take large participations, better call protection, and better covenant protection.57

D. Intermediaries

Intermediaries are used in the private placement market as in other U.S. financial markets. However, the system for placing new issues in the private market is less standardized than that in the public market. 58 While in some cases the issuer and investor deal directly with each other, the major portion of new issues in the private market is placed by intermediaries. 59 The average size of private issues sold by intermediaries tends to be larger than private placements sold directly,60

Historically, investment banks have played the major role as intermediaries in the private market;61 however, in the 1980s, commercial banks have become more active.62 Of the 20 private placement agents placing the largest amount of 57 Dash, supra n. 16, at 128; see also LBOS Forced to Abandon Public Market for Private Investors, 13 Corp. Fin. Week (Dec. 28, 1987); Parker, supra n. 9, at 34.

58 See Cabanilla, supra n. 51, at 72.

59 Market Participants, supra n. 17; Shapiro and Wolf, supra n. 8, at 79.

60 Market Participants, supra n. 17.

61 Rudin, Investment Banks Retain Dominance, Pens. & Inv. Age 17 (October 5, 1987).

62 Neustadt, Banks Take Big Share of Private Financing Market, 153 Am. Bank. 21 (March 21, 1988); Neustadt, Banks Encroach on Wall Street's Turf, 153 Am. Bank. 1 (April 4, 1988); Keslar, Joining in the Private Fight: Commercial Banks Entering the Private Placement Market, Euromoney 175 (Dec. 19, 1986); Albert, Banks Forge Ahead with Private Placements, 151 Am. Bank. 1 (July 17, 1988); Parker, Commercial Banks Take Aim, 16 Pens. & Inv. Age 35 (Feb. 22, 1988); cf. A.G. Becker, Inc. v. Board of Governors of Fed. Res. Sys., 519 F. Supp. 602, 604 (D.D.C. 1981), rev'd, 693 F.2d 136 (D.C. Cir 1982), rev'd sub nom., Securities Industry Ass'n v. Board of Governors of the Fed. Reserve Sys., 468 U.S. 137 (1984) (discussing placement activities of banks in commercial paper markets). See also Long-Term Credit Bank of Japan Looks to Become Private Placement Agent, 13 Corp. Fin. Week (Mar. 23, 1987).

Until Board of Governors of the Federal Reserve System, Statement Regarding Determination Not to Initiate Enforcement Action (Sept. 26, 1980) (Bankers Trust), it was generally assumed that the Glass-Steagall Act barred banks (and bank holding companies) from acting as intermediaries in private placements. See also Staff of the Board of Governors of the Federal Reserve System, Commercial Bank Private Placement Activities 86-87 (1977).

63 Bensman, supra n. 11, at 19. Three commercial banks were included in the top ten placement agents for 1987. Id. According to the Investment Dealers' Digest, the top ten placement agents in 1987, and the amounts of securities placed (in billions) were Salomon Brothers Inc, $14.9; The First Boston Corp., $11.5; Drexel Burnham Lambert Incorporated, $11.4; Goldman, Sachs & Co., $11.3; Shearson Lehman Hutton Inc., $10.1; Merrill Lynch, Pierce, Fenner & Smith, Inc., $9.3; Bankers Trust Company, $9.0; Morgan Stanley & Co., Incorporated, $7.2; Paine Webber Incorporated, $7.2; and Morgan Guaranty Trust Company of New York, $6.8. See Bensman, supra n. 11, at 19.

securities in 1987, 12 investment banks placed $96 billion of securities and eight commercial banks placed $34 billion.63 Traditionally, commercial banks have been most active in placing straight debt securities,64 but banks are reported to be increasingly active in privately placing asset-backed securities and certificates of deposit.65 The parameters of commercial banks' participation as intermediaries are set by the Glass-Steagall Act.66

III. THE SECONDARY MARKET FOR
PRIVATE PLACEMENTS

A secondary market for privately placed securities has become an established feature of American corporate finance.67 In 1979, a Bar committee reported that "an active and substantial68 secondary market for the resale of privately placed debt securities exists and functions alongside the secondary markets for the resale of other securities."69 Estimates of total volume of 64 Picker, supra n. 9, at 33.

65 Neustadt, Banks Take Big Share of Private Financing Market, Am. Banker 10 (Mar. 21, 1988) (commercial banks strongest in asset-backed securities, private certificates of deposit and straight debt, and weakest in acquisition-related transactions). See also Albert, Banks Sell Notes Backed by Associated Grocers' Assets, Am. Banker 30 (Feb. 10, 1988). 66 The United States Court of Appeals for the District of Columbia Circuit ruled, in a case involving a bank's placements of commercial paper, that the Glass-Steagall Act's prohibition of underwriting by banks does not prevent agency private placements. Securities Industry Ass'n v. Board of Governors of the Fed. Reserve Sys., 807 F.2d 1052 (1986), cert. denied, 107 S. Ct. 3228 (D.C. Cir. 1987). See also Comptroller Staff No-Objection Letter No. 87-4 (May 19, 1987); Comptroller Staff No-Objection Letter No. 87-3 (March 24, 1987); S. 1886, 100th Cong., 2d Sess., 134 Cong. Rec. S3360-79 (1988); H.R. 5094, 100th Cong., 2d Sess., H.R. Rep. No. 100-822, Part 1, 1-99. Cf. H.R. Rep. No. 100-822, Part 2, 100th Cong., 2d Sess, (1988) (version of H.R. 5094 favorably reported by Committee on Energy and Commerce).

67 See Monahan, Trading in Private Placements: Secondary Market Liquidity and Volume are Increasing, Investment Dealers' Digest 5 (Apr. 26, 1983). As indicated below, the secondary market for privately placed debt securities is well established, while the secondary market for private equity is relatively small.

Published data regarding the secondary market for privately placed securities is almost completely unavailable. Much of the following discussion is based, therefore, on information compiled by the Commission's staff in a series of interviews with market participants. See supra n. 17. 68 Footnote in original omitted.

69 Committee on Developments in Business Financing of the Section of Corporation, Banking and Business Law of the American Bar Association, Resale by Institutional Investors of Debt Securities Acquired in Private Placements, 34 Bus. L. 1927, 1931 (July 1979) (hereinafter "Committee”). "The secondary market for privately placed debt securities provides to institutional investors, and to dealers in such securities, a market place for the offering and resale of substantial amounts of such securities on the basis of quality and yield." Id. at 1937.

secondary trading in private placements in the 1980s have ranged from $1.5 to $6 billion annually,70

In contrast to the primary market for private placements, which includes a significant equity component, the secondary market for private placements reportedly consists almost entirely of debt securities.71 The majority of these securities have not been rated by a nationally recognized statistical rating organization,72 although in many cases other debt securities of the issuer are rated, often investment grade.73 Straight debt securities are resold in the secondary market more frequently than debt securities with complex terms and covenants.74 Larger original issues are resold more frequently than smaller issues.75 The secondary market for privately placed commercial paper reportedly is small, due to the short-term nature of the instruments.76

Most issuers of securities resold in the secondary private placement market are domestic issuers.77 Domestic issuers of debt securities resold in the secondary private market are, more often than not, reporting companies.78 However, the limited equity securities resold in the secondary market usually are issued by non-reporting companies. 79 Buying and selling in the secondary market mirror the activity in the primary market. Buyers and

sellers are almost always institutions,80 and are predominantly insurance companies.81

Volume is often higher at year-end,82 reflecting the tax considerations that may prompt an institution to sell a portion of its private portfolio at that time.83 Portfolio and asset management, including matching assets and liabilities, responding to interest rate fluctuations and reacting to deteriorations in credit quality, also motivates institutions to sell in the secondary market 84 Resales in the secondary market reportedly range from $500,000 to $20 million per transaction.85

Decisions to buy privately placed debt securities in the secondary market are reported to be "influenced particularly by the differences between the yields in the secondary market for such securities and for other debt securities, as well as by the relatively more advantageous redemption and sinking fund provisions of many privately placed securities."86

Intermediaries, such as investment and commercial banks, are almost always involved in resales of privately placed securities, although direct resales occasionally do occur.87 While the intermediary sometimes acts on an agency basis, it usually operates on a principal basis. Resales generally are intermediated by the original placing agent.88

Volume in the secondary market appears to have increased significantly in the mid-late 1970s. See generally Monahan, supra n. 67; Raising More Cash in Private Placements, Business Week 96 (Oct. 27, 1975) (forty-four percent of 200 institutions surveyed indicated they had bought or sold privately placed securities in the past year). In earlier periods, the secondary market for privately placed securities was not considered a liquid market. E. Altman, supra n. 18, at 4-22; Lund, supra n. 4, at 122; Shapiro and Wolf, supra n. 8, at 104; Corey, supra, n. 8, at 97. The resale market became more liquid in the mid-late 1970s, though no systemic changes occurred in the private market during this period. See Committee, supra at 1931; Monahan, supra n. 67 at 5. 70 See, e.g., Monahan, supra n. 67 at 6; Market Participants, supra n. 17.

71 Market Participants, supra n. 17. Privately placed preferred stock is resold less frequently than debt but more frequently than common equity. Id.

72 Id. Currently, the nationally recognized statistical rating organizations include Moody's Investor Services; Standard & Poor's Corporation; Duff & Phelps, Inc.; Fitch Investor Services, Inc.; and McCarthy, Crisanti & Maffei, Inc. 73 Id.

74 Id.

75 Id.

76 Id.

77 Id.

84 Id.; see also Committee, supra n. 69, at 1933 (increase liquidity, create or use capital gains or losses, diversify portfolios).

85 Market Participants, supra n. 17.

It has been reported that, in the secondary market for privately placed debt, "the credit quality of the debt securities being sold, their yield to maturity and the extent to which such yield is or may be affected by redemption provisions, are much more important factors in establishing resale prices than is the identity of the particular issuer or transient economic factors affecting the current market prices of its common stock." Committee, supra n. 69 at 1932, citing Exchange Act Release No. 15220 (Oct. 16, 1978) [43 FR 47538]. Credit quality and yield appear still to be critical elements in the pricing of debt securities, at least with respect to investment grade debt.

86 Committee, supra n. 69, at 1933.

87 Market Participants, supra n. 17. See also Kleinfield, Prudential to Sell Prices of Its Private Placements, The New York Times D3 (Aug. 11, 1988).

88 Id.

78 Id.

IV. INSTITUTIONAL SALES UNDER THE FEDERAL SECURITIES LAWS

The Congress and the Commission historically have recognized the ability of professional institutional investors to make investment decisions without the protections mandated by the registration requirement of the Securities Act. The Commission has not until now, however, formally addressed the difference between the institutional and public resale markets. The institutional resale market for restricted securities has evolved to a point where its existence should be acknowledged.

Proposed Rule 144A could have a significant impact on both the primary and secondary domestic markets for unregistered securities of reporting as well as non-reporting issuers.89 Removing uncertainties as to the legitimacy of resales to institutional buyers by providing a safe harbor from registration could permit some transactions to take place that otherwise might not occur. Such transactions might include resales by persons that purchased securities privately with a view to their immediate resale to a number of institutions. Providing a framework in which institutional resales could be made freely may increase the efficiency of the private placement market. Liquidity in the market may increase,90 not only as the result of increased efficiency, but

also as a consequence of the resale provisions of proposed Regulation S.91 The potential increase in efficiency and liquidity could significantly lower the discount commonly associated with private placements,92 which in turn may attract an increasing number of issuers to the private placement market.93

The Rule may have significant implications for offerings by foreign issuers. Foreign issuers who previously may have foregone raising capital in the United States due to the compliance costs and liability exposure associated with registered public offerings, and the costs of financing inherent in placing restricted securities, may find pri

vate placements in the United States a more viable capital-raising option as a result of the

combined effect of proposed Rule 144A and proposed Regulation S. Greater participation by foreign issuers in the U.S. capital market also would have the benefit of reducing the costs borne by U.S. institutional investors that wish to invest in foreign securities and are compelled at present to go overseas to obtain such securities. Moreover, U.S. intermediaries who may have lost business to foreign competitors simply because such securities may be available only offshore may be afforded more opportunities to participate in the internationalization of investment strategies.

While the Commission recognizes that a substantial institutional resale market currently exists, it anticipates that the development under Rule 144A of more formal, active trading markets will raise questions as to the effect of institutional markets on the efficiency and liquidity of the public trading markets. Those consequences need to be understood in considering adoption of Rule 144A, and, if the Commission determines to proceed, in determining whether to adopt the three tiers of the proposed Rule as a package, separately at different points in time, or in some combination.

The Commission anticipates that resales made in reliance on Rule 144A, whether executed on

proposed closed systems such as PORTAL or SITUS94 or elsewhere, would be used principally for transactions involving debt securities, preferred stock or common equity securities of a class not already publicly traded in the United States. While the qualified institutional buyer and fungible securities tiers of the Rule would be available for transactions in securities that are fungible with securities publicly traded in the United States, the Commission does not expect that Rule 144A would give rise to any significant volume of private transactions in classes of publicly traded securities. That is not currently the case,95 and, notwithstanding the potential for in

89 Issuers in the "non-reporting" category would include start-up companies and foreign issuers.

90 The perception among investors of illiquidity in the private placement market has been cited as a reason why some investors avoid the market. Market Participants, supra n. 17.

91 Proposed Regulation S (17 CFR §230.901-906), Securities Act Release No. 6779 (June 10, 1988) [53 FR 22661]. The resale safe harbor of Rule 906 of proposed Regulation S, which allows persons other than issuers or underwriters to sell specified unregistered securities on foreign securities

exchanges without imposing resale restrictions, should provide significantly more liquidity for restricted securities of foreign issuers.

92 See supra n. 44.

93 Market Participants, supra n. 17. For example, U.S. issuers who now raise capital through the international capital market might instead elect to offer their securities through private placements in the U.S.

94 See infra n. 191.

95 See supra n. 43.

creased efficiency in the private resale market and the ability to avoid costs and delays associated with registration, it may not be financially advantageous in the future for companies to sell securities in a market that was comparatively limited in its depth and liquidity.

Nonetheless, the Commission requests comment on the likelihood that an active, liquid private market will develop alongside a public market for the same class of securities in the United States. If such a development is viewed as likely, comment is requested on the nature of such markets, the consequences to the liquidity and efficiency of the public market for such securities, and whether any steps should be taken to prevent such a development. For example, should reliance on Rule 144A be precluded with respect to any class of securities that is registered under the Securities Act or the Exchange Act? Comment also is requested on the likelihood that arbitrage would occur between the public and private markets for common stock, if dual markets were to develop; whether such arbitrage would be beneficial or harmful to the U.S. markets; if harmful, how it might be discouraged, and if beneficial, how it might be encouraged? Commenters should indicate whether their responses to the above questions would differ depending on whether the qualified institutional buyer tier of proposed Rule 144A, the fungible securities tier, or both were adopted.

The Commission also requests comment as to whether the risks of market manipulation and insider trading will increase significantly enough with the evolution of a more active institutional market that the Commission should permit such a market to develop only in a more formalized structure subject to surveillance, Commission oversight, and transaction reporting require

ments.

The Commission also anticipates that proposed Rule 144A will facilitate, and thereby encourage, dealers' purchases of securities, particularly foreign securities, either in primary offerings or secondary transactions, with a view to resale in the United States. The Commission requests comment on the appropriateness, and the potential consequences, of the use of the Rule to

exempt from registration such resales to institutional purchasers.

The Commission also recognizes that, by increasing the efficiency of the resale market for "restricted securities," issuers, particularly foreign issuers, that eventually might have chosen to register their securities for public sale in the United States, may forego registration and still have the benefits of access to the U.S. markets. Market participants have suggested that foreign issuers choosing to sell securities publicly in the United States do so for reasons not directly related to capital-raising needs, such as obtaining name recognition in the U.S. capital markets. The Commission requests comment on the likelihood that adoption of any of the three tiers of proposed Rule 144A, or some combination of the three tiers, might diminish the number of foreign issuers that eventually would choose to make a public offering in the United States. Similarly, how would the adoption of any or all of the three tiers affect the process by which domestic issuers typically first access the private market and then graduate to registered public offerings?

To the extent that an active institutional trading market continues to evolve, the trading market interest, both institutional and retail, in the securities of the issuer is likely to increase. In such case, the potential for "leakage" into the retail market would be greater, particularly in the case of common equity securities. Under Section 12(g) of the Exchange Act, the public markets would be protected in the case of domestic issuers because reporting obligations generally will be incurred when any class of equity securities is held by 500 or more persons. In the case of foreign securities, however, under current rules, there would be no such protection because Rule 12g3-2(b)97 would permit the securities to be held by any number of shareholders so long as the securities were not quoted in NASDAQ or listed on U.S. securities exchanges. Rule 144A can thus be expected to create the potential for greater trading in foreign securities in the United States. In addition, the proposed changes to Rule 144, which will in many cases telescope the required holding period for securities, could further accelerate this development. In light of this potential, the Commission requests comment on the appro

96 15 U.S.C. 8781(g). Section 12(g) requires issuers to file reports under the Exchange Act if they have assets of over $1 million or a class of equity securities held of record by 500 or more persons. Rule 12g-1 under the Exchange Act [17 CFR

$240.12g-1] exempts issuers from this obligation if they have total assets not exceeding $5 million. 9717 CFR § 240.12g3-2(b).

priateness of continuing the exemption provided by Rule 12g3-2(b) for issuers whose securities are widely held by non-institutional investors, if proposed Rule 144A (particularly the qualified institutional buyer tier), the proposed change to Rule 144 or both were adopted.

A. Historical Treatment of Institutions 1. Legislative History

The Securities Act was remedial legislation designed "to protect the investing public and honest business. "98 The "investing public" intended to benefit from the registration provisions of the Securities Act was unsophisticated, individual investors.99 Despite measurable institutional presence in the capital markets, 100 Congress concentrated on the protection of individuals. 101 James Landis, a principal draftsman of the Securities Act and the second Chairman of the Commission, recalled that the draftsmen believed that "[t]he sale of an issue of securities to insurance companies or to a limited group of experienced investors, was certainly not a matter of concern to the federal government." 102 Writing

at the same time as Landis, the Commission itself stated that the 1933 Congress imposed upon the industry "standards of conduct... basic to any proper relationship to public investors. " 103

Two early bills introduced in the Congress exempted "isolated transactions" in securities, and it was suggested that the proposed legislation should be revised "to exempt from its provisions all types of securities which are not customarily sold to the small investor."104 This wish was broadly consistent with the developing Congressional decision to "carefully exempt[ ]" from the application of the Securities Act those "types of ... securities transactions where there is no practical need for its application or where the public benefits are too remote." 105 H.R. 5480 deleted the isolated transactions exemption and in its place exempted trading transactions 106 as well as private placements; that is, "[t]ransactions by an issuer not with or through an underwriter."107 A clarifying amendment later added the language “and not involving a public offering" to the latter exemption. This was the form in which the exemption eventually became law.

98 S. Rep. No. 47, 73rd Cong., 1st Sess. 1 (1933) (hereinafter "Senate Report"):

The aim [of the legislation] is ... to protect honest enterprise, seeking capital by honest presentation against the competition afforded by dishonest securities offered to the public through crooked promotion; ... to bring into productive channels of industry and development capital which has grown timid to the point of hoarding; and to aid in providing employment and restoring buying and consuming power.

See generally J. Seligman, The Transformation of Wall Street 1-72 (1982).

99 See infra nn. 101, 102.

100 See Proposed Amendments to the Securities Act of 1933 and to the Securities Exchange Act of 1934: Hearings on H.R. 4344, H.R. 5065, and H.R. 5832 Before the House Comm. on Interstate and Foreign Commerce, 77th Cong., 1st Sess. pt. II, 586 (1941) (statement of Commissioner Purcell):

There seems to be practically no statistical information on private placements prior to 1932. However, . . . the private placement is by no means a novelty, putting in its appearance coincident with the passage of the Securities Act. . . . [I]t appears that in a good many instances subsequent to 1907, and prior to 1933, the insurance companies did in fact purchase securities in substantial blocks directly from issuers.

See also 1 SEC, Institutional Investor Study Report, 59 (1971): ("The stock market boom of the 1920's was accompanied by a rather dramatic increase in the institutional share of the market, as investment companies in particular increased their holdings."); id. at 58 (“[T]here was greater institutional participation in the 1923-29 boom period, particularly among investment companies, than either before or after 1945. ..."); Kuhn, supra n. 8, at 84 ("[M]any corpo

rations... have sold their securities privately. The larger institutions in general have been the principal purchasers of such issuers").

101 References to investors in the legislative history of the Securities Act are to "the poor woman who ha[d] a little money to invest" (77 Cong. Rec. 2938 (1933) (statement of Rep. Beck)), "poor men and women who turned over their life savings" (id. at 2942 (statement of Rep. Cannon)), and "widows who owned Liberty bonds, having invested the accumulations of a lifetime" (id. at 2983 (Statement of Sen. Fletcher)), not to sophisticated institutions. Speaking of the "rank and file of the people" who "possess stocks and bonds," Representative Rayburn concluded that "[m]illions of citizens" had been "swindled into exchanging their savings for worthless stocks." 77 Cong. Rec. 2918. Ferdinand Pecora's account of the exhaustive hearings conducted by the Senate Committee on Banking and Currency dealt solely with the abuses suffered by individual investors. See F. Pecora, Wall Street Under Oath (1939).

102 Landis, The Legislative History of the Securities Act of 1933, 28 Geo. Wash. L. Rev. 29, 37 (1959).

103 SEC, 25th Annual Report xviii (1959) (emphasis added). Cf. SEC, 18th Annual Report 1 (1953) (emphasis added): "[T]he prospectus, which must be furnished to prospective investors at or before delivery of the security, effectually brings the prescribed disclosure directly to the attention of the individual investor."

104 Henderson & Dean, Memorandum on H.R. 4314 Submitted to Rep. Rayburn 2 (Apr. 4, 1933), reprinted in I SEC, Legislative History of the Securities Act of 1933 at tab 18 (available in the SEC library).

105 H.R. Rep. No. 85, 73rd Cong., 1st Sess. 5 (1933). 106 See 15 U.S.C. 77d(1) (1982), exempting "transactions by any person other than an issuer, underwriter, or dealer." 107 H.R. 5480, 73d Cong., 1st Sess. § 4(1) (1933).