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Industry Spotlight > Broker Dealers

Gardner Carton Interprets NASD's 'New Issue' Rule

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CHICAGO (–Gardner Carton & Douglas LLP has sent out a client memorandum expounding on the significance of the National Association of Securities Dealers’ new conduct rule 2790, which governs responsibilities of broker-dealers in the allocation of new issues in initial public offerings.

The hedge fund team at GCD said in the memorandum that unlike the older hot-issue rule–which generally prohibited an NASD member firm from selling hot issues to any account in which a restricted person has a beneficial interest, absent implementation of carve-out and certification procedures–the new rule contains a de minimis exemption that permits NASD member firms to sell new issues to an account without such procedures so long as the restricted persons own less than 10% of the beneficial interests in such an account.

One of the most significant changes in practice to come from the new rule is that a broker-dealer NASD member, in permitting a pooled investment vehicle such as a hedge fund to participate in new issues, need no longer get a representation letter from its attorney or accountant representing that the fund is not restricted. The broker-dealer now can rely upon a representation directly from the manager of the hedge fund itself.

“At the same time,” the memorandum cautioned, “the NASD indicated that it expects a hedge fund manager to obtain appropriate representations from the investors in the fund no less frequently than annually. The initial representations from investors must be in writing, and subsequent representations must either be in writing or obtained through the ‘negative representation’ process.”

A “negative representation” occurs when an NASD member sends a notice to the authorized account representative of a fund or pool containing the pertinent information relating to the account and asking the authorized account representative to indicate whether anything has changed to make the account restricted. In the absence of a response, the NASD member may continue to treat that account as non-restricted.

“Of course,” the memorandum adds, “neither a NASD member nor a hedge fund manager may rely upon any affirmative or negative representation if it believes or has reason to believe that the representation is inaccurate.”

Until March 23, NASD member firms may elect to comply with either the hot issue rule or the new issue rule, either generally or on an account-by-account basis. On March 23, the hot issue rule will no longer be effective, and NASD member firms will be required to comply with conduct rule 2790 .

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