Frequently Asked Questions About Regulation M
Division of Market Regulation:
Staff Legal Bulletin No. 9
Revised April 12, 2002
Action: Publication of Division of Market Regulation Staff
Legal Bulletin.
Date: October 27, 1999.
Summary: This staff legal bulletin sets forth the views of
the Division of Market Regulation in response to questions raised about
various provisions of Regulation M.
Supplementary Information: The statements in this legal
bulletin represent the views of the staff of the Division of Market
Regulation. This legal bulletin is not a rule, regulation, or statement
of the Securities and Exchange Commission ("Commission"). Further, the
Commission has neither approved nor disapproved its content.
Contact Persons: For further information, please contact the
Office of Trading Practices, Division of Market Regulation, at (202)
942-0772 (James Brigagliano, Assistant Director).
I. Introduction
Regulation M was adopted by the Commission on December 10, 1996 and
was accompanied by an adopting release (See Securities Exchange Act
Release No. 38067
(December 20, 1996), 62 FR 520 ("Adopting Release"); the Adopting
Release may also be found on the Commission's Internet website
(http://www.sec.gov)). Regulation M became effective on March 4, 1997.
Regulation M replaced Exchange Act Rules 10b-6, 10b-6A, 10b-7, 10b-8,
and 10b-21 with a set of six new rules. Rule 100 is a definitional rule.
Rule 101 covers the activities of underwriters, broker-dealers, and
others participating in a distribution.
Rule 102 governs the activities
of issuers and selling security holders.
Rule 103 pertains to Nasdaq
passive market making.
Rule 104 governs stabilization transactions and
certain post-offering activities by the underwriters, and
Rule 105
governs short selling in anticipation of a public offering.
The following questions and answers regarding Regulation M have been
compiled by the staff of the Division of Market Regulation to assist in
the understanding and application of this regulation. The questions and
answers do not necessarily contain a discussion of all the material
considerations necessary to reach the conclusions stated. Therefore,
these questions and answers are intended to provide general guidance,
but do not constitute formal interpretations of Regulation M. Further,
facts and circumstances of particular offerings may differ, and the
staff notes that even slight variations may require different responses.
The Commission is not bound by these statements and may interpret
Regulation M in any manner that it deems necessary or appropriate in the
public interest or for the protection of investors.
These questions and answers are premised on several important
assumptions. First, the discussions assume familiarity with Regulation M
and the Adopting Release. The responses are a complement to, and not a
substitute for, these sources. Second, the terms have the meanings as
defined in Rule 100 or elsewhere in Regulation M.
The Division of Market Regulation will update these questions and
answers periodically. In each update, the questions added after
publication of the last version will be marked with " ".
Order of Contents:
 Rule
100
Rule
101
Rule
102
Rule
103
Rule
104
Rule
105
Miscellaneous
II. Questions and Answers
Rule 100
Q: Are
affiliated purchasers of the issuer, a
selling security
holder, or of a
distribution participant permitted to purchase the
issuer's securities that are being distributed?
A: Yes. The definition of "completion of participation in a
distribution" clarifies that affiliated purchasers of an issuer, a
selling security holder, or of a distribution participant may purchase
in the distribution, provided that the securities are acquired for
investment purposes. However, consideration may need to be given to
other requirements, depending on the nature of the offering or the
extent of purchases. For example, disclosure in the registration
statement may be necessary, if information regarding such purchases
would be material to investors' decision to buy in the offering. Also,
affiliated purchasers must comply with the requirements under Exchange
Act Rule 10b-9 if applicable to the offering and the Free-Riding and
Withholding Interpretation,
IM-2110-1 (Interpretation) contained in
National Association of Securities Dealers, Inc. ("NASD") Conduct Rule
2110, if the offering involves a "hot issue."
Q: A broker-dealer is an affiliate of an issuer (or selling
security holder) and it is a
distribution participant in a distribution
of the issuer's securities. The securities qualify for the
actively-traded securities exception under Rule 101. Under Regulation M,
does Rule 101 or
Rule 102 apply to the broker-dealer?
A: Rule 101 applies. Note, however, that a distribution
participant that is an affiliate of the issuer may not rely on the
actively-traded securities exception of Rule 101. Of course, if the
broker-dealer engages in stabilization activity,
Rule 104 applies also.
Q: An acquiror and a target company have signed a merger
agreement. Would the target be an "affiliated purchaser" of the acquiror?
A: Yes. The restrictions of
Rule 102 apply to the target
company with respect to purchases of the acquiror's securities.
Q: At what point in the day does a restricted period start?
A: "Business day" refers to the 24 hour period based on the
principal market for the securities to be distributed, and includes a
complete trading session for that market.
For example, if pricing occurs at the close of trading in the
principal market on Tuesday, and a one business day restricted period
applies, the restricted period would begin at the close of trading in
the principal market on Monday. If, however, pricing occurs prior to the
close of trading on Tuesday, the restricted period would then begin
prior to the opening of trading in the principal market on Monday,
because the restricted period requires a full trading day.
Q: When is an
underwriter's participation in a
distribution
completed? Furthermore, when is the participation in a distribution
completed for a selling group member that is not part of the
underwriting syndicate?
A: Generally, each syndicate member's participation in a
distribution is completed when all of the shares in the offering have
been distributed and after any stabilization arrangements and trading
restrictions in connection with the distribution have been terminated.
For a selling group member that is not part of the underwriting
syndicate, its participation in a distribution is completed when the
selling group member has sold its entire allotment.
Q: If the managing underwriter of a distribution intends to
exercise an overallotment option granted in connection with the
offering, when is the distribution considered completed?
A: A syndicate member's participation in the distribution is
completed when all of the securities have been distributed and after any
stabilization arrangements and trading restrictions in connection with
the distribution have been terminated. A later exercise of an
overallotment option does not affect the "termination" of the
distribution, unless it is exercised for an amount exceeding the
syndicate short position at the time of exercise. In this case, the
distribution would be deemed to continue until the time that all the
excess shares were sold. If the syndicate agreement is terminated before
all of the shares have been sold, a syndicate member's participation
would be completed once its remaining shares are distributed and its
financial interests in the offering are terminated.
Q: Does the existence of outstanding exercisable warrants
place an issuer in distribution? If not in distribution now, would the
issuer be in distribution just before the warrants expire if it
anticipates that a large number of warrants will be exercised before
their expiration? Similarly, does the existence of outstanding
convertible securities that can be converted into an issuer's common
stock cause the issuer to be deemed in distribution of its common stock?
A: No. Neither the existence of exercisable warrants (or
convertible securities) nor the approaching expiration date of such
securities alone would cause the issuer to be deemed in distribution.
However, a distribution could be present if special selling efforts,
such as the solicitation to exercise the warrants or the payment of a
soliciting dealer's fee, are used to encourage the exercise of the
securities.
Q: Can a private placement of securities be a distribution
under Regulation M?
A: Yes, if the offering satisfies the "magnitude" and "special
selling efforts and selling methods" criteria of the definition of
distribution.
Q: Rule 101 applies to
distribution participants and their
affiliated purchasers. The definition of a distribution participant
includes any "other person who has agreed to participate or is
participating in a distribution." Can an issuer or a selling security
holder ever fit within the definition of a distribution participant?
A: No. Issuers and
selling security holders are always subject
to the provisions of
Rule 102.
Q: Is a broker-dealer considered a
distribution participant if
its sole responsibility with respect to a call for redemption of
warrants is to send notices to warrant holders of the call for
redemption and it receives a fixed fee for its services?
A: No. If the broker-dealer performs only ministerial duties
and receives a fixed fee consistent with its limited role (i.e.,
its compensation is not based on the success of the offering and is a
customary amount), it will not be deemed a distribution participant.
Q: In an exchange offer, the market price of the target's
securities will be used as a factor in determining the exchange ratio
for the offer. In other words, the relationship between the target's and
acquiror's securities is solely a result of an external factor (i.e.,
the exchange offer terms). Would the target's securities be considered
reference securities for the acquiror's securities?
A: No. The target's securities would be reference securities
only if the relationship between the two securities was a feature of the
acquiror's securities themselves.
Q: In a distribution in which an issuer will exchange
publicly-traded securities for restricted securities, and the
publicly-traded and restricted securities are otherwise identical in all
material respects, would Regulation M apply to transactions in the
restricted securities?
A: Yes. They would be considered the same security.
Q: When is the price of an offered security "determined" for
purposes of applying the Regulation M
restricted period? Is the price
determined when the underwriter and issuer orally agree on the price or
when the underwriters formally contract to underwrite the offering,
which may occur later?
A: The determination of the offering price occurs when the
parties agree on the price, whether or not the agreement is memorialized
in writing.
Q: A security in distribution is convertible into an
actively-traded security. Is the security in distribution subject to a
restricted period under Rule 101?
A: Yes. The
ADTV value of the subject security determines the
restricted period. The ADTV value of a reference security does not
affect the restricted period of a subject security.
Q: How is ADTV calculated?
A: As defined in
Rule 100 of Regulation M, ADTV is worldwide
average daily trading volume as measured during the two full calendar
months immediately preceding, or any 60 consecutive calendar days ending
within the 10 calendar days preceding, the filing of the registration
statement. If the offering is made without a registration statement or
involves the sale of securities on a delayed basis pursuant to
§230.415, ADTV would be measured during the two full calendar months immediately
preceding, or any consecutive 60 calendar days ending within the 10
calendar days preceding, the determination of the offering price.
Q: A security in distribution is an actively-traded security
and thus excepted from
Rule 101. It is convertible into a security (a
reference security) that is not an actively-traded security. Is the
reference security subject to a
restricted period under Rule 101?
A: No. The restricted period for a reference security is never
greater than that of the subject security.
Q: When does the
restricted period for a distribution through
a call for redemption of "in-the-money" convertibles or exercisable
securities commence?
A: The restricted period commences upon mailing of the notice
and continues through the end of the period in which the security
holders can decide whether to convert.
Q: What is the
restricted period for a security to be
distributed through a merger or an exchange offer? If the valuation
period extends after the vote, how does this affect the restricted
period?
A: The restricted period begins on the day of mailing the
proxy solicitation materials and continues through the end of the period
in which the target shareholders can vote on the merger or exchange. The
restricted period includes the valuation period as well. For instance,
if the valuation period occurs outside of the proxy solicitation period,
an additional restricted period would commence one or five business days
prior to the commencement of the valuation period and continue until the
valuation period ends.
Q: In a merger, is the
restricted period based on both the
target company's and acquiror company's shareholder votes?
A: No. The restricted period is based solely on the target
company's shareholder vote.
Q: What is the
restricted period for a security to be
distributed in connection with the acquisition of a privately held
company when the shareholders will not be solicited through proxies?
A: The day most comparable to the day of mailing the proxy
solicitation materials is the day the target security holders are first
asked to commit to the transaction, which would be the day the acquiror
sends a definitive acquisition agreement to the target security holders
for their execution. The restricted period would commence on the earlier
of one (or five) business day(s) prior to (i) the time the acquiror
furnishes the definitive acquisition agreement for execution to the
security holders of the privately held target company or (ii) the
commencement of the valuation period. The restricted period would
continue until the later of (i) execution of the definitive acquisition
agreement or (ii) the end of the valuation period.
Q: If an issuer purchases its securities before the Regulation
M
restricted period begins for the security in distribution, may the
settlement of this trade occur during the restricted period without
violating Regulation M?
A: Yes. The settlement may occur during the restricted period
as long as the trade occurred outside the restricted period.
Q:
Rule 100 of Regulation M states that in the case of a merger,
acquisition or exchange offer, a restricted period commences on the day
proxy solicitations or offering materials are first disseminated to
security holders. Is a
restricted period triggered when a third party
solicits proxies in opposition to a proposed merger on the basis of its
proposed alternative to exchange its stock for the target company stock
(alternative stock transaction)?
A: In some cases, the answer is yes. "Distribution" is defined
in Rule 100 as an "offering of securities . . . that is distinguished
from ordinary trading transactions by the magnitude of the offering and
the presence of special selling efforts." The application of Regulation
M to the opposition proxy solicitation involves an analysis of the three
elements of a distribution: (1) is there an "offering of securities;"
(2) does the amount offered satisfy the "magnitude" test; and (3) will
"special selling efforts and selling methods" be employed.
For purposes of this question, it is assumed that the alternative
stock transaction will satisfy the "magnitude" and "special selling
efforts and selling methods" elements because a large quantity of shares
will be offered in exchange for the target company, and because of the
use of a proxy solicitation.
Where the alternative stock transaction is presented to target
shareholders in such specific terms so as to constitute an offering of
securities under the Securities Act of 1933 (Securities Act), then the
offering element is satisfied. In such circumstances, Securities Act
Rules 165 and 425 permit the company presenting the alternative proposal
to publicly disclose information about its counteroffer before filing a
registration statement.
When an alternative investment transaction is presented to target
shareholders at the time they are to vote on the proposed merger and
specific details about the proposed alternative are presented so as to
invite comparison with the terms of the pending proposed merger, the
investment decision (i.e., the vote) necessarily requires shareholders
to consider both transactions. Consequently, the company offering the
alternative stock transaction has an incentive to manipulate its stock
price to facilitate its offering. Therefore, the restricted period with
respect to the alternative transaction would commence with the
dissemination of materials soliciting proxies against the proposed
merger that contained the terms of the proposed alternative.
Example: B solicits the target's shareholders to vote against A's
proposed stock merger with the target. In conjunction with B's
solicitation against the merger, B states that it intends to propose its
own stock merger with the target. B's solicitation against the target's
merger with A contains detailed information about B's proposal (such as
a fixed exchange ratio and a prospective dividend payout). B's proposal
constitutes an offer of securities under the Securities Act and a
distribution under Regulation M. The restricted period for B's
distribution begins when it sends its proxy solicitation and continues
through the vote on A's merger proposal.
B's distribution continues until B's offering is concluded or
abandoned. Therefore, B will be in distribution at least until the
shareholder vote on B's alternative stock merger proposal or until B's
offering is abandoned.
In the staff's view, however, B's restricted period need not be
co-extensive with B's distribution period. Instead, it should apply when
the target company's shareholders are requested to make an investment
decision affected by B's counteroffer and B has an incentive to
manipulate the price of its securities. Therefore, after the vote for or
against A's merger proposal (and implicitly on B's counter offer), the
restricted period for B would terminate. B would have another restricted
period if and when it sends out the proxy solicitation for its merger
proposal, and this restricted period would end upon that shareholder
vote. Note that other restricted periods may apply if the offer involves
an election or a valuation period separate from the proxy solicitation
periods.
Rule 101
Q: The actively-traded securities exception from
Rule 101
requires the public float value of the issuer's "common equity
securities" to be at least $150 million. Are ordinary shares issued by a
foreign issuer treated as "common equity securities" for purposes of
this calculation?
A: Yes. The phrase "common equity securities" includes the
equivalent type of stock of a foreign issuer.
Q: A distribution participant for an actively-traded Nasdaq
security is also a Nasdaq market maker for the security. Can the
distribution participant obtain an excused withdrawal from the NASD so
that it may temporarily stop making a market in the security in
distribution?
A: No. The NASD has amended its rules to permit excused
withdrawals for Nasdaq market makers if the withdrawal is necessary for
the market maker to comply with the restricted period under Rule 101 or
with its obligations when it stabilizes the price of a security or acts
as a passive market maker. See NASD Notices to Members
97-10 and
98-06 concerning
NASD Marketplace Rule 4619. Such excused withdrawals
are not applicable to actively-traded securities because these
securities are not subject to a restricted period under Rule 101.
Q: If a syndicate manager is an affiliate of an issuer, it is
subject to Rule 101 and cannot avail itself of the actively-traded
securities exception under Rule 101. Are syndicate members (i.e.,
all syndicate members not affiliated with the issuer) able to avail
themselves of the actively-traded securities exception?
A: Yes. The non-affiliated syndicate members are subject to
Rule 101 and may rely on the actively-traded securities exception.
Q: Can debt securities qualify for the actively-traded
securities exception?
A: As a practical matter, the absence of public information
regarding the debt security's trading history generally would prevent
reliance on this exception for most debt issues.
Q: Is the ADTV used to calculate the restricted periods the
same ADTV used to calculate the 2% de minimis exception?
A: Yes.
Q: Have restrictions on purchases of target company securities
by an acquiror during an exchange offer been eliminated?
A: Regulation M generally does not apply to purchases of the
target security by an acquiror or target during a merger or exchange
offer. Purchases of the target stock are restricted, however, where the
acquiror's securities have a feature that ties its value directly to the
price of the target securities. We also note that Rule 14e-5 under the
Exchange Act generally will prohibit purchases of the target security by
the bidder during an exchange offer.
Q: If a syndicate member solicits an indication of interest
from a client to purchase in a distribution, and the client instead
wishes to buy immediately in the market, are the market transactions
considered unsolicited?
A: No. Any market transactions during the restricted period
resulting from the original solicitation would be deemed solicited.
Rule 102
Q: A shareholder that has shares registered on a shelf plans
to make periodic sales of those shares. Does
Rule 102 apply from the
time the shares are registered on the shelf until they are all sold?
A: No. The shareholder should analyze each takedown off the
shelf to determine whether it constitutes a distribution for purposes of
Rule 102.
Q: Is the method for determining whether a particular sale
off of a shelf constitutes a distribution different under
Rule 102 from
that under
Rule 101?
A: No. The distribution analysis is the same under
both: each takedown off the shelf must be analyzed to determine
whether it constitutes a distribution. Moreover, when sales off a shelf
by an issuer, or by any affiliated purchaser, constitute a distribution
of securities, an issuer and all its affiliated purchasers are subject
to the applicable restricted period under Rule 102. Similarly, when
sales off a shelf by a selling security holder constitute a
distribution, all other security holders who are affiliated purchasers
of the selling security holder are subject to the applicable restricted
period under Rule 102.
Q: An issuer conducts different but concurrent distributions
of the same securities, such as an offering of its common stock for cash
while it is offering its common stock to security holders of another
company in connection with a merger or exchange offer. Is the issuer (or
distribution participant) permitted to solicit investors to purchase the
common stock in the cash distribution without violating
Rule 102 (or
Rule 101 in the case of a distribution participant) as it applied to the
merger or exchange offer distribution, and vice versa, or would selling
activity in one distribution be deemed an impermissible inducement to
purchase with regard to the other distribution?
A:
Paragraph (b)(5) of Rule 102 provides an exception for
"offers to sell or the solicitation of offers to buy the securities
being distributed." Similarly,
Rule 101(b)(9) allows distribution
participants and their affiliated purchasers to conduct bona fide
selling activities in connection with the securities being distributed.
However, neither Rule 101(b)(9) nor Rule 102(b)(5) explicitly allows any
inducements to purchase otherwise than for offers to sell the securities
in a specific distribution. Accordingly, these provisions do not extend
to inducements to purchase in one distribution while the issuer or
distribution participant is engaged in another distribution of the same
security or a reference security. We do not believe, however, that
solicitation activity qualifying for the Rule 101(b)(9) and Rule
102(b)(5) exceptions necessarily creates an impermissible inducement to
purchase in a concurrent distribution. Therefore, absent additional
factors, bona fide offers to sell or the solicitation of offers to buy
the securities being distributed in one distribution would not be
impermissible inducements with respect to a concurrent distribution.
For example, Company A conducts an offering of A common stock for
cash. At the same time, Company A conducts an exchange offer in which it
distributes A common stock and purchases Company B's common stock.
Assuming the cash offering and exchange offer are distributions of A's
common stock, Company A may solicit offers to purchase the common stock
in the cash offering at same time it solicits offers to exchange
securities in the exchange offer, and vice versa.
However, a distribution may rise to the level of an impermissible
inducement to purchase when a distribution participant engages in sales
efforts that go beyond bona fide offers to sell or the solicitation of
offers to buy the securities in distribution.
Rule 103
Q: May a passive market maker that, just prior to the
beginning of the
restricted period, is quoting the highest bid as of the Nasdaq close carry over its bid to the restricted period?
A: No. Once a market maker becomes passive,
Rule 103 requires
that its bids and purchases be no higher than the current highest
independent bid. A passive market maker may submit a bid at the same
level that it previously was quoting only if the bid is no higher than
the current highest independent bid.
Q: May a
distribution participant (e.g., an
underwriter) that is an affiliate of an issuer or
selling security
holder conduct
passive market making in a covered security pursuant to
Rule 103?
A: Yes. However, a Nasdaq market maker that is affiliated with
the issuer or selling security holder, but is not acting as a
distribution participant, may not rely on Rule 103.
Rule 104
Q: Does
Rule 104 apply only to
distributions?
A: No. Rule 104 applies to all offerings, not just
distributions. This means that a person placing a stabilizing bid for an
offering not satisfying the definition of "distribution" is nonetheless
subject to Rule 104.
Q: Is the exercise of the overallotment option considered a
syndicate covering transaction?
A: No.
Q: Does an underwriter stabilizing the price of a security
have to comply with
Rule 104
even though the securities qualify for the
actively-traded securities exception under
Rule 101?
A: Yes. Rule 104 does not contain an exception for
actively-traded securities.
Q: When should notice of
penalty bids be submitted to the
relevant SRO under
Rule 104?
A: Notice of penalty bids need only be furnished when the
penalty bid will be assessed. If notice of a penalty bid is given at the
time of pricing because an agreement among the underwriters contains a
penalty bid provision, but the penalty bid is not in fact imposed, an
amended notice should be filed to reflect that no assessments were made.
The Commission has granted an exemption from the notification
requirement contained in
Rule 104(h)(2) for nonconvertible debt
securities, nonconvertible preferred securities and asset-backed
securities that are rated investment grade.
Q: A company's debt is listed on an exchange, but a majority
of the debt is expected to trade in the over-the-counter market. Where
should the company's underwriter give notice of its syndicate covering
transactions, as required by
Rule 104?
A: The underwriter should give notice to the NASD, the
self-regulatory organization that has direct oversight authority over
the principal market for the security.
Rule 105
Q: If a person has a short position and makes short sales
during the five business day period prior to the pricing of a
distribution of that security, may it purchase shares in the
distribution to cover securities sold short prior to the five day
window?
A: No. In order to avoid the abuse at which
Rule 105 is
directed, a person cannot purchase securities in a distribution to cover
any short position where it made short sales of the security during the
five business days before pricing.
Miscellaneous
Exemption and No-Action Letters
Q: Are exemption and no-action letters issued under the former
trading practices regulations still valid?
A: No. Any recipient or beneficiary of such a letter who
believes that the relief granted by a particular letter is still
necessary or appropriate under Regulation M should contact the Office of
Risk Management and Control at (202) 942-0772.
Q: Does Regulation M apply to
affiliated purchasers located
outside the United States?
A: Yes.
Q: In an entirely foreign distribution of a security that has
no market in the United States, but whose
reference security does have a
market in the United States, is the foreign distribution subject to
Regulation M?
A: No. However, the general anti-fraud and anti-manipulation
provisions of the federal securities laws apply to any transactions
effected in the United States.
Q: What is meant by the statement that Regulation M
deregulates rights offerings?
A: There no longer is a separate rule covering rights
offerings. Rather, rights offerings will be treated under Regulation M
like any other offering. Therefore, if the rights offering involves a
distribution, as defined in Rule 100, the applicable
restricted period
of Rules
101 and
102 applies to bids for or purchases of the security
being distributed (i.e., the security acquired through the
exercise of the rights) and any
reference security. Transactions in the
rights themselves are not subject to Rules
101 or
102. However,
Rule 104
applies to stabilization transactions in any security, including the
rights.
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