| Release No. 34-22979 March 7, 1986
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 Table of Contents
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I. Introduction
The Commission today announced the adoption of Rule 3a12-9 (17 CFR 240.3a12-9) under the Exchange Act. 1 The Rule was published for comment in November, 1984. 2 Pursuant to Section 3(a)(12) of the Exchange Act, the Rule provides that interests in certain direct participation programs 3are exempted securities for purposes of the arranging for credit provisions of Sections 7(c) and 11(d)(1) of the Exchange Act. 4 The Rule will thus permit broker-dealers to participate in public offerings of securities of direct participation programs that provide for mandatory payments on a deferred basis, 5provided that certain conditions are met. Specifically, (1) the securities must be registered under the Securities Act of 1933 ("1933 Act") or be offered exclusively on an intrastate basis in accordance with Section 3(a)(11) of that Act, (2) the mandatory deferred payments must bear a reasonable relationship to the capital needs and program objectives described in a business development plan, (3) a minimum of 50 percent of the purchase price of the program securities must be paid by the investor at the time the securities are sold; and (4) the total purchase price of a program security must be paid within three years in the case of specified property programs and two years in the case of non-specified property programs.
II. Background
Since 1972, Regulation T, 6promulgated by the Board of Governors of the Federal Reserve System ("Board") under Section 7 of the Exchange Act, and Section 11(d)(1) of the Exchange Act, 7have been interpreted to prohibit broker-dealers from participating in public offerings of securities of direct participation programs with mandatory installment or deferred payment features. 8 Sales of program securities with deferred payment features have been permissible, however, in private placements. 9 An effect of these prohibitions has been to force issuers to either eliminate deferred payments altogether in public offerings, use private placements for sales of interests in direct participation programs with mandatory installment payment features, or to make public offerings with voluntary installment payments. 10
In 1972, shortly after the Boards staff indicated that Regulation T was applicable to public offerings of direct participation programs with installment features, the Commissions Real Estate Advisory Committee, composed of members of the real estate syndication industry and Commission staff, issued a report based upon a comprehensive review of the disclosure procedures and policy objectives in the area of real estate securities ("REAC Report"). Among the recommendations contained in the REAC Report was that the Commission use its rulemaking authority to exempt from the requirements of Regulation T interests in real estate limited partnerships where deferred payments "are made on a schedule based on anticipated need as is set forth in the registration statement." 11 More recently, in 1983, the National Association of Securities Dealers, Inc. ("NASD") petitioned the staff of the Board to provide relief in this area. 12 The NASD argued in its request that relief was appropriate since, among other things, the concerns which led Congress to adopt Section 7(c) are not present in the context of deferred sales of direct participation programs. In addition, the NASD noted that regulatory oversight of the programs by the states, the NASD, and the federal government has increased substantially over the past decade.
The NASD suggested that sales of direct participation program interests on a deferred payment basis should be entirely exempt from the credit restrictions. Alternatively, the NASD suggested several conditions that could apply to such sales. After extensive consultation between the staff of the Board and the Commissions staff, it appeared that the most efficient way to expose the issue for public comment was for the Commission to propose a rule pursuant to its authority under Section 3(a)(12) of the Exchange Act, which allows the Commission to define exempted securities. 13
III. Determination to Adopt Rule 3a12-9
In response to the release proposing Rule 3a12-9, the Commission received letters from 125 commentators. The comment letters reflected a broad range of interests within the securities industry and were evenly divided in support of and opposition to adoption of the proposed Rule. 14 After evaluating the comment letters, the Commission has determined to adopt Rule 3a12-9, incorporating a number of changes in the Rule as a result of suggestions made in the comment letters. The Commission believes that permitting program interests to be sold on a deferred payment basis, so that payments by investors to a program can be coordinated to match the programs capital needs, will produce economic benefits to investors and program sponsors which justify adoption of the Rule. Nevertheless, the Commission also believes that the imposition of specific conditions in connection with sales of program interests with deferred payments is necessary to preserve investor protection.
Commentators noted that under the previous credit restrictions applied to public offerings of direct participation programs, investors were forced to make cash contributions at the outset of the program, even though a considerable portion of the funds might remain idle until used by the program, perhaps a significant period of time following termination of the offering. For example, where projects are completed over a period of time in identifiable stages, the program may not need investor funds to make payments until work has been completed on a particular stage. In such cases, all the investors money is at risk, while the program may hold unneeded funds providing the investor with either no return, or a return at a far lower rate than he or she might have received if allowed to make alternative investments until the program had an actual need for funds.
Commentators also pointed out that the Rule will allow program sponsors to access new sources of capital. Because programs with staged payments have only been available in private offerings, many investors, for whom investments in such programs would otherwise be suitable, were denied the opportunity to participate. Commentators argued that by permitting public offerings of direct participation programs with deferred payment features, the Rule will provide investors with new investment alternatives and, at the same time, facilitate the formation of programs with broader capital bases. The Commission believes that the Rule will reduce the current constraints on the formation of capital and eliminate the misallocation of investor resources without compromising investor protection or contravening the intent of Congress in enacting Sections 7(c) and 11(d)(1).
The rationale behind the adoption of Section 7 of the Exchange Act was to limit the amount of credit which might be devoted to speculation in the securities markets, to maintain the availability of credit for financing local commerce and industry, to prevent undue market volatility by exerting a positive, stabilizing effect on the market and, to protect investors from purchasing on too thin a margin. Section 11(d)(1), in turn, was enacted by Congress to prevent potential conflicts of interest which might arise where underwriters, who are both brokers and dealers, extend credit on new issues of securities. 15
In deciding whether to adopt Rule 3a12-9, the Commission gave extensive consideration to the impact of the Rule in light of the Congressional philosophy underlying the credit restrictions. Since interests in direct participation programs are generally not traded on exchanges or actively traded in the over-the-counter market, they are considered to be illiquid instruments and therefore afford less opportunities for speculation and related abuses which Congress sought to prevent by enacting the credit restrictions. Although the Commission is aware that an active secondary market has developed for a few direct participation programs, it is not expected that programs with deferred payment features will be actively traded. Moreover, limitations have been established in the Rule which are designed to preclude those direct participation programs with deferred payment features which are actively traded from taking advantage of the Rules exemptive provisions.
Some commentators suggested that allowing direct participation programs with deferred payments to be sold through public offerings might lead to instances of broker-dealer overreaching. Many of the same commentators also forecast the possibility of widespread defaults on deferred payments by investors in public offerings who lacked the financial capacity to fulfill their commitments. By permitting programs with staged payments to be publicly offered, the Commission believes that Rule 3a12-9 will enhance investor protection.
Public offerings of direct participation program securities are subject to many regulatory standards imposed by the states and the NASD which are not directly applicable to most private offerings. For example, Appendix F to the NASDs Rules of Fair Practice 16imposes additional regulation on public offerings of direct participation programs in areas such as investor suitability, due diligence by members, the accuracy and adequacy of disclosure and the amount and form of underwriting compensation. In addition, separate state regulatory guidelines for the offering of direct participation programs in real estate, oil and gas, and equipment leasing have been adopted by the North American Securities Administrators Association, Inc. ("NASAA"), a voluntary organization comprised of state securities regulatory agencies. The NASAA guidelines, which are followed by many states and apply primarily to public offerings, establish standards regulating program sponsors, impose investor suitability requirements, and require that substantive features designed to protect investors are included in the partnership agreement.
In the Commissions view the provisions of the Rule, coupled with state laws, NASD regulations, and the antifraud provisions under the federal securities laws, are sufficient to protect investors against abusive sales practices. In this regard, broker-dealers are reminded that Rule 15c2-5 under the Exchange Act requires that they make a suitability determination when arranging for the extension of credit in transactions, such as those under Rule 3a12-9, which are not subject to Regulation T. 17
The Commission also notes that it has not been presented with any evidence that significant numbers of defaults have occurred in the private offerings of direct participation programs with deferred payment features which are currently being made. Indeed, the Commission understands that the number of defaults by investors in these offerings has been minimal. While the Commission recognizes the most purchasers of program interests in private offerings have been accredited investors, the Commission has no basis upon which to conclude that other creditworthy investors, for whom the transactions are otherwise suitable, are more likely to default on their payments. In addition, provisions have been added to the Rule which require a substantial down payment and limit the duration of the pay-in period. These provisions will increase the incentive of the investor to fulfill his obligation to make additional payments and, at the same time, reduce the likelihood that unforeseen events will alter the economic attractiveness of the program or effect the investors ability to make payments. 18
Commentators also raised concerns that adoption of Rule 3a12-9 might cause sponsors to offer increased numbers of programs emphasizing tax benefits at the expense of the underlying economics of the programs operations or perhaps encourage the promotion of abusive tax shelters. Because of this, they estimated that the Rule would adversely affect federal tax revenues. While the administration of federal tax policy is not within its jurisdiction, the Commission notes that the Internal Revenue Service has substantial weapons with which to monitor and combat abusive tax shelters.
In sum, the Commission believes that Rule 3a12-9 will provide a useful alternative for capital formation to sponsors that wish to provide for mandatory deferred payments in public offerings of direct participation programs. In addition, investors who previously were denied the opportunity to invest in such offerings will now have access to these programs. Finally, in the Commissions view, the Rule will eliminate the current misallocation of economic resources in a manner consistent with the protection of investors.
IV. Scope of Rule 3a12-9
A. General
As noted earlier, Rule 3a12-9 is designed to permit broker-dealers to participate in public offerings of securities with deferred payment features where the securities satisfy the provisions of the Rule. The Rule does not, however, require that all offerings with deferred payment features be offered on a public basis or that private offerings comply with its provisions. Instead, the Rule is intended to provide both investors and promoters with previously unavailable alternatives.
As adopted, the Rule contains a number of amendments which were made as a result of suggestions received from commentators. Specifically, in response to concerns raised by state regulators, along with members of the syndication industry, the Rule now contains several limitations designed to minimize the possibility of investor defaults and make the extension of credit under the Rule compatible with current regulations applied to margin securities under Regulation T of the Exchange Act. At the same time, however, the Commission has deleted requirements in the proposed Rule which commentators believed would impose additional costs or uncertainty on the part of program sponsors without a corresponding increase in investor protection.
B. Definition of Direct Participation Program
As proposed, the Rule applied to direct participation program securities, which were defined as securities created pursuant to a contractual agreement between and among investors, that were not margin securities, and that provided direct flow through tax consequences to investors. The proposed Rule also specifically excluded from the definition of a direct participation program certain forms of business organizations which might otherwise have fallen within the definition.
The definition of direct participation program as adopted in paragraph (b)(1) of the Rule has been broadened by eliminating the requirement that the program be created through contractual agreements between and among investors, and that tax consequences flow directly to investors. These changes were made, in part, to reflect commentators observations that certain financing vehicles which fall within the spirit of the Rule, such as some investment contract securities, might be precluded from relying on the Rule if the definition of a direct participation program were adopted as proposed. 19
Finally, the Commission recognizes that some program securities may have active secondary markets. These securities raise price volatility and speculation concerns that are central to the policy underlying the Exchange Acts margin regulations. To ensure that actively traded securities are treated in a manner consistent with all other potentially marginable securities, the Commission is modifying the definition of a direct participation program to exclude securities that are listed on exchanges or quoted on NASDAQ during the pay-in period. In addition, the Rule will also not be applicable to securities that will otherwise be actively traded during the pay-in period as a result of the direct or indirect efforts of the issuer, underwriter, or other participants in the initial distribution to facilitate a trading market in the securities. Should active trading markets develop for direct participation program securities, generally, the Commission may re-evaluate the continued appropriateness of the Rule.
C. Deferred Payments Required Pursuant to a Business Development Plan.
The proposed Rule contained a requirement that mandatory installment payments bear a direct relationship to the capital needs and program objectives as described in a business development plan disclosed in a registration statement filed with the Commission under the 1933 Act. A business development plan was defined as a specific plan of the programs anticipated economic development and the amount of future capital contributions to be required at specified times or upon the occurrence of certain events during the life of the program. The Commission received a number of comments concerning the necessity of requiring a business development plan. Several commentators argued that the provision was unnecessary in light of current disclosure requirements for registered securities. In addition, members of the oil and gas industry were divided over whether their programs would be able to provide sufficient information about upcoming capital expenditures to fulfill such a requirement. Along the same lines, commentators questioned whether non-specified property programs, in general, would be able to meet such a standard.
In the Commissions view, disclosure of a business development plan will be a useful supplement to existing disclosure requirements for registered offerings. Since the fundamental purpose of the Rule is to allow sponsors to coordinate payments by investors with the capital needs of the program, the Commission believes that development of such a plan is necessary to establish the business reasons for offering securities with deferred payments. Although the Commission requested comment on the merits of imposing specific disclosure requirements, it has determined not to dictate the content of such disclosure, aside from the general description in the definition of a business development plan. 20
The Commission has also decided to permit non-specified property programs to take advantage of the Rules exemptive provisions. 21 Although such programs may not have determined specific property to be purchased with investor funds, it may be possible to reasonably fix the type, timing and necessity of future cash needs. Accordingly, the Commission believes that uniformly excluding non-specified programs from the Rule would not be appropriate.
As proposed, the Rule required that mandatory deferred payments bear a "direct" relationship to the capital needs of the program. Many commentators expressed concern that this requirement may prove difficult to apply. In light of these concerns, the Commission is modifying the requirement to state that installment payments from investors need only be "reasonably" related to the capital needs and business objectives of the program. Nevertheless, the Commission wishes to make clear that programs relying on the Rule must coordinate payments so that they bear a reasonable relationship to substantive program events or capital needs. Programs which intend at the outset of the offering to factor or otherwise assign investor notes in order to raise capital to purchase property or meet program objectives prior to receipt of the deferred payments, will not meet this test and cannot rely on the Rule. The Commission recognizes, however, that investor notes are program assets and it does not intend to unreasonably encumber their use by programs relying on this Rule. Accordingly, investor notes may be used as collateral to secure program debt.
D. Registration of Securities
The proposed Rule would have required that program securities be registered pursuant to the 1933 Act and that the securities remain registered under Section 12(g) of the Exchange Act until the total purchase price of the security was paid. Since public intrastate offerings of securities need not be registered with the Commission by virtue of Section 3(a)(11) of the 1933 Act, 22the Commission requested comment on the merits of exempting intrastate offerings from these requirements. As adopted, the Rule continues to require registration under the 1933 Act, with the exception of programs making unregistered public offerings in reliance upon Section 3(a)(11) of the 1933 Act. Those programs offered in reliance on Section 3(a)(11) will also be able to utilize the Rule provided they meet its other requirements and disclosure of the business development plan is made in the relevant state filing and provided to investors. In deciding to extend the Rule to public intrastate offerings, the Commission weighed heavily the fact that many states securities regulations require substantially the same disclosure as required on Form S-1 under the 1933 Act and that public intrastate offerings would remain subject to NASD and state guidelines as well as relevant provisions of the federal securities laws. 23
As a result of comments received, the Commission is eliminating the requirement that all programs utilizing the exemption remain subject to the reporting requirements of Section 12(g) of the Exchange Act until the total purchase price of the securities is paid. Commentators suggested that compelling issuers to register under Section 12(g), who might not otherwise be required to do so, would increase expenses on the part of some smaller programs and be of little or no additional benefit to investors. They also noted that those offerings registered with the Commission would generally be subject to the annual reporting requirements under Section 15(d) of the Exchange Act during the first year of operation. In light of these arguments, as well as the imposition of maximum pay-in periods, and the understanding that annual or periodic disclosure is currently required of publicly offered programs under many states securities laws, the Commission has decided to remove the provision that programs remain subject to the reporting requirements under Section 12(g) as a prerequisite for qualification under the Rule. Nevertheless, issuers relying on the Rule should be aware that they are not relieved of the responsibility for complying with reporting obligations that may otherwise exist.
E. Maximum Pay-in Period; Required Down Payment
In the proposing release, the Commission requested comment on whether the Rule should specify an outside time limit by which installment payments must be made. In addition, the Commission inquired whether different maximum pay-in periods should be imposed on specified and non-specified property programs. The proposing release noted that the NASD had previously suggested that the total purchase price of a program interest might be required to be discharged in a period of three years from the date the investor is admitted as a limited partner in a non-specified property program or five years in a specified property program.
The Commission believes that investor protection will be increased, while continuing to provide issuers and investors with substantial flexibility, by limiting the amount of time over which the deferred payments must be made. As adopted, the Rule provides that the maximum period over which deferred payments may be made is two years for non-specified property programs and three years for specified property programs. Although commentators suggested a variety of maximum pay-in periods, the Commission anticipates that the time periods incorporated in the Rule should satisfy the business needs of most programs and at the same time reduce the possibility that either the investor or program will experience financial adversities during the pay-in period. A distinction has also been drawn between specified and non-specified programs, in part, to reflect the greater economic risks inherent in non-specified programs. Further, time periods will be measured from the earlier of the completion of the offering or one year from the effective date of the offering, rather than the date the investor is included in the program as suggested in the proposing release. 24 This latter modification was made to avoid administrative problems associated with multiple admission dates for investors which might have existed under the proposed method for calculating time periods.
In addition to imposing maximum time periods over which installment payments must be made, the Rule requires a minimum down payment of 50 percent of the purchase price of the program security. By requiring a substantial down payment, the Commission expects to alleviate many of the concerns raised by commentators that excessive leveraging of program securities might result in customer sales practice abuses and substantial defaults. 25 It should be noted, however, that the Rule now requires payment of the initial portion of the purchase price to be made at the time of sale, rather than over the course of twelve months as suggested by the NASD.
The Commission recognizes that the availability of staged payments for public offerings of direct participation programs may have a substantial impact on the structure and investor population of those markets. Therefore, the Commission believes that initially a cautious approach including limited pay-in periods and minimum down payments is advisable. After the Commission has had an opportunity to monitor the effects of the Rule, it anticipates reevaluating, in conjunction with state securities regulators, the limitations presently contained in the Rule.
V. Contingency Offerings
Since securities of direct participation programs are frequently offered on an "all or none" or "part or none" basis, the Commission solicited comments on the application of Rules 10b-9 and 15c2-4 of the Exchange Act 26to public offerings made in reliance on Rule 3a12-9. Rule 10b-9 requires specificity in the terms of contingency offerings. In other words, a specified amount of securities ("specified sales level") must be sold at a specified price within a specified time, and the total amount due to the seller (i.e., the issuer) must be received by it by a specified date. Moreover, Rule 10b-9 also requires that, if the contingencies are not satisfied fully by the specified date, "all or a specified amount" of the consideration paid must be promptly refunded to the purchaser. Rule 15c2-4 addresses the handling of investor funds by broker-dealers in contingency offerings and provides that, prior to the satisfaction of all contingencies, any consideration received by broker-dealers from investors must either be promptly deposited by the broker-dealer in a separate bank account as agent or trustee for the persons who have the beneficial interests therein, or promptly transmitted to a bank which has agreed in writing to hold all such consideration in escrow for the persons who have the beneficial interests therein.
After considering the views of the commentators, the Commission believes that a security offered on an "all or none" or "part or none" basis pursuant to Rule 3a12-9 is "sold" for purposes of Rule 10b-9 when the issuer or a broker-dealer participating in the offering receives the consideration specified by the terms of the offering. The specified consideration would consist of the 50 percent down payment and the documentation reflecting the contractual obligation of the investor to make mandatory installment payments. Rule 10b-9 would be satisfied, and the consideration may be released to the issuer, only where: (1) the specified sales level is achieved; (2) with respect to the sale of each security counted towards the specified sales level, the 50 percent down payment is fully paid; 27and (3) the required documentation reflecting the installment payment obligation comports with the requirements of the offering material. Any consideration received by a broker-dealer in a Rule 3a12-9 offering prior to satisfaction of the contingencies must be deposited or transmitted in compliance with Rule 15c2-4.
VI. Coordination with State Securities Regulators
As noted earlier, the Commissions decision to adopt Rule 3a12-9 at this time is based, in part, upon the increased quality of state securities regulations which will be applicable to many of the offerings able to utilize the Rule. In drafting the final version of the Rule, the Commission has sought to minimize some of the conflicts between the Rule and the NASAA guidelines for certain direct participation programs which are applied by many states. However, the Commission recognizes that conflicts do exist.
The Commission wishes to emphasize that Rule 3a12-9 is an exemptive rule under the federal securities laws only and is not intended to preempt state securities laws. Accordingly, those securities which qualify under the Rule to be deemed exempted securities for purposes of the arranging for credit provisions of Sections 7(c) and 11(d)(1) of the Exchange Act must also comply with applicable state securities laws. The Commission is hopeful that the additional investor safeguards which have been incorporated in the Rule will facilitate complementary amendments to present state securities regulations.
Staff of the Commissions Division of Market Regulation will be working with members of NASAA in an effort to resolve conflicts.
VII. Certain Findings, Effective Date and Statutory Basis
Section 23(a)(2) of the Exchange Act 28requires the Commission, in adopting rules under that Act, to consider the anticompetitive effect of such rules, if any, and to balance any impact against the regulatory benefits gained in terms of furthering the purposes of the Exchange Act. The Commission has considered proposed Rule 3a12-9 in light of the standards cited in Section 23(a)(2) and believes that adoption of the Rule will not impose any burden on competition not necessary or appropriate in furtherance of the Act. Indeed, the Commission believes that the Rule will enhance competition by increasing issuers flexibility in constructing and offering direct participation programs to suitable investors.
Pursuant to the Administrative Procedure Act, 5 U.S.C. 553(b) interested persons were given an opportunity to submit written views on proposed Rule 3a12-9. After consideration of the relevant matters, the Rule is being adopted substantially as proposed, but with certain changes made in response to suggestions of commentators. In response to comments received, the requirement in the proposed Rule that all securities issued in reliance on the Rule remain subject to the reporting requirements of Section 12(g) of the Exchange Act has been eliminated. In addition, the Rules coverage has been expanded to include securities offered on an intrastate basis which are registered with state securities administrators. Provisions have also been added to the Rule requiring a minimum down payment and limiting the amount of time over which deferred payments may be made.
Since Rule 3a12-9 is exemptive in nature, pursuant to Section 553(d) of the Administrative Procedures Act, 5 U.S.C. 553(d) it may become effective immediately upon publication in the Federal Register. However, in recognition of the fact that state securities administrators may wish some time to study the Rule, the Commission decided to delay its effectiveness for 30 days following publication in the Federal Register.
VIII. Summary of Final Regulatory Flexibility Analysis
The Commission has prepared a Final Regulatory Flexibility Analysis for Rule 3a12-9 in accordance with 5 U.S.C. 603. The Analysis notes that Rule 3a12-9 is designed to allow programs, which do not need all investors funds at the outset, to match investor payments for program securities sold in public offerings with the actual capital needs of the program. Programs with staged payment features are currently permitted only in private offerings. The Analysis indicates that Rule 3a12-9 will provide promoters with alternative means of raising capital and will give investors new investment choices, without compromising investor protection. No commentators specifically referred to the Initial Regulatory Flexibility Analysis. However, the Analysis notes the Commission has deleted certain requirements in the proposed Rule which commentators believed would impose additional costs or uncertainty on the part of program sponsors without a corresponding increase in investor protection.
A copy of the Final Regulatory Flexibility Analysis may be obtained by contacting Edward L. Pittman, Esq., Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549 (202) 272-2848.
IX. Statutory Basis
The Securities and Exchange Commission, acting pursuant to the Exchange Act, 15 U.S.C. 78a et. seq., and particularly Sections 3(a)(12), 7(c), 11(d)(1) and 23 15 U.S.C. 78c(a)(12), 78g, 78k and 78w, hereby amends Chapter II, Title 17 of the Code of Federal Regulations by adding §240.3a12-9 thereto.
List of Subjects in 17 CFR Part 240
Brokers, Credit, Securities
Text of Rule 3a12-9
CHAPTER II, TITLE 17 OF THE CODE OF FEDERAL REGULATIONS IS AMENDED AS FOLLOWS:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934.
1. The authority citation for Part 240 is amended by adding the following citation: (Citation before * * * indicates general rulemaking authority)
Authority: Sec. 23, 48 Stat. 901, as amended (15 U.S.C. 78w). * * * §240.3a12-9 also issued under Secs. 3(a)(12), 7(c), 11(d)(1), 15 U.S.C. 78c(a)(12), 78g(c), 78k(d)(1)).
2. Section 240.3a12-9 is added to read as follows:
§240.3a12-9 Exemption of certain direct participation program securities from the arranging provisions of Sections 7(c) and 11(d)(1).
a Direct participation program securities sold on a basis whereby the purchase price is paid to the issuer in one or more mandatory deferred payments shall be deemed to be exempted securities for purposes of the arranging provisions of Sections 7(c) and 11(d)(1) of the Act, provided that:
1 The securities are registered under the Securities Act of 1933 or are sold or offered exclusively on an intrastate basis in reliance upon Section 3(a)(11) of that Act;
2 The mandatory deferred payments bear a reasonable relationship to the capital needs and program objectives described in a business development plan disclosed to investors in a registration statement filed with the Commission under the Securities Act of 1933 or, where no registration statement is required to be filed with the Commission, as part of a statement filed with the relevant state securities administrator;
3 Not less than 50 percent of the purchase price of the direct participation program security is paid by the investor at the time of sale;
4 The total purchase price of the direct participation program security is due within three years in specified property programs or two years in non-specified property programs. Such pay-in periods are to be measured from the earlier of the completion of the offering or one year following the effective date of the offering.
b For purposes of this Rule:
1 "Direct participation program" shall mean a program financed through the sale of securities, other than securities that are listed on an exchange, quoted on NASDAQ, or will otherwise be actively traded during the pay-in period as a result of efforts by the issuer, underwriter, or other participants in the initial distribution of such securities, that provides for flow-through tax consequences to its investors; Provided, however, that the term "direct participation program" does not include real estate investment trusts, Subchapter S corporate offerings, tax qualified pension and profit sharing plans under Sections 401 and 403(a) of the Internal Revenue Code ("Code"), tax shelter annuities under Section 403(b) of the Code, individual retirement plans under Section 408 of the Code, and any issuer, including a separate account, that is registered under the Individual Company Act of 1940.
2 "Business development plan" shall mean a specific plan describing the programs anticipated economic development and the amounts of future capital contributions, in the form of mandatory deferred payments, to be required at specified times or upon the occurrence of certain events.
3 "Specified property program" shall mean a direct participation program in which, at the date of effectiveness, more than 75 percent of the net proceeds from the sale of program securities are committed to specific purchases or expenditures. "Non-specified property program" shall mean any other direct participation program.
By the Commission.
115 U.S.C. 78a et seq.
2Securities Exchange Act Release No. 21495 (November 16, 1984), 49 FR 46556 (November 27, 1984).
3As defined more fully in the Rule, direct participation programs are programs which provide for flow-through tax consequences to their investors such as limited partnerships or some investment contract securities. It is anticipated that such programs may include oil and gas, real estate, agricultural, cattle breeding, and equipment leasing programs.
4The Rule does not provide an exemption from the prohibition against the direct extension of credit by the broker-dealer, nor does it permit the broker-dealer to arrange for the extension of credit beyond the deferred payment itself.
5For some purposes a distinction may be drawn by state regulators between the terms "installment payments" and "deferred payments." The latter, which are intended to be encompassed by Rule 3a12-9, must bear a reasonable relationship to the programs cash needs and business objectives, and are not merely an optional method of financing the purchase of program interests over a period of time. Nevertheless, these two terms, along with the term "staged payments," may in some instances be used interchangeably for purpose of this release.
612 CFR 220.
7Section 11(d)(1) of the Exchange Act generally prohibits a broker-dealer who participates in a distribution of securities from extending or arranging for credit during the first 30 days following termination of the distribution.
8In March of 1972, the Board concluded that the sale by a broker-dealer of a publicly offered tax shelter program with installment features constitutes an "arranging" for the extension of credit in violation of Regulation T (12 CFR 220.124). Subsequently, the Board adopted an "economic penalty" test in determining whether the likelihood of an exercise of a warrant was so great as to make it equivalent to an installment purchase. Securities Credit Transactions Handbook §5-560.31 (Board Ruling of October 30, 1973). See also, Id. at §5-606.31 (Staff Op. September 30, 1983).
9In July of 1972, the Boards staff indicated that the prohibition against the use of installment payments under Regulation T set forth in its March interpretation related only to publicly offered programs which were not exempt from registration with the Commission. Securities Credit Transactions Handbook, §5-551. In 1975, the Board amended Regulation T to except from the arranging prohibition those private offerings exempt from registration with the Commission pursuant to Section 4(2) of the 1933 Act. See, 12 CFR 220.7(a). Because the prohibitions of Section 11(d)(1) of the Exchange Act would have rendered an exemption for intrastate offerings ineffective, the staffs of the Board and the Commission concluded that an express exemption from Regulation T for intrastate offerings was inappropriate.
10Public offerings with deferred payment features have been conducted using so-called "toothless notes" which do not involve an economic penalty to the investors for failure to pay subsequent installments and therefore are permissible under Regulation T.
11Report of the Real Estate Advisory Committee to the Securities and Exchange Commission, at 65 (October 12, 1972).
12See, Letter dated April 26, 1983 to Robert S. Plotkin, Assistant Director of the Board, from Frank J. Wilson, Executive Vice President, NASD (publicly available in File No. S7-36-84).
13Section 3(a)(12) defines "exempted securities" to include such securities:
"as the Commission may, by such rules and regulations as its deems consistent with the public interest and the protection of investors, either unconditionally or upon specified terms and conditions or for stated periods, exempt from the operation of any one or more provisions of this title which by their terms do not apply to an "exempted security" or to "exempted securities."
14A summary of the comments prepared by the Commissions staff is available for public inspection and copying in File No. S7-36-84.
15See, Securities Exchange Act Release No. 11220, 40 FR 6644 (February 13, 1975) (adopting Rule 3a12-5; 17 CFR 240.3a12-5). See also, A Review and Evaluation of Federal Margin Regulations, A Study by the Staff of the Board of Governors of the Federal Reserve System (December 1984).
16Appendix F to Art. III, Section 34, NASD Rules of Fair Practice.
17Rule 15c2-5 (17 CFR 240.15c2-5) states, among other things, that it shall constitute a "fraudulant, deceptive, or manipulative act or practice," as used in Section 15(c)(2) of the Exchange Act, for a broker-dealer to arrange for credit in connection with the sale of any security unless, prior to the purchase, the broker-dealer obtains information concerning the financial situation and needs of the investor and reasonably determines that the entire transaction, including the loan arrangement, is suitable for the investor. Although this rule does not apply to transactions made in accordance with the provisions of Regulation T, it does not distinguish between public and private offerings. Accordingly, Rule 15c2-5s requirements are equally applicable to transactions which are not governed by Regulation T because they are either made pursuant to Rule 3a12-9 or because they are done in private offerings.
18Commentators indicated that it is currently the practice in many private offerings using installment payments to obtain insurance to protect the working capital of the program in the event of investor defaults. The Commission anticipates that similar practices will develop among publicly offered programs with staged payment features.
19To the extent that other financing vehicles fall within the spirit of the Rule, but may not come directly within the definition of a direct participation program, the staff of the Commissions Division of Market Regulation will consider, on a case by case basis, requests for relief in the form of no-action or interpretive letters.
20One commentator suggested that the following information should be disclosed in the business development plan: (1) the investment and business objectives of the program; (2) the proposed investments and operations of the program; (3) the amount and timing of the financing for such investments and operations; (4) the relationship of such financing to the investment and business objectives of the program; (5) the relationship of installment payment provisions of the program, to the financing for the program, to the cash needs of the program, to the proposed investments and operations of the program; (6) any alternative or supplementary financing arranged by or available to the program to provide for future uncertainties (including possible inaccuracies in forecasts of financial needs and possible investor defaults); (7) the financial, contractual and tax consequences to the investor and to the program of defaults by investors in making mandatory installment payments. The Commission believes that this type of disclosure may be appropriate in connection with offerings of programs with staged payments.
21For purposes of the Rule, a specified property program is defined as a program in which at the time of securities registration, 75 percent of the amount of money available for investment is committed to specific program expenditures. A non-specified property program would be one in which less than 75 percent of the money available for investment has been so committed. Examples of specifically identifiable program expenditures would include the purchase of a particular parcel of real property or type of computer equipment. Specifically identifiable program expenditures would not include expenditures committed to a broad category of equipment such as "transportation equipment," or to other than specific parcels of real property.
22Rule 147 under the 1933 Act (17 CFR 230.147) provides a non-exclusive "safe harbor" from securities registration for intrastate offerings that meet its requirements.
23Outside of the context of the Rule, the Commission continues to believe that Section 11(d)(1) prohibits a person who is both a broker and a dealer from extending or arranging for the extension of credit in the distribution of a new issue of securities offered on an intrastate basis.
24The effective date of the offering for purposes of the Rule will generally be the date the registration statement is declared effective by the Commission. Where offerings are conducted in reliance upon the intrastate exemption under Section 3(a)(11) of the 1933 Act, the effective date will be the date upon which the offering is approved by state securities administrators.
25This portion of the Rule is intended to be in parity with the margin requirements under Regulation T. If those requirements change, the Commission may wish to reexamine the minimum down payment requirement of the Rule in light of those changes.
2617 CFR 240.10b-9 and 240.15c2-4.
27It should be noted that the down payment would be considered to be fully paid only upon the receipt of cleared funds.
2815 U.S.C. 78w(a)(2).
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