NEW YORK (HedgeWorld.com)–The National Association of Securities Dealers has begun putting into effect its conduct rule 2790, which will govern the allocation of new issues in initial public offerings.

Rule 2790 replaces the interpretation in two stages. As of Dec. 23, NASD members have had the option of conforming either with the new rule or with an earlier interpretation, but 2790 will become mandatory on March 23 of this year. Once a member chooses to comply with 2790, it must ensure that all representations on which it relies are in conformity with the rule.

According to John M. Baker, a partner with Stradley Ronon Stevens & Young LLP, Washington DC, the new guidance is particularly significant for hedge funds that invest in IPOs. Under the older system, the “free-riding and withholding interpretation,” a hedge fund with investors who are considered restricted persons could invest in IPOs only by implementing carve-out procedures to segregate those persons. Those procedures are no longer necessary. A hedge fund may now maintain one brokerage account and adjust the capital amounts of the restricted persons to remove any gains or losses attributable to the new issues.

“Hedge funds and other collective investment accounts will no longer be required to obtain a written representation of counsel or a certified public accountant to show eligibility to invest in new issues,” wrote Mr. Baker, in a memorandum prepared for Stradley Ronon.

Another difference is that the interpretation has allowed a member that had sold a “hot issue” to a restricted person to cancel the trade before the end of the first business day following the date on which secondary market trading commenced. Rule 2790 removes this cancellation provision.

Under both the rule and the interpretation, who is a “restricted person” is defined by a person’s relationship with a member or other broker/dealer. The NASD said in its notice to members on the change that one difference between the two is that “a person who has authority to buy or sell securities for an investment club or a family investment vehicle is no longer deemed to be a restricted person based solely upon that investment authority.”

CFaille@HedgeWorld.com