes of this subparagraph (4), shall be made on the basis of such factors as the timing of the transaction, the consideration rendered, the investment risk, and the role of the member or affiliate in the organization, management and direction of the enterprise in which the sponsor is involved. (i) An affiliate of a member which acts or proposes to act as a general partner, associate general partner, or other sponsor of a program or REIT shall be presumed to be bearing investment risk for purposes of this paragraph (b) if the affiliate: a. Through b. No Change. c. Has a net worth equal to at least five percent of the net proceeds of the public offering or $1.0 million, whichever is less; provided, however, that the computation of the net worth PO 00000 Frm 00099 Fmt 4703 Sfmt 4703 5887 shall not include an interest in the program offered but may include net worth applied to satisfy the requirements of this paragraph (b) with respect to other programs or REITs; and d. Agrees to maintain net worth as required by subparagraph c. above under its control until the earlier of the removal or withdrawal of the affiliate as a general partner, associate general partner, or other sponsor, or the dissolution of the program or REIT. (ii) No Change. [(E)](G) Subject to the limitations on direct and indirect non-cash compensation provided under subparagraph [(E)](C), no member shall accept any cash compensation unless all of the following conditions are satisfied: (i) Through (v) No Change. (5) Valuation for Customer Account Statements. No member may participate in a public offering of direct participation program or REIT securities unless[:] [(A)] The general partner or sponsor of the program will disclose in each annual report distributed to investors pursuant to Section 13(a) of the Act a per share estimated value of the direct participation program securities, the method by which it was developed, and the date of the data used to develop the estimated value. (6) No Change. (c) Non-Cash Compensation. (1) No Change. (2) Restriction on Non-Cash Compensation. In connection with the sale and distribution of direct participation program or REIT securities, no member or person associated with a member shall directly or indirectly accept or make payments or offers of payments of any non-cash compensation, except as provided in this provision. Non-cash compensation arrangements are limited to the following: (A) Through (B) No Change. (C) Payment or reimbursement by offerors in connection with meetings held by an offeror or by a member for the purpose of training or education of associated persons of a member, provided that: (i) No Change. (ii) The location is appropriate to the purpose of the meeting, which shall mean a United States [an] office of the offeror or the member holding the meeting, or a facility located in the vicinity of such office, or a United States regional location with respect to meetings of associated persons who work within that region or, with respect to [regional] meetings with direct participation programs or REITs, a United States location at which a E:\FR\FM\31JAN1.SGM 31JAN1 5888 Federal Register / Vol. 73, No. 21 / Thursday, January 31, 2008 / Notices significant or representative asset of the program or REIT is located; (iii) Through (iv) No Change. (D) Through (E) No Change. (d) No Change. [* A guideline for underwriting compensation of ten percent of proceeds received, plus a maximum of 0.5% for reimbursement of bona fide diligence expenses was published in Notice to Members 82–51 (October 19, 1982).] [** A guideline for organization and offering expenses of 15 percent proceeds received was published in Notice to Members 82–51 (October 19, 1982).] * * * * * 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 rwilkins on PROD1PC63 with NOTICES 1. Purpose FINRA is proposing to amend Rule 2810 to address the regulation of compensation, fees and expenses in public offerings of direct participation programs (as defined in Rule 2810(a)(4)) (‘‘DPPs’’) and unlisted real estate investment trusts (as defined in Rule 2340(d)(4)) (‘‘REITs’’) (collectively ‘‘Investment Programs’’).9 Specifically, the proposed rule change addresses: (1) Compensation limitations and the use and allocation of offering proceeds; (2) disclosure regarding the liquidity of prior programs offered by the same sponsor; (3) sales loads on reinvested dividends; and (4) non-cash compensation provisions regarding the appropriate location for training and education meetings. The proposed rule change also adds REITs to provisions that already apply to DPPs, however, these amendments do not make any substantive changes to these sections.10 9 The DPPs and REITs that comprise Investment Programs typically are structured so that several affiliated entities make up the program. The affiliated entities include the sponsor, the trust or limited partnership, and a broker-dealer. 10 Proposed amendments to Rule 2810(b)(3)(A), Rule 2810(b)(4)(A), Rule 2810(b)(4)(B)(v), Rules 2810(b)(4)(D)–(G) and Rule 2810(b)(5). The VerDate Aug<31>2005 18:07 Jan 30, 2008 Jkt 214001 a. Organization and Offering Expenses Rule 2810 provides three limitations on compensation and offering expenses (‘‘O & O expenses’’) in Investment Programs. In the current rule, as interpreted by NASD compensation guidelines, these expenses are broken down into three categories: ‘‘compensation,’’ ‘‘due diligence,’’ and ‘‘issuer organization and offering expenses.’’ First, compensation payable to underwriters, broker-dealers, or affiliates may not exceed 10 percent of the gross proceeds of the offering, regardless of the source from which it is derived. Second, members or independent due diligence firms may be reimbursed an additional 0.5 percent for bona fide due diligence expenses. And third, total issuer O & O expenses for programs in which the member is affiliated with the program sponsor may not exceed 15 percent of the offering proceeds, including any compensation and due diligence expenses.11 For offerings of programs in which the member is affiliated with the sponsor, this allows an additional 4.5 percent for issuer O & O expenses above the 10 percent underwriting compensation and 0.5 percent due diligence expenses. As discussed below, the proposed rule change would make the Rule more explicit and objective in its treatment of the allocation of certain fees and expenses between issuer O & O expenses and compensation (eliminating the current 0.5 percent limit on due diligence expenses and modifying the limitations pertaining to due diligence expenses). i. Issuer Expenses In the Original Proposal, NASD proposed to codify the methodology described in NASD Notice to Members 04–07 12 for allocating O & O expenses proposed amendment to Rule 2810(b)(4)(G) also corrects a typographical error by citing to ‘‘subparagraph (C),’’ instead of ‘‘subparagraph (E)’’ under the existing rule. 11 See current Rule 2810(b)(4)(B)(i) and Notice to Members 82–51. This 15 percent limitation on O & O expenses applies only to sponsors that are affiliated with NASD members, while the 10 percent compensation limitation applies to all DPPs. 12 In Notice to Members 04–07 (‘‘Notice’’), NASD requested comment on a proposed rule change and interpretive policies regarding the allocation of fees and expenses between issuers, sponsors and brokerdealers for Investment Programs in which the sponsors and broker-dealers offering such securities are affiliated. The Notice also addressed due diligence practices and disclosure in connection with Investment Programs as well as the allocation of underwriter compensation and issuer organization and offering expenses. The Notice also proposed prohibiting sales loads on reinvested dividends in Investment Programs and closed-end funds. Finally, the Notice requested comment on changes to two non-cash compensation provisions PO 00000 Frm 00100 Fmt 4703 Sfmt 4703 between compensation, due diligence and issuer O & O expenses. Under the Original Proposal, issuer O & O expenses would have included: (i) Expenses, including overhead expenses, for assembling and mailing offering materials, processing subscription agreements and generating advertising and sales materials; (ii) legal services provided to the sponsor or issuer; and (iii) salaries and non-transaction-based compensation paid to employees or agents of the sponsor or issuer for performing such services. Also included as part of issuer O & O expenses would have been expenses incurred in connection with transfer agents, escrow holders, depositories, engineers and other experts, and registration and qualification of securities under federal and state law, including taxes and fees and NASD fees.13 Three commenters addressed the proposed treatment of issuer O & O expenses.14 Two commenters generally supported the proposal.15 One commenter suggested revising the proposed rule change to clarify that the calculation of issuer expenses would only include those issuer O & O expenses that are reimbursed or paid for with offering proceeds.16 This commenter believed that this clarification would be consistent with NASD’s longstanding policy to include in the limitations on issuer O & O expenses only those expenses deemed to be in connection with the public offering and reimbursed or paid for with offering proceeds. The commenter also noted that the issuer’s ‘‘business overhead’’ expenses, such as rent, telephone, insurance and employee benefits are costs generally not related to the public offering of an Investment Program’s securities and not paid for from offering proceeds.17 In addition, this commenter recommended that, to be consistent with Rule 2710, NASD should clarify that issuer O & O expenses include printing costs and accountants’ fees, in Rules 2710(i) and 2810(c): (1) A proposal to amend what would constitute an ‘‘appropriate location’’ for training and education meetings; and (2) new ‘‘equal weighting’’ and ‘‘total production’’ limitations for internal sales contests. NASD received 10 comments on Notice to Members 04–07. Because the Original Proposal discussed the Notice in detail, this proposal only cites to the Notice when necessary. 13 See Original Proposal amendment to Rule 2810(b)(4)(C)(i). 14 ABA Committee, Massachusetts Securities Division and NASAA. 15 Massachusetts Securities Division and NASAA. 16 ABA Committee. 17 Id. E:\FR\FM\31JAN1.SGM 31JAN1 Federal Register / Vol. 73, No. 21 / Thursday, January 31, 2008 / Notices which are typically borne by the issuer.18 Finally, the commenter suggested that the term ‘‘issuer O & O expenses’’ should be changed to minimize confusion with the O & O expenses for the entire offering, which are capped at an amount that equals fifteen percent of the proceeds of an offering and include: (1) ‘‘Issuer expenses;’’ (2) ‘‘items of compensation;’’ and (3) ‘‘due diligence expenses.’’ 19 FINRA agrees that it has been longstanding NASD policy to include in the limitations on issuer O & O expenses only those expenses deemed to be in connection with the public offering and reimbursed or paid for with offering proceeds. FINRA is amending the proposed rule change to clarify this position 20 and also to clarify that issuer expenses include expenses related to printing costs and accounting fees.21 Finally, FINRA has replaced the term ‘‘issuer O & O expenses’’ 22 with ‘‘issuer expenses’’ 23 to minimize confusion with the term ‘‘O & O expenses,’’ which includes (1) issuer expenses; (2) items of compensation; and (3) due diligence expenses.24 With these modifications, FINRA is re-proposing in Amendment No. 3 the same amendments regarding issuer expenses that were the subject of the Original Proposal. ii. Limits on Compensation As in the Original Proposal, the rule change would clarify that amounts deducted from the offering proceeds or amounts paid to underwriters, brokerdealers or affiliates as trail commissions over time are to be treated as underwriting compensation.25 In addition, paragraph (b)(4)(B)(ii) of Rule 2810 would be amended to expressly state that all items of compensation shall not exceed ‘‘ten percent of the gross proceeds of the offering.’’ 26 Accordingly, all items of compensation paid from any source, 18 Id. 19 Id. 20 Proposed amendment to Rule 2810(b)(4)(C)(i)– rwilkins on PROD1PC63 with NOTICES (ii). 21 Proposed amendment to Rule 2810(b)(4)(C)(i)(a) (printing costs) and Rule 2810(b)(4)(C)(i)(b) (accounting costs). 22 Original Proposal amendment to Rule 2810(b)(4)(C)(i). 23 Proposed amendment to Rule 2810(b)(4)(C)(i). 24 See generally proposed amendment to Rule 2810(b)(4)(C). 25 See proposed amendment to Rule 2810(b)(4)(B)(ii). The proposed amendment deletes the requirement that the compensation be ‘‘deemed to be in connection with or related to the distribution of the public offering.’’ This provision has been moved to proposed Rule 2810(b)(4)(B). 26 The ten percent figure currently is FINRA policy and is not in the text of the Rule. VerDate Aug<31>2005 18:07 Jan 30, 2008 Jkt 214001 including offering proceeds, partnership assets or management fees, would be subject to a ‘‘hard cap’’ of an amount that equals ten percent of gross offering proceeds.27 The proposed rule change also limits total O & O expenses, as defined in paragraph (b)(4)(C), to fifteen percent of gross proceeds in an offering in which a member or an affiliate of a member is a sponsor.28 The proposed rule change also would delete paragraphs (b)(4)(B)(v)(a) through (d) of Rule 2810 relating to continuing compensation arrangements. Members have not relied on these provisions since their adoption, and the limitations on continuing compensation are included in paragraph (b)(4)(B)(i) of Rule 2810 as proposed to be amended. iii. Wholesaling and Dual Employees The amendments to Rule 2810(b)(4)(C)(ii)(a) in the Original Proposal would have deemed underwriting compensation to include payments to: any wholesaler that is engaged in the solicitation, marketing, distribution or sales of the program or REIT securities and any employee of the wholesaler involved in the solicitation, development, maintenance and monitoring of selling agreements and relationships with broker/dealers and accounts and account holders at broker/ dealers[.] Commenters generally supported the proposal with regard to wholesaling firms engaged in solicitation, marketing or distribution of an Investment Program’s securities, but believed that the description of wholesaling activities by an employee of a wholesaler was too broad, noting that it included clerical and administrative functions in connection with the offering that traditionally had not been included as underwriting compensation.29 The Original Proposal also would have deemed underwriting compensation to include payments to: any employee of a member and any dual employee of a member and the sponsor, issuer or other affiliate who receives transaction-based compensation unless information has been provided to NASD, with regard to a program or REIT with fewer than ten people engaged in wholesaling, from which the Corporate Financing Department can readily conclude that the payments are 27 Proposed amendment to Rule 2810(b)(4)(B)(ii). amendment to Rule 2810(b)(4)(B)(i). 29 ABA Committee, IPA and NASAA. The Massachusetts Securities Division and NASAA urged the SEC and NASD to bring greater scrutiny to wholesaling activities, including how sponsors contact brokerage personnel. 28 Proposed PO 00000 Frm 00101 Fmt 4703 Sfmt 4703 5889 made as consideration for non-broker/dealer services[.] 30 Two commenters viewed the proposed treatment of payments to dual employees who receive transactionbased compensation as too broad because it failed to take into account situations in which such employees only spend part of their time engaged in marketing, distribution or sales of Investment Program securities.31 These commenters suggested an alternative approach of requiring the sponsor to make a good faith allocation for payments to dual employees (i.e., employees of a sponsor of an Investment Program and its affiliated broker-dealer) between underwriting compensation and non-distribution related expenses, so that only the allocable portion of a dual employee’s transaction-based compensation would be included in the calculation of underwriting compensation.32 These commenters also suggested excluding from the rule’s underwriting compensation limits payments to those employees that solely perform clerical, administrative or operational functions that generally do not require such persons to be registered as a representative or principal.33 FINRA revised the proposed amendments to Rules 2810(b)(4)(C)(ii)(a)–(b) described above in response to these comments. The proposed rule change clarifies that payments to wholesaling or retailing firms engaged in solicitation, marketing, distribution or sales of Investment Program securities will be included in the underwriting compensation limits.34 The Original Proposal would have included payments to employees engaged in wholesaling, regardless of whether they are registered. In general, employees who engage in wholesaling would be required to be registered as representatives under Rule 1031.35 Accordingly, as described below, FINRA has amended the proposed rule change so that only payments to employees who are registered persons would be included in the underwriting compensation limits. First, the proposed rule change would include as underwriting compensation 30 Original Proposal amendment to Rule 2810(b)(4)(C)(ii)(b). 31 ABA Committee and IPA. 32 Id. 33 Id. 34 Proposed amendment to Rule 2810(b)(4)(C)(ii)(a). 35 If in the course of reviewing an offering of an Investment Program, the Corporate Financing Department believes that an individual is not properly registered, it will refer such matter to the Member Regulation or Enforcement Departments for further review. E:\FR\FM\31JAN1.SGM 31JAN1 5890 Federal Register / Vol. 73, No. 21 / Thursday, January 31, 2008 / Notices rwilkins on PROD1PC63 with NOTICES all payments to a registered representative (including a dual employee) that receives transactionbased compensation in connection with the sale or distribution of Investment Program securities, subject to two exceptions for small companies and top executives discussed below.36 Second, with regard to payments to registered representatives who do not receive transaction-based compensation in connection with the sale or distribution of Investment Program securities, the proposed rule change would treat as underwriting compensation payments to employees who are engaged in the solicitation, marketing, distribution or sales of the Investment Program securities, except individuals whose functions in connection with the offering are solely and exclusively clerical or ministerial.37 While commenters suggested an alternative approach of requiring the sponsor or affiliate to make a good faith allocation of payments to dualemployees between underwriting compensation and issuer expenses, FINRA believes the approach described above would be clearer and easier to administer, and would promote more consistency with the application of the rule among Investment Programs. Investment Programs should easily be able to ascertain whether a registered person’s activities involve solicitation, marketing, distribution or sales of the Investment Program securities, and whether those activities are conducted solely and exclusively in a clerical or ministerial capacity. Moreover, this approach should minimize the opportunity for an Investment Program to mischaracterize dual employees’ dayto-day activities or to make allocations that are inconsistent with industry standards.38 36 Proposed amendment to Rule 2810(b)(4)(C)(ii)(b). If a dual employee receives compensation for services provided in connection with more than one public offering, or for private placements in addition to offerings of Investment Programs, payments to such employees may be reasonably allocated between the offerings based on the time periods in which the employee was engaged in the offerings, if they are distinct, or based on the relative size of the offerings. 37 Proposed amendment to Rule 2810(b)(4)(C)(ii)(c). Notwithstanding the exemption in Rule 1060(a)(1) and the proposed amendment to Rules 2810(b)(4)(C)(ii)(b)–(c) discussed above, certain persons whose functions are solely and exclusively clerical or ministerial may choose to be registered as representatives. See Rule 1031(a). 38 Under the alternative approach suggested by the ABA Committee and IPA, an Investment Program that misallocated payments to dual employees to issuer expenses instead of underwriting compensation would, compared to its competitors, have more offering proceeds available under the compensation limits to market and sell its securities. VerDate Aug<31>2005 18:07 Jan 30, 2008 Jkt 214001 NASD proposed to modify and improve upon the burdensome process involved when its Corporate Financing Department (‘‘Department’’) reviews Investment Programs for compliance with the compensation guidelines by analyzing information about job functions, time spent on those functions, and compensation paid to dual employees whose job functions include conducting a securities business. Commenters on Notice to Members 04–07 urged NASD to continue to utilize the detailed job function analysis in its review of compensation associated with smaller Investment Programs, for which registered representatives are more likely to work in both the securities business and operations and administration. Accordingly, the Original Proposal provided that Investment Programs with fewer than ten people engaged in wholesaling could provide detailed per-employee information to the Department for its review. Based on its review, the Department could conclude that certain salary or other non-transaction-based payments made to the employee will be allocated to issuer expenses, notwithstanding the fact that the employee also received transactionbased compensation or spent allocable portions of time engaged in securities business activities.39 Commenters supported this approach to smaller Investment Programs 40 and the proposed rule change includes these provisions. Many Investment Programs’ top executives are registered persons who engage in multiple job functions among the program sponsor, wholesaler, property or equipment manager, and portfolio manager. FINRA believes that the Department can conduct an accurate and efficient review of this small group of individuals, whose job functions should be relatively easy to identify and evaluate given their level of prominence within an Investment Program. Accordingly, in response to comments, FINRA also is amending the Original Proposal to include the same job function analysis for any dual employee that is one of the ten highest paid executives in an Investment Program, based on his or her non-transactionbased compensation.41 39 Original Proposal amendment to Rule 2810(b)(4)(C)(ii)(b). 40 IPA, Massachusetts Securities Division and NASAA. 41 Proposed amendment to Rule 2810(b)(4)(D). PO 00000 Frm 00102 Fmt 4703 Sfmt 4703 iv. Training and Education Meetings, Legal Services, and Advertising and Sales Materials The Original Proposal would have allocated to underwriting compensation fees and payments for training and education meetings, legal services provided to a broker-dealer participating in the offering and advertising and sales material generated by a broker-dealer participating in the offering.42 Two commenters supported these provisions, while another commenter recommended technical changes.43 FINRA has amended this proposal to include contributions to conferences and meetings held by non-affiliated members for their registered representatives.44 v. Due Diligence The Original Proposal would have eliminated the 0.5 percent limit on due diligence expenses under Rule 2810 and would have required that due diligence expenses combined with issuer expenses not exceed the limits on O & O expenses in Rule 2810(b)(4)(B)(i).45 The Original Proposal also would have required that a member not accept any payments or reimbursements for due diligence expenses unless they are included in a detailed and itemized invoice that is presented by the member to the program sponsor or other entity that pays or reimburses due diligence expenses.46 Two commenters supported the proposed rule change.47 Two commenters stated that the proposed rule change should allow due diligence expense reimbursements without a detailed and itemized invoice, and permit such expenses to be included in the 10 percent compensation limitation as a non-accountable expense, which is subject to a limit of up to three percent of the offering proceeds pursuant to NASD Rule 2710(f)(2)(B).48 One commenter also requested clarification that any payments for due diligence 42 Original Proposal amendment to Rule 2810(b)(4)(C)(iii)(c). 43 The Massachusetts Securities Division and NASAA supported the proposal. The ABA Committee recommended deleting ‘‘legal services’’ from the proposal because it would be duplicative of NASD Rule 2710(C)(3)(iii). 44 Proposed amendment to Rule 2810(b)(4)(C)(ii)(d). 45 Instead, the maximum amount of O & O expenses would have remained fifteen percent of the gross proceeds of the offering (which amount would include: (1) Issuer expenses; (2) compensation up to the maximum of ten percent of gross proceeds; and (3) due diligence expenses that are supported by a detailed and itemized invoice). 46 Proposed amendment to Rule 2810(b)(4)(B)(vii). 47 Massachusetts Securities Division and NASAA. 48 ABA Committee and IPA. E:\FR\FM\31JAN1.SGM 31JAN1 Federal Register / Vol. 73, No. 21 / Thursday, January 31, 2008 / Notices expenses that are made pursuant to a detailed and itemized invoice will not be included in the 10 percent limit on underwriting compensation.49 Rule 2810 currently permits members to receive compensation up to 10 percent of the offering proceeds for services rendered in a distribution. These payments may include unitemized expense allowances of up to three percent of the offering proceeds. FINRA agrees that it is reasonable to include un-itemized due diligence expenses as part of the underwriting compensation. FINRA, therefore, is amending the proposal to include, as part of underwriting compensation, due diligence reimbursements without a detailed and itemized invoice.50 However, any member seeking to include due diligence expense as part of issuer expenses must submit an itemized invoice of their actual costs incurred for bona fide due diligence expenses.51 FINRA is also re-proposing to eliminate the 0.5 percent limit in due diligence expenses.52 b. Liquidity Disclosure Rule 2810(b)(3)(D) currently provides that prior to executing a purchase transaction in a direct participation program, a member or person associated with a member shall inform the prospective participant of all pertinent facts relating to the liquidity and marketability of the program during the terms of the investment. FINRA is concerned that some investors do not fully appreciate that the liquidation of some sponsors’ programs are frequently delayed. The Original Proposal would have amended Rule 2810(b)(3)(D) to include REITs, and would have required members and their associated persons to inform prospective investors whether the sponsor has offered prior programs for which the prospectus disclosed a date or time period when the program might be liquidated, and whether the prior programs, in fact, liquidated on or around that date or time period. In addition, members selling Investment Programs would be required to disclose to investors whether prior programs 49 ABA Committee. amendment to Rule 2810(b)(4)(B)(vii). 51 Nothing in the proposed rule change would prohibit the inclusion of a profit margin in the due diligence expense bill of a firm that has conducted due diligence on behalf of a member and that is not a member or an affiliate of a member. See NASD Notice to Members 86–66 (‘‘Due Diligence Expense Reimbursements in Connection with Direct Participation Programs’’). 52 See footnote accompanying existing Rule 2810(b)(4)(B)(i). rwilkins on PROD1PC63 with NOTICES 50 Proposed VerDate Aug<31>2005 18:07 Jan 30, 2008 Jkt 214001 offered by the program sponsor were, in fact, liquidated on or during the date or time period disclosed in the prospectuses for those programs. For example, if a sponsor has offered ten prior programs and only two of them liquidated by the date or time period set forth in the prospectus, the member would be required to disclose these facts. Two commenters supported the proposal.53 One commenter objected to the proposed liquidity disclosure stating that prospectus disclosure typically includes a warning that the liquidity event or liquidation may be delayed due to market conditions and other factors.54 In this commenter’s view, the liquidity disclosure provision would unfairly characterize all situations in which a liquidity event was delayed as a ‘‘failure’’ or ‘‘inappropriate.’’ This commenter also stated that the recordkeeping burdens of the proposal and the unwarranted negative implications of such disclosure would outweigh the benefit. The commenter suggested that if a liquidity disclosure requirement were to be imposed, it should be done by an SEC rule rather than an NASD rule. Alternatively, if adopted by NASD, it should only apply to Investment Programs with fixed dates.55 FINRA is not persuaded by the commenter’s suggestion that additional disclosure regarding historical liquidity practices necessarily creates ‘‘unwarranted negative implications.’’ Rather, FINRA believes that the proposed disclosure requirement will help investors make informed investment decisions based on the facts about a sponsor’s liquidity track record. FINRA recognizes that delays in liquidity events may be due to market conditions and other factors beyond the sponsor’s control, and that, under certain circumstances, investors ultimately may benefit from delays in liquidity events. When these facts are relevant, they can be conveyed in addition to the facts regarding the sponsor’s liquidity track record providing investors with a complete picture of liquidity issues. FINRA also notes that the proposal would not require a member to ‘‘characterize’’ a previous delay in liquidation. Rather, the proposed rule change would require members to inform investors whether the sponsor has previously disclosed a date or time period when prior programs may be liquidated, and whether the programs 53 Massachusetts 54 ABA Securities Division and NASAA. Committee. 55 Id. PO 00000 Frm 00103 Fmt 4703 Sfmt 4703 5891 were in fact liquidated on or around that date or time period. Therefore, FINRA is re-proposing the amendment to Rule 2810(b)(3)(D) as in the Original Proposal. c. Sales Loads on Reinvested Dividends The Original Proposal would have amended Rule 2810(b)(4)(B)(vi) to prohibit sales loads on reinvested dividends for Investment Programs after the effective date of the proposed rule change. Two commenters strongly agreed with this proposal.56 FINRA is re-proposing this amendment to Rule 2810(b)(4)(B)(vi). d. Non-Cash Compensation Provisions i. Location of Training and Education Meetings The Original Proposal would have amended the current non-cash compensation rule to provide that an ‘‘appropriate location’’ for training and education meeting may include a location at which a significant or representative Investment Program asset is located.57 This provision would recognize that an important part of bona fide training and education meetings for Investment Programs may be inspecting real estate, oil and gas production facilities, and other types of assets that will be held and managed by the program,58 and would provide that a training and education meeting may include a location at which a ‘‘significant or representative’’ asset is located. Commenters generally supported this aspect of the proposal; 59 however, one commenter suggested that the rule should explicitly state that the non-cash compensation provision applies to public offerings, and not private placements.60 Because Rule 2810 by its terms applies only to public offerings, FINRA believes that such additional clarification in this section is 56 Massachusetts Securities Division and NASAA. amendment to Rule 2810(c)(2)(C)(ii). 58 As discussed above, FINRA proposes to amend Rule 2810 so that the Rule’s compensation, disclosure and non-cash compensation provisions expressly govern illiquid REITs (i.e., REITs as defined in Rule 2340(d)(4)). The proposed rule change would not amend the non-cash compensation provisions in Rule 2710, which currently are identical to those in Rule 2810. Accordingly, the non-cash compensation provisions regarding the location of training and education meetings will be different for exchange-traded REITs under Rule 2710 and illiquid REITs under Rule 2810. 59 IPA, Massachusetts Securities Division and NASAA. 60 IPA (noting that it understands from conversations with NASD staff that the non-cash compensation rules are not intended to apply to private placements). 57 Proposed E:\FR\FM\31JAN1.SGM 31JAN1 5892 Federal Register / Vol. 73, No. 21 / Thursday, January 31, 2008 / Notices unnecessary. FINRA is re-proposing the amendment to Rule 2810(c)(2). principles of trade, and protect investors and the public interest. ii. Total Production and Equal Weighting Requirements B. Self-Regulatory Organization’s Statement on Burden on Competition In connection with the Original Proposal, NASD stated that it was considering future amendments to Rule 2810 to incorporate the total production and equal weighting conditions for internal sales contests in its Investment Company Rule (Rule 2820) and Variable Contracts Rule (Rule 2830) in the context of a broader non-cash compensation rulemaking initiative.61 Two commenters urged NASD to abolish sales contests because they create incentives that are contrary to the obligations broker-dealers have to their customers, such as fair dealing.62 As noted above, FINRA will consider these issues in future rulemaking. 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. e. Effective Date of the Proposed Rule Change The Commission published the proposed rule change in the Federal Register on July 17, 2006.64 The comment period closed on August 7, 2006. The Commission received six comments in response to the Federal Register publication of the proposal. The comments are summarized in Item II above. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action FINRA will announce the effective date of the proposed rule change in a Regulatory Notice to be published no later than 60 days following Commission approval. The effective date will be 30 days following publication of the Regulatory Notice announcing Commission approval. 2. Statutory Basis rwilkins on PROD1PC63 with NOTICES C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others FINRA believes that the proposed rule change is consistent with the provisions of section 15A(b)(6) of the Act,63 which require, 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. The proposed rule change would codify FINRA’s longstanding policy of applying certain regulatory requirements in Rule 2810 to REITs. In context of Investment Programs, FINRA believes that clarifying the standards for determining the fairness and reasonableness of compensation, treating the use and allocation of offering proceeds in a more explicit and objective manner, requiring disclosure regarding the liquidity of prior programs offered by the same sponsor, prohibiting sales loads on reinvested dividends and enabling bona fide training and education meetings to take place at appropriate locations, are measures designed to prevent fraudulent practices, promote just and equitable Notice to Members 05–40. Securities Division and NASAA. 63 15 U.S.C. 78o–3(b)(6). 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, as amended, 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 rulecomments@sec.gov. Please include File Number SR–NASD–2005–114 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 61 See 62 Massachusetts VerDate Aug<31>2005 18:07 Jan 30, 2008 Jkt 214001 64 See Securities Exchange Act Release No. 54118 (July 10, 2006), 71 FR 40569 (July 17, 2006). PO 00000 Frm 00104 Fmt 4703 Sfmt 4703 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NASD–2005–114. 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 submissions should refer to File Number SR–NASD–2005–114 and should be submitted on or before February 21, 2008. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.65 Florence E. Harmon, Deputy Secretary. [FR Doc. E8–1725 Filed 1–30–08; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–57198; File No. SR– NASDAQ–2007–094] Self-Regulatory Organizations; The NASDAQ Stock Market, LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Regarding Notification Requirements for Issuers Making Distributions to Shareholders January 24, 2008. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 65 17 E:\FR\FM\31JAN1.SGM CFR 200.30–3(a)(12). 31JAN1

Agencies

[Federal Register Volume 73, Number 21 (Thursday, January 31, 2008)]
[Notices]
[Pages 5885-5892]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-1725]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57199; File No. SR-NASD-2005-114]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc. (n/k/a Financial Industry Regulatory Authority, Inc.); 
Notice of Filing of Proposed Rule Change and Amendment Nos. 1, 2, 3 and 
4 Relating to the Regulation of Compensation, Fees and Expenses in 
Public Offerings of Real Estate Investment Trusts and Direct 
Participation Programs

January 25, 2008.
    On September 28, 2005, pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ the National Association of Securities Dealers, Inc. 
(``NASD'') \3\ filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') proposed amendments to NASD Rule 2810. On 
June 12, 2006, NASD filed Amendment No. 1 to the proposed rule 
change.\4\ The proposed rule change was published for comment in the 
Federal Register on July 17, 2006 (``Original Proposal''),\5\ and the 
Commission received six comments, which are discussed below in section 
II.\6\ On April 16, 2007, NASD filed

[[Page 5886]]

Amendment No. 2.\7\ On November 9, 2007, FINRA filed Amendment No. 
3.\8\ On January 2, 2008, FINRA filed Amendment No. 4 to respond to the 
comments, and to make revisions to the rule change as described in 
Items I, II, and III below, which Items have been prepared by FINRA. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On July 26, 2007, the Commission approved a proposed rule 
change filed by NASD to amend NASD's Certificate of Incorporation to 
reflect its name change to Financial Industry Regulatory Authority, 
Inc., or FINRA, in connection with the consolidation of the member 
firm regulatory functions of NASD and NYSE Regulation, Inc. See 
Exchange Act Release No. 56146 (July 26, 2007), 72 FR 42190 (Aug. 1, 
2007).
    \4\ Amendment No. 1 replaced and superseded the original rule 
filing.
    \5\ See Securities Exchange Act Release No. 54118 (July 10, 
2006), 71 FR 40569 (July 17, 2006) (SR-NASD-2005-114).
    \6\ See letters from the Committee on Federal Regulation of 
Securities of the American Bar Association (Keith F. Higgins), dated 
Aug. 22, 2006 (``ABA Committee''); North American Securities 
Administrators Association (Patricia D. Struck), dated Aug. 11, 2006 
(``NASAA''); Dominion Investor Services, Inc. (Kevin P. Takacs), 
dated Aug. 7, 2006; Investment Program Association (Rosemarie 
Thurston), dated Aug. 7, 2006 (``IPA''); the Securities Division of 
Office of the Secretary of the Commonwealth of Massachusetts (Bryan 
Lantagne), dated Aug. 4, 2006 (``Massachusetts Securities 
Division''); and Cambridge Legacy Group (Frank Akridge, Jr.), dated 
Aug. 4, 2006.
    \7\ Amendment No. 2 replaced and superseded Amendment No. 1.
    \8\ Amendment No. 3 replaced and superseded Amendment No. 2.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend NASD Rule 2810 to address the 
regulation of compensation, fees and expenses in public offerings of 
direct participation programs and real estate investment trusts. Below 
is the text of the proposed rule change. Proposed new language is in 
italics; proposed deletions are in brackets.
* * * * *

2810. Direct Participation Programs

    (a) No Change.
    (b) Requirements.
    (1) Application.
    No member or person associated with a member shall participate in a 
public offering of a direct participation program, [or] a limited 
partnership rollup transaction or, where expressly provided below, a 
real estate investment trust as defined in Rule 2340(d)(4) (``REIT''), 
except in accordance with this paragraph (b), provided however, this 
paragraph (b) shall not apply to an initial or secondary public 
offering of or a secondary market transaction in a unit, depositary 
receipt or other interest in a direct participation program that 
complies with subparagraph (2)(D).
    (2) No Change.
    (3) Disclosure.
    (A) Prior to participating in a public offering of a direct 
participation program or REIT, a member or person associated with a 
member shall have reasonable grounds to believe, based on information 
made available to him by the sponsor through a prospectus or other 
materials, that all material facts are adequately and accurately 
disclosed and provide a basis for evaluating the program.
    (B) through (C) No Change.
    (D) Prior to executing a purchase transaction in a direct 
participation program or a REIT, a member or person associated with a 
member shall inform the prospective participant of all pertinent facts 
relating to the liquidity and marketability of the program or REIT 
during the term of the investment[;]. Included in the pertinent facts 
shall be information regarding whether the sponsor has offered prior 
programs or REITs in which disclosed in the offering materials was a 
date or time period at which the program or REIT might be liquidated, 
and whether the prior program(s) or REIT(s) in fact liquidated on or 
around that date or during the time period. [provided, however, that 
paragraph (b) shall not apply to an initial or secondary public 
offering of a secondary market transaction in a unit, depositary 
receipt or other interest in a direct participation program which 
complies with subparagraph (2)(D).]
    (4) Organization and Offering Expenses.
    (A) No member or person associated with a member shall underwrite 
or participate in a public offering of a direct participation program 
or REIT if the organization and offering expenses are not fair and 
reasonable, taking into consideration all relevant factors.
    (B) In determining the fairness and reasonableness of organization 
and offering expenses that are deemed to be in connection with or 
related to the distribution of the public offering for purposes of 
subparagraph (A) hereof, the arrangements shall be presumed to be 
unfair and unreasonable if:
    (i) Organization and offering expenses, as defined in subparagraph 
(b)(4)(C), in which a member or an affiliate of a member is a sponsor 
exceed an amount that equals fifteen percent of the gross proceeds of 
the offering;
    [(i)] (ii) The total amount of all items of compensation from 
whatever source, including offering proceeds and ``trail commissions'' 
payable to underwriters, broker/dealers, or affiliates thereof, [which 
are deemed to be in connection with or related to the distribution of 
the public offering,] exceeds an amount that equals ten percent of the 
gross proceeds of the offering [currently effective compensation 
guidelines for direct participation programs published by the 
Association];[\*\]
    [(ii) Organization and offering expenses paid by a program in which 
a member or an affiliate of a member is a sponsor exceed currently 
effective guidelines for such expenses published by the 
Association;\**\]
    (iii) No Change.
    (iv) Commissions or other compensation are to be paid or awarded 
either directly or indirectly, to any person engaged by a potential 
investor for investment advice as an inducement to such advisor to 
advise the purchaser of interests in a particular program or REIT, 
unless such person is a registered broker/dealer or a person associated 
with such a broker/dealer; [or]
    (v) The program or REIT provides for compensation of an 
indeterminate nature to be paid to members or persons associated with 
members for sales of the program [units] or REIT, or for services of 
any kind rendered in connection with or related to the distribution 
thereof, including, but not necessarily limited to, the following: a 
percentage of the management fee, a profit sharing arrangement, 
brokerage commissions, an[d] over-riding royalty interest, a net 
profits interest, a percentage of revenues, a reversionary interest, a 
working interest, a security or right to acquire a security having an 
indeterminate value, or other similar incentive items; [provided 
however, that an arrangement which provides for continuing compensation 
to a member or person associated with a member in connection with a 
public offering shall not be presumed to be unfair and unreasonable if 
all of the following conditions are satisfied:]
    [a. The continuing compensation is to be received only after each 
investor in the program has received cash distributions from the 
program aggregating an amount equal to his cash investment plus a six 
percent cumulative annual return on his adjusted investment;]
    [b. The continuing compensation is to be calculated as a percentage 
of program cash distributions;]
    [c. The amount of continuing compensation does not exceed three 
percent for each one percentage point that the total of all 
compensation pursuant to subparagraph (B)(i) received at the time of 
the offering and at the time any installment payment is made fall below 
nine percent; provided, however, that in no event shall the amount of 
continuing compensation exceed 12 percent of program cash 
distributions; and]
    [d. If any portion of the continuing compensation is to be derived 
from the limited partners' interest in the program cash distributions, 
the percentage of the continuing compensation shall be no greater than 
the percentage of program cash distributions to which limited partners 
are entitled at the time of the payment.]
    (vi) The program or REIT charges a sales load or commission on 
securities that are purchased through the reinvestment of dividends, 
unless the registration statement registering the securities under the 
Securities Act of 1933 became effective prior to [the

[[Page 5887]]

effective date of this proposed rule change]; or
    (vii) The member has received reimbursement for due diligence 
expenses that are not included in a detailed and itemized invoice, 
unless the amount of the reimbursement is included in the calculation 
of underwriting compensation as a non-accountable expense allowance, 
which when aggregated with all other such non-accountable expenses, 
does not exceed three percent of offering proceeds.
    (C) The organization and offering expenses subject to the 
limitations in subparagraph (b)(4)(B)(i) above include the following:
    (i) Issuer expenses, including overhead expenses that are 
reimbursed or paid for with offering proceeds, which include, but are 
not limited to, expenses for:
    a. Assembling, printing and mailing offering materials, processing 
subscription agreements, generating advertising and sales materials;
    b. Legal and accounting services provided to the sponsor or issuer;
    c. Salaries and non-transaction-based compensation paid to 
employees or agents of the sponsor or issuer for performing services 
for the sponsor or issuer;
    d. Transfer agents, escrow holders depositories, engineers and 
other experts, and
    e. Registration and qualification of securities under federal and 
state law, including taxes and fees and NASD fees;
    (ii) Underwriting compensation, which includes but is not limited 
to items of compensation listed in Rule 2710(c)(3) including payments:
    a. To any wholesaling or retailing firm that is engaged in the 
solicitation, marketing, distribution or sales of the program or REIT 
securities;
    b. To any registered representative of a member who receives 
transaction-based compensation in connection with the offering;
    c. To any registered representative who is engaged in the 
solicitation, marketing, distribution or sales of the program or REIT 
securities, other than one whose functions in connection with the 
offering are solely and exclusively clerical or ministerial; or
    d. For training and education meetings, legal services provided to 
a member in connection with the offering, advertising and sales 
material generated by the member and contributions to conferences and 
meetings held by non-affiliated members for their registered 
representatives.
    (iii) Due diligence expenses incurred when a member affirmatively 
discharges its responsibilities to ensure that all material facts 
pertaining to a program or REIT are adequately and accurately disclosed 
in the offering document.
    (D) Notwithstanding subparagraphs (b)(4)(C)(ii)b. and c. above, 
information may be provided to NASD from which the Corporate Financing 
Department can readily determine that some portion of a registered 
representative's non-transaction based compensation should not be 
deemed to be underwriting compensation if the registered representative 
is either: a dual employee of a program or REIT with fewer than ten 
people engaged in wholesaling; or a dual employee who is one of the top 
ten highest paid executives based on non-transaction based compensation 
in any program or REIT.
    [(C)] (E) All items of compensation paid by the program or REIT 
directly or indirectly from whatever source to underwriters, brokers/
dealers, or affiliates thereof, including, but not limited to, sales 
commissions, wholesaling fees, due diligence expenses, other 
underwriter's expenses, underwriter's counsel's fees, securities or 
rights to acquire securities, rights of first refusal, consulting fees, 
finder's fees, investor relations fees, and any other items of 
compensation for services of any kind or description, which are deemed 
to be in connection with or related to the public offering, shall be 
taken into consideration in computing the amount of compensation for 
purposes of determining compliance with the provisions of subparagraphs 
(A) and (B).
    [(D)] (F) The determination of whether compensation paid to 
underwriters, broker/dealers, or affiliates thereof is in connection 
with or related to a public offering, for purposes of this subparagraph 
(4), shall be made on the basis of such factors as the timing of the 
transaction, the consideration rendered, the investment risk, and the 
role of the member or affiliate in the organization, management and 
direction of the enterprise in which the sponsor is involved.
    (i) An affiliate of a member which acts or proposes to act as a 
general partner, associate general partner, or other sponsor of a 
program or REIT shall be presumed to be bearing investment risk for 
purposes of this paragraph (b) if the affiliate:
    a. Through b. No Change.
    c. Has a net worth equal to at least five percent of the net 
proceeds of the public offering or $1.0 million, whichever is less; 
provided, however, that the computation of the net worth shall not 
include an interest in the program offered but may include net worth 
applied to satisfy the requirements of this paragraph (b) with respect 
to other programs or REITs; and
    d. Agrees to maintain net worth as required by subparagraph c. 
above under its control until the earlier of the removal or withdrawal 
of the affiliate as a general partner, associate general partner, or 
other sponsor, or the dissolution of the program or REIT.
    (ii) No Change.
    [(E)](G) Subject to the limitations on direct and indirect non-cash 
compensation provided under subparagraph [(E)](C), no member shall 
accept any cash compensation unless all of the following conditions are 
satisfied:
    (i) Through (v) No Change.
    (5) Valuation for Customer Account Statements.
    No member may participate in a public offering of direct 
participation program or REIT securities unless[:]
    [(A)] The general partner or sponsor of the program will disclose 
in each annual report distributed to investors pursuant to Section 
13(a) of the Act a per share estimated value of the direct 
participation program securities, the method by which it was developed, 
and the date of the data used to develop the estimated value.
    (6) No Change.
    (c) Non-Cash Compensation.
    (1) No Change.
    (2) Restriction on Non-Cash Compensation.
    In connection with the sale and distribution of direct 
participation program or REIT securities, no member or person 
associated with a member shall directly or indirectly accept or make 
payments or offers of payments of any non-cash compensation, except as 
provided in this provision. Non-cash compensation arrangements are 
limited to the following:
    (A) Through (B) No Change.
    (C) Payment or reimbursement by offerors in connection with 
meetings held by an offeror or by a member for the purpose of training 
or education of associated persons of a member, provided that:
    (i) No Change.
    (ii) The location is appropriate to the purpose of the meeting, 
which shall mean a United States [an] office of the offeror or the 
member holding the meeting, or a facility located in the vicinity of 
such office, or a United States regional location with respect to 
meetings of associated persons who work within that region or, with 
respect to [regional] meetings with direct participation programs or 
REITs, a United States location at which a

[[Page 5888]]

significant or representative asset of the program or REIT is located;
    (iii) Through (iv) No Change.
    (D) Through (E) No Change.
    (d) No Change.

    [* A guideline for underwriting compensation of ten percent of 
proceeds received, plus a maximum of 0.5% for reimbursement of bona 
fide diligence expenses was published in Notice to Members 82-51 
(October 19, 1982).]
    [** A guideline for organization and offering expenses of 15 
percent proceeds received was published in Notice to Members 82-51 
(October 19, 1982).]
* * * * *

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
    FINRA is proposing to amend Rule 2810 to address the regulation of 
compensation, fees and expenses in public offerings of direct 
participation programs (as defined in Rule 2810(a)(4)) (``DPPs'') and 
unlisted real estate investment trusts (as defined in Rule 2340(d)(4)) 
(``REITs'') (collectively ``Investment Programs'').\9\ Specifically, 
the proposed rule change addresses: (1) Compensation limitations and 
the use and allocation of offering proceeds; (2) disclosure regarding 
the liquidity of prior programs offered by the same sponsor; (3) sales 
loads on reinvested dividends; and (4) non-cash compensation provisions 
regarding the appropriate location for training and education meetings. 
The proposed rule change also adds REITs to provisions that already 
apply to DPPs, however, these amendments do not make any substantive 
changes to these sections.\10\
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    \9\ The DPPs and REITs that comprise Investment Programs 
typically are structured so that several affiliated entities make up 
the program. The affiliated entities include the sponsor, the trust 
or limited partnership, and a broker-dealer.
    \10\ Proposed amendments to Rule 2810(b)(3)(A), Rule 
2810(b)(4)(A), Rule 2810(b)(4)(B)(v), Rules 2810(b)(4)(D)-(G) and 
Rule 2810(b)(5). The proposed amendment to Rule 2810(b)(4)(G) also 
corrects a typographical error by citing to ``subparagraph (C),'' 
instead of ``subparagraph (E)'' under the existing rule.
---------------------------------------------------------------------------

a. Organization and Offering Expenses
    Rule 2810 provides three limitations on compensation and offering 
expenses (``O & O expenses'') in Investment Programs. In the current 
rule, as interpreted by NASD compensation guidelines, these expenses 
are broken down into three categories: ``compensation,'' ``due 
diligence,'' and ``issuer organization and offering expenses.'' First, 
compensation payable to underwriters, broker-dealers, or affiliates may 
not exceed 10 percent of the gross proceeds of the offering, regardless 
of the source from which it is derived. Second, members or independent 
due diligence firms may be reimbursed an additional 0.5 percent for 
bona fide due diligence expenses. And third, total issuer O & O 
expenses for programs in which the member is affiliated with the 
program sponsor may not exceed 15 percent of the offering proceeds, 
including any compensation and due diligence expenses.\11\
---------------------------------------------------------------------------

    \11\ See current Rule 2810(b)(4)(B)(i) and Notice to Members 82-
51. This 15 percent limitation on O & O expenses applies only to 
sponsors that are affiliated with NASD members, while the 10 percent 
compensation limitation applies to all DPPs.
---------------------------------------------------------------------------

    For offerings of programs in which the member is affiliated with 
the sponsor, this allows an additional 4.5 percent for issuer O & O 
expenses above the 10 percent underwriting compensation and 0.5 percent 
due diligence expenses.
    As discussed below, the proposed rule change would make the Rule 
more explicit and objective in its treatment of the allocation of 
certain fees and expenses between issuer O & O expenses and 
compensation (eliminating the current 0.5 percent limit on due 
diligence expenses and modifying the limitations pertaining to due 
diligence expenses).
i. Issuer Expenses
    In the Original Proposal, NASD proposed to codify the methodology 
described in NASD Notice to Members 04-07 \12\ for allocating O & O 
expenses between compensation, due diligence and issuer O & O expenses. 
Under the Original Proposal, issuer O & O expenses would have included: 
(i) Expenses, including overhead expenses, for assembling and mailing 
offering materials, processing subscription agreements and generating 
advertising and sales materials; (ii) legal services provided to the 
sponsor or issuer; and (iii) salaries and non-transaction-based 
compensation paid to employees or agents of the sponsor or issuer for 
performing such services. Also included as part of issuer O & O 
expenses would have been expenses incurred in connection with transfer 
agents, escrow holders, depositories, engineers and other experts, and 
registration and qualification of securities under federal and state 
law, including taxes and fees and NASD fees.\13\
---------------------------------------------------------------------------

    \12\ In Notice to Members 04-07 (``Notice''), NASD requested 
comment on a proposed rule change and interpretive policies 
regarding the allocation of fees and expenses between issuers, 
sponsors and broker-dealers for Investment Programs in which the 
sponsors and broker-dealers offering such securities are affiliated. 
The Notice also addressed due diligence practices and disclosure in 
connection with Investment Programs as well as the allocation of 
underwriter compensation and issuer organization and offering 
expenses. The Notice also proposed prohibiting sales loads on 
reinvested dividends in Investment Programs and closed-end funds. 
Finally, the Notice requested comment on changes to two non-cash 
compensation provisions in Rules 2710(i) and 2810(c): (1) A proposal 
to amend what would constitute an ``appropriate location'' for 
training and education meetings; and (2) new ``equal weighting'' and 
``total production'' limitations for internal sales contests. NASD 
received 10 comments on Notice to Members 04-07. Because the 
Original Proposal discussed the Notice in detail, this proposal only 
cites to the Notice when necessary.
    \13\ See Original Proposal amendment to Rule 2810(b)(4)(C)(i).
---------------------------------------------------------------------------

    Three commenters addressed the proposed treatment of issuer O & O 
expenses.\14\ Two commenters generally supported the proposal.\15\ One 
commenter suggested revising the proposed rule change to clarify that 
the calculation of issuer expenses would only include those issuer O & 
O expenses that are reimbursed or paid for with offering proceeds.\16\ 
This commenter believed that this clarification would be consistent 
with NASD's longstanding policy to include in the limitations on issuer 
O & O expenses only those expenses deemed to be in connection with the 
public offering and reimbursed or paid for with offering proceeds. The 
commenter also noted that the issuer's ``business overhead'' expenses, 
such as rent, telephone, insurance and employee benefits are costs 
generally not related to the public offering of an Investment Program's 
securities and not paid for from offering proceeds.\17\
---------------------------------------------------------------------------

    \14\ ABA Committee, Massachusetts Securities Division and NASAA.
    \15\ Massachusetts Securities Division and NASAA.
    \16\ ABA Committee.
    \17\ Id.
---------------------------------------------------------------------------

    In addition, this commenter recommended that, to be consistent with 
Rule 2710, NASD should clarify that issuer O & O expenses include 
printing costs and accountants' fees,

[[Page 5889]]

which are typically borne by the issuer.\18\
---------------------------------------------------------------------------

    \18\ Id.
---------------------------------------------------------------------------

    Finally, the commenter suggested that the term ``issuer O & O 
expenses'' should be changed to minimize confusion with the O & O 
expenses for the entire offering, which are capped at an amount that 
equals fifteen percent of the proceeds of an offering and include: (1) 
``Issuer expenses;'' (2) ``items of compensation;'' and (3) ``due 
diligence expenses.'' \19\
---------------------------------------------------------------------------

    \19\ Id.
---------------------------------------------------------------------------

    FINRA agrees that it has been longstanding NASD policy to include 
in the limitations on issuer O & O expenses only those expenses deemed 
to be in connection with the public offering and reimbursed or paid for 
with offering proceeds. FINRA is amending the proposed rule change to 
clarify this position \20\ and also to clarify that issuer expenses 
include expenses related to printing costs and accounting fees.\21\
---------------------------------------------------------------------------

    \20\ Proposed amendment to Rule 2810(b)(4)(C)(i)-(ii).
    \21\ Proposed amendment to Rule 2810(b)(4)(C)(i)(a) (printing 
costs) and Rule 2810(b)(4)(C)(i)(b) (accounting costs).
---------------------------------------------------------------------------

    Finally, FINRA has replaced the term ``issuer O & O expenses'' \22\ 
with ``issuer expenses'' \23\ to minimize confusion with the term ``O & 
O expenses,'' which includes (1) issuer expenses; (2) items of 
compensation; and (3) due diligence expenses.\24\
---------------------------------------------------------------------------

    \22\ Original Proposal amendment to Rule 2810(b)(4)(C)(i).
    \23\ Proposed amendment to Rule 2810(b)(4)(C)(i).
    \24\ See generally proposed amendment to Rule 2810(b)(4)(C).
---------------------------------------------------------------------------

    With these modifications, FINRA is re-proposing in Amendment No. 3 
the same amendments regarding issuer expenses that were the subject of 
the Original Proposal.
ii. Limits on Compensation
    As in the Original Proposal, the rule change would clarify that 
amounts deducted from the offering proceeds or amounts paid to 
underwriters, broker-dealers or affiliates as trail commissions over 
time are to be treated as underwriting compensation.\25\ In addition, 
paragraph (b)(4)(B)(ii) of Rule 2810 would be amended to expressly 
state that all items of compensation shall not exceed ``ten percent of 
the gross proceeds of the offering.'' \26\
---------------------------------------------------------------------------

    \25\ See proposed amendment to Rule 2810(b)(4)(B)(ii). The 
proposed amendment deletes the requirement that the compensation be 
``deemed to be in connection with or related to the distribution of 
the public offering.'' This provision has been moved to proposed 
Rule 2810(b)(4)(B).
    \26\ The ten percent figure currently is FINRA policy and is not 
in the text of the Rule.
---------------------------------------------------------------------------

    Accordingly, all items of compensation paid from any source, 
including offering proceeds, partnership assets or management fees, 
would be subject to a ``hard cap'' of an amount that equals ten percent 
of gross offering proceeds.\27\
---------------------------------------------------------------------------

    \27\ Proposed amendment to Rule 2810(b)(4)(B)(ii).
---------------------------------------------------------------------------

    The proposed rule change also limits total O & O expenses, as 
defined in paragraph (b)(4)(C), to fifteen percent of gross proceeds in 
an offering in which a member or an affiliate of a member is a 
sponsor.\28\
---------------------------------------------------------------------------

    \28\ Proposed amendment to Rule 2810(b)(4)(B)(i).
---------------------------------------------------------------------------

    The proposed rule change also would delete paragraphs 
(b)(4)(B)(v)(a) through (d) of Rule 2810 relating to continuing 
compensation arrangements. Members have not relied on these provisions 
since their adoption, and the limitations on continuing compensation 
are included in paragraph (b)(4)(B)(i) of Rule 2810 as proposed to be 
amended.
iii. Wholesaling and Dual Employees
    The amendments to Rule 2810(b)(4)(C)(ii)(a) in the Original 
Proposal would have deemed underwriting compensation to include 
payments to:

any wholesaler that is engaged in the solicitation, marketing, 
distribution or sales of the program or REIT securities and any 
employee of the wholesaler involved in the solicitation, 
development, maintenance and monitoring of selling agreements and 
relationships with broker/dealers and accounts and account holders 
at broker/dealers[.]

    Commenters generally supported the proposal with regard to 
wholesaling firms engaged in solicitation, marketing or distribution of 
an Investment Program's securities, but believed that the description 
of wholesaling activities by an employee of a wholesaler was too broad, 
noting that it included clerical and administrative functions in 
connection with the offering that traditionally had not been included 
as underwriting compensation.\29\
---------------------------------------------------------------------------

    \29\ ABA Committee, IPA and NASAA. The Massachusetts Securities 
Division and NASAA urged the SEC and NASD to bring greater scrutiny 
to wholesaling activities, including how sponsors contact brokerage 
personnel.
---------------------------------------------------------------------------

    The Original Proposal also would have deemed underwriting 
compensation to include payments to:

any employee of a member and any dual employee of a member and the 
sponsor, issuer or other affiliate who receives transaction-based 
compensation unless information has been provided to NASD, with 
regard to a program or REIT with fewer than ten people engaged in 
wholesaling, from which the Corporate Financing Department can 
readily conclude that the payments are made as consideration for 
non-broker/dealer services[.] \30\

    \30\ Original Proposal amendment to Rule 2810(b)(4)(C)(ii)(b).
---------------------------------------------------------------------------

    Two commenters viewed the proposed treatment of payments to dual 
employees who receive transaction-based compensation as too broad 
because it failed to take into account situations in which such 
employees only spend part of their time engaged in marketing, 
distribution or sales of Investment Program securities.\31\
---------------------------------------------------------------------------

    \31\ ABA Committee and IPA.
---------------------------------------------------------------------------

    These commenters suggested an alternative approach of requiring the 
sponsor to make a good faith allocation for payments to dual employees 
(i.e., employees of a sponsor of an Investment Program and its 
affiliated broker-dealer) between underwriting compensation and non-
distribution related expenses, so that only the allocable portion of a 
dual employee's transaction-based compensation would be included in the 
calculation of underwriting compensation.\32\
---------------------------------------------------------------------------

    \32\ Id.
---------------------------------------------------------------------------

    These commenters also suggested excluding from the rule's 
underwriting compensation limits payments to those employees that 
solely perform clerical, administrative or operational functions that 
generally do not require such persons to be registered as a 
representative or principal.\33\
---------------------------------------------------------------------------

    \33\ Id.
---------------------------------------------------------------------------

    FINRA revised the proposed amendments to Rules 
2810(b)(4)(C)(ii)(a)-(b) described above in response to these comments. 
The proposed rule change clarifies that payments to wholesaling or 
retailing firms engaged in solicitation, marketing, distribution or 
sales of Investment Program securities will be included in the 
underwriting compensation limits.\34\
---------------------------------------------------------------------------

    \34\ Proposed amendment to Rule 2810(b)(4)(C)(ii)(a).
---------------------------------------------------------------------------

    The Original Proposal would have included payments to employees 
engaged in wholesaling, regardless of whether they are registered. In 
general, employees who engage in wholesaling would be required to be 
registered as representatives under Rule 1031.\35\ Accordingly, as 
described below, FINRA has amended the proposed rule change so that 
only payments to employees who are registered persons would be included 
in the underwriting compensation limits.
---------------------------------------------------------------------------

    \35\ If in the course of reviewing an offering of an Investment 
Program, the Corporate Financing Department believes that an 
individual is not properly registered, it will refer such matter to 
the Member Regulation or Enforcement Departments for further review.
---------------------------------------------------------------------------

    First, the proposed rule change would include as underwriting 
compensation

[[Page 5890]]

all payments to a registered representative (including a dual employee) 
that receives transaction-based compensation in connection with the 
sale or distribution of Investment Program securities, subject to two 
exceptions for small companies and top executives discussed below.\36\
---------------------------------------------------------------------------

    \36\ Proposed amendment to Rule 2810(b)(4)(C)(ii)(b). If a dual 
employee receives compensation for services provided in connection 
with more than one public offering, or for private placements in 
addition to offerings of Investment Programs, payments to such 
employees may be reasonably allocated between the offerings based on 
the time periods in which the employee was engaged in the offerings, 
if they are distinct, or based on the relative size of the 
offerings.
---------------------------------------------------------------------------

    Second, with regard to payments to registered representatives who 
do not receive transaction-based compensation in connection with the 
sale or distribution of Investment Program securities, the proposed 
rule change would treat as underwriting compensation payments to 
employees who are engaged in the solicitation, marketing, distribution 
or sales of the Investment Program securities, except individuals whose 
functions in connection with the offering are solely and exclusively 
clerical or ministerial.\37\
---------------------------------------------------------------------------

    \37\ Proposed amendment to Rule 2810(b)(4)(C)(ii)(c). 
Notwithstanding the exemption in Rule 1060(a)(1) and the proposed 
amendment to Rules 2810(b)(4)(C)(ii)(b)-(c) discussed above, certain 
persons whose functions are solely and exclusively clerical or 
ministerial may choose to be registered as representatives. See Rule 
1031(a).
---------------------------------------------------------------------------

    While commenters suggested an alternative approach of requiring the 
sponsor or affiliate to make a good faith allocation of payments to 
dual-employees between underwriting compensation and issuer expenses, 
FINRA believes the approach described above would be clearer and easier 
to administer, and would promote more consistency with the application 
of the rule among Investment Programs. Investment Programs should 
easily be able to ascertain whether a registered person's activities 
involve solicitation, marketing, distribution or sales of the 
Investment Program securities, and whether those activities are 
conducted solely and exclusively in a clerical or ministerial capacity. 
Moreover, this approach should minimize the opportunity for an 
Investment Program to mischaracterize dual employees' day-to-day 
activities or to make allocations that are inconsistent with industry 
standards.\38\
---------------------------------------------------------------------------

    \38\ Under the alternative approach suggested by the ABA 
Committee and IPA, an Investment Program that misallocated payments 
to dual employees to issuer expenses instead of underwriting 
compensation would, compared to its competitors, have more offering 
proceeds available under the compensation limits to market and sell 
its securities.
---------------------------------------------------------------------------

    NASD proposed to modify and improve upon the burdensome process 
involved when its Corporate Financing Department (``Department'') 
reviews Investment Programs for compliance with the compensation 
guidelines by analyzing information about job functions, time spent on 
those functions, and compensation paid to dual employees whose job 
functions include conducting a securities business. Commenters on 
Notice to Members 04-07 urged NASD to continue to utilize the detailed 
job function analysis in its review of compensation associated with 
smaller Investment Programs, for which registered representatives are 
more likely to work in both the securities business and operations and 
administration. Accordingly, the Original Proposal provided that 
Investment Programs with fewer than ten people engaged in wholesaling 
could provide detailed per-employee information to the Department for 
its review. Based on its review, the Department could conclude that 
certain salary or other non-transaction-based payments made to the 
employee will be allocated to issuer expenses, notwithstanding the fact 
that the employee also received transaction-based compensation or spent 
allocable portions of time engaged in securities business 
activities.\39\ Commenters supported this approach to smaller 
Investment Programs \40\ and the proposed rule change includes these 
provisions.
---------------------------------------------------------------------------

    \39\ Original Proposal amendment to Rule 2810(b)(4)(C)(ii)(b).
    \40\ IPA, Massachusetts Securities Division and NASAA.
---------------------------------------------------------------------------

    Many Investment Programs' top executives are registered persons who 
engage in multiple job functions among the program sponsor, wholesaler, 
property or equipment manager, and portfolio manager. FINRA believes 
that the Department can conduct an accurate and efficient review of 
this small group of individuals, whose job functions should be 
relatively easy to identify and evaluate given their level of 
prominence within an Investment Program. Accordingly, in response to 
comments, FINRA also is amending the Original Proposal to include the 
same job function analysis for any dual employee that is one of the ten 
highest paid executives in an Investment Program, based on his or her 
non-transaction-based compensation.\41\
---------------------------------------------------------------------------

    \41\ Proposed amendment to Rule 2810(b)(4)(D).
---------------------------------------------------------------------------

iv. Training and Education Meetings, Legal Services, and Advertising 
and Sales Materials
    The Original Proposal would have allocated to underwriting 
compensation fees and payments for training and education meetings, 
legal services provided to a broker-dealer participating in the 
offering and advertising and sales material generated by a broker-
dealer participating in the offering.\42\ Two commenters supported 
these provisions, while another commenter recommended technical 
changes.\43\ FINRA has amended this proposal to include contributions 
to conferences and meetings held by non-affiliated members for their 
registered representatives.\44\
---------------------------------------------------------------------------

    \42\ Original Proposal amendment to Rule 2810(b)(4)(C)(iii)(c).
    \43\ The Massachusetts Securities Division and NASAA supported 
the proposal. The ABA Committee recommended deleting ``legal 
services'' from the proposal because it would be duplicative of NASD 
Rule 2710(C)(3)(iii).
    \44\ Proposed amendment to Rule 2810(b)(4)(C)(ii)(d).
---------------------------------------------------------------------------

v. Due Diligence
    The Original Proposal would have eliminated the 0.5 percent limit 
on due diligence expenses under Rule 2810 and would have required that 
due diligence expenses combined with issuer expenses not exceed the 
limits on O & O expenses in Rule 2810(b)(4)(B)(i).\45\ The Original 
Proposal also would have required that a member not accept any payments 
or reimbursements for due diligence expenses unless they are included 
in a detailed and itemized invoice that is presented by the member to 
the program sponsor or other entity that pays or reimburses due 
diligence expenses.\46\
---------------------------------------------------------------------------

    \45\ Instead, the maximum amount of O & O expenses would have 
remained fifteen percent of the gross proceeds of the offering 
(which amount would include: (1) Issuer expenses; (2) compensation 
up to the maximum of ten percent of gross proceeds; and (3) due 
diligence expenses that are supported by a detailed and itemized 
invoice).
    \46\ Proposed amendment to Rule 2810(b)(4)(B)(vii).
---------------------------------------------------------------------------

    Two commenters supported the proposed rule change.\47\ Two 
commenters stated that the proposed rule change should allow due 
diligence expense reimbursements without a detailed and itemized 
invoice, and permit such expenses to be included in the 10 percent 
compensation limitation as a non-accountable expense, which is subject 
to a limit of up to three percent of the offering proceeds pursuant to 
NASD Rule 2710(f)(2)(B).\48\ One commenter also requested clarification 
that any payments for due diligence

[[Page 5891]]

expenses that are made pursuant to a detailed and itemized invoice will 
not be included in the 10 percent limit on underwriting 
compensation.\49\
---------------------------------------------------------------------------

    \47\ Massachusetts Securities Division and NASAA.
    \48\ ABA Committee and IPA.
    \49\ ABA Committee.
---------------------------------------------------------------------------

    Rule 2810 currently permits members to receive compensation up to 
10 percent of the offering proceeds for services rendered in a 
distribution. These payments may include un-itemized expense allowances 
of up to three percent of the offering proceeds. FINRA agrees that it 
is reasonable to include un-itemized due diligence expenses as part of 
the underwriting compensation. FINRA, therefore, is amending the 
proposal to include, as part of underwriting compensation, due 
diligence reimbursements without a detailed and itemized invoice.\50\ 
However, any member seeking to include due diligence expense as part of 
issuer expenses must submit an itemized invoice of their actual costs 
incurred for bona fide due diligence expenses.\51\
---------------------------------------------------------------------------

    \50\ Proposed amendment to Rule 2810(b)(4)(B)(vii).
    \51\ Nothing in the proposed rule change would prohibit the 
inclusion of a profit margin in the due diligence expense bill of a 
firm that has conducted due diligence on behalf of a member and that 
is not a member or an affiliate of a member. See NASD Notice to 
Members 86-66 (``Due Diligence Expense Reimbursements in Connection 
with Direct Participation Programs'').
---------------------------------------------------------------------------

    FINRA is also re-proposing to eliminate the 0.5 percent limit in 
due diligence expenses.\52\
---------------------------------------------------------------------------

    \52\ See footnote accompanying existing Rule 2810(b)(4)(B)(i).
---------------------------------------------------------------------------

b. Liquidity Disclosure
    Rule 2810(b)(3)(D) currently provides that prior to executing a 
purchase transaction in a direct participation program, a member or 
person associated with a member shall inform the prospective 
participant of all pertinent facts relating to the liquidity and 
marketability of the program during the terms of the investment. FINRA 
is concerned that some investors do not fully appreciate that the 
liquidation of some sponsors' programs are frequently delayed.
    The Original Proposal would have amended Rule 2810(b)(3)(D) to 
include REITs, and would have required members and their associated 
persons to inform prospective investors whether the sponsor has offered 
prior programs for which the prospectus disclosed a date or time period 
when the program might be liquidated, and whether the prior programs, 
in fact, liquidated on or around that date or time period. In addition, 
members selling Investment Programs would be required to disclose to 
investors whether prior programs offered by the program sponsor were, 
in fact, liquidated on or during the date or time period disclosed in 
the prospectuses for those programs. For example, if a sponsor has 
offered ten prior programs and only two of them liquidated by the date 
or time period set forth in the prospectus, the member would be 
required to disclose these facts.
    Two commenters supported the proposal.\53\ One commenter objected 
to the proposed liquidity disclosure stating that prospectus disclosure 
typically includes a warning that the liquidity event or liquidation 
may be delayed due to market conditions and other factors.\54\ In this 
commenter's view, the liquidity disclosure provision would unfairly 
characterize all situations in which a liquidity event was delayed as a 
``failure'' or ``inappropriate.'' This commenter also stated that the 
recordkeeping burdens of the proposal and the unwarranted negative 
implications of such disclosure would outweigh the benefit. The 
commenter suggested that if a liquidity disclosure requirement were to 
be imposed, it should be done by an SEC rule rather than an NASD rule. 
Alternatively, if adopted by NASD, it should only apply to Investment 
Programs with fixed dates.\55\
---------------------------------------------------------------------------

    \53\ Massachusetts Securities Division and NASAA.
    \54\ ABA Committee.
    \55\ Id.
---------------------------------------------------------------------------

    FINRA is not persuaded by the commenter's suggestion that 
additional disclosure regarding historical liquidity practices 
necessarily creates ``unwarranted negative implications.'' Rather, 
FINRA believes that the proposed disclosure requirement will help 
investors make informed investment decisions based on the facts about a 
sponsor's liquidity track record. FINRA recognizes that delays in 
liquidity events may be due to market conditions and other factors 
beyond the sponsor's control, and that, under certain circumstances, 
investors ultimately may benefit from delays in liquidity events. When 
these facts are relevant, they can be conveyed in addition to the facts 
regarding the sponsor's liquidity track record providing investors with 
a complete picture of liquidity issues.
    FINRA also notes that the proposal would not require a member to 
``characterize'' a previous delay in liquidation. Rather, the proposed 
rule change would require members to inform investors whether the 
sponsor has previously disclosed a date or time period when prior 
programs may be liquidated, and whether the programs were in fact 
liquidated on or around that date or time period.
    Therefore, FINRA is re-proposing the amendment to Rule 
2810(b)(3)(D) as in the Original Proposal.
c. Sales Loads on Reinvested Dividends
    The Original Proposal would have amended Rule 2810(b)(4)(B)(vi) to 
prohibit sales loads on reinvested dividends for Investment Programs 
after the effective date of the proposed rule change. Two commenters 
strongly agreed with this proposal.\56\
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    \56\ Massachusetts Securities Division and NASAA.
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    FINRA is re-proposing this amendment to Rule 2810(b)(4)(B)(vi).
d. Non-Cash Compensation Provisions
i. Location of Training and Education Meetings
    The Original Proposal would have amended the current non-cash 
compensation rule to provide that an ``appropriate location'' for 
training and education meeting may include a location at which a 
significant or representative Investment Program asset is located.\57\ 
This provision would recognize that an important part of bona fide 
training and education meetings for Investment Programs may be 
inspecting real estate, oil and gas production facilities, and other 
types of assets that will be held and managed by the program,\58\ and 
would provide that a training and education meeting may include a 
location at which a ``significant or representative'' asset is located.
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    \57\ Proposed amendment to Rule 2810(c)(2)(C)(ii).
    \58\ As discussed above, FINRA proposes to amend Rule 2810 so 
that the Rule's compensation, disclosure and non-cash compensation 
provisions expressly govern illiquid REITs (i.e., REITs as defined 
in Rule 2340(d)(4)). The proposed rule change would not amend the 
non-cash compensation provisions in Rule 2710, which currently are 
identical to those in Rule 2810. Accordingly, the non-cash 
compensation provisions regarding the location of training and 
education meetings will be different for exchange-traded REITs under 
Rule 2710 and illiquid REITs under Rule 2810.
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    Commenters generally supported this aspect of the proposal; \59\ 
however, one commenter suggested that the rule should explicitly state 
that the non-cash compensation provision applies to public offerings, 
and not private placements.\60\
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    \59\ IPA, Massachusetts Securities Division and NASAA.
    \60\ IPA (noting that it understands from conversations with 
NASD staff that the non-cash compensation rules are not intended to 
apply to private placements).
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    Because Rule 2810 by its terms applies only to public offerings, 
FINRA believes that such additional clarification in this section is

[[Page 5892]]

unnecessary. FINRA is re-proposing the amendment to Rule 2810(c)(2).
ii. Total Production and Equal Weighting Requirements
    In connection with the Original Proposal, NASD stated that it was 
considering future amendments to Rule 2810 to incorporate the total 
production and equal weighting conditions for internal sales contests 
in its Investment Company Rule (Rule 2820) and Variable Contracts Rule 
(Rule 2830) in the context of a broader non-cash compensation 
rulemaking initiative.\61\
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    \61\ See Notice to Members 05-40.
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    Two commenters urged NASD to abolish sales contests because they 
create incentives that are contrary to the obligations broker-dealers 
have to their customers, such as fair dealing.\62\ As noted above, 
FINRA will consider these issues in future rulemaking.
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    \62\ Massachusetts Securities Division and NASAA.
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e. Effective Date of the Proposed Rule Change
    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective 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,\63\ which require, 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. The proposed rule change would codify FINRA's 
longstanding policy of applying certain regulatory requirements in Rule 
2810 to REITs. In context of Investment Programs, FINRA believes that 
clarifying the standards for determining the fairness and 
reasonableness of compensation, treating the use and allocation of 
offering proceeds in a more explicit and objective manner, requiring 
disclosure regarding the liquidity of prior programs offered by the 
same sponsor, prohibiting sales loads on reinvested dividends and 
enabling bona fide training and education meetings to take place at 
appropriate locations, are measures designed to prevent fraudulent 
practices, promote just and equitable principles of trade, and protect 
investors and the public interest.
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    \63\ 15 U.S.C. 78o-3(b)(6).
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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 Commission published the proposed rule change in the Federal 
Register on July 17, 2006.\64\ The comment period closed on August 7, 
2006. The Commission received six comments in response to the Federal 
Register publication of the proposal. The comments are summarized in 
Item II above.
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    \64\ See Securities Exchange Act Release No. 54118 (July 10, 
2006), 71 FR 40569 (July 17, 2006).
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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, as amended, 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-NASD-2005-114 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NASD-2005-114. 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 submissions 
should refer to File Number SR-NASD-2005-114 and should be submitted on 
or before February 21, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\65\
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    \65\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-1725 Filed 1-30-08; 8:45 am]
BILLING CODE 8011-01-P