## Facts

- A mutual fund’s investment adviser also acted as an underwriter and NASD-registered broker-dealer.
- Mutual fund shareholders asserted the adviser should have used “underwriting recapture”: purchasing offering shares at a discount, reselling them to the fund at the fixed public offering price, and applying the resulting gain to reduce the advisory fee charged to the fund.
- In related private litigation, shareholders prevailed; the adviser had argued NASD rules prohibited underwriting recapture, but the court rejected that position.
- After the litigation, the adviser sought clarification from NASD about whether underwriting recapture was permitted under NASD rules.
- NASD responded by filing a proposed rule change with the SEC under Exchange Act § 19(b) to clarify and regulate practices in fixed-price offerings.
- The proposal addressed (i) when selling concessions, discounts, or other allowances may be granted in fixed-price offerings, (ii) restrictions on sales in fixed-price offerings to persons related to the selling firm, and (iii) a limited exception for sales at the stated public offering price to recipients of “bona fide research,” as defined by the rules and interpretive materials.
- The SEC published the proposal, considered public comments, and issued an administrative order approving the package of NASD rule changes commonly called the “Papilsky rules.”

## Issues

1. Whether NASD’s proposed restrictions on concessions, discounts, and allowances in fixed-price offerings, including limits tied to distribution services, were consistent with Exchange Act requirements for association rules.
2. Whether NASD could bar underwriting recapture arrangements in fixed-price offerings as inconsistent with uniform public pricing and investor protection.
3. Whether permitting a narrow “bona fide research” exception—conditioned on payment of the full stated public offering price and bounded by definitional limits—was consistent with protecting investors and maintaining fixed-price offering integrity.

## Decision

- The SEC approved NASD’s proposed rule changes (the Papilsky rules).
- The approved rules prohibited granting selling concessions, discounts, or other allowances in connection with fixed-price offerings except as permitted under the rules’ limited framework (including allowances tied to broker-dealer distribution services).
- The approved rules restricted sales in new fixed-price offerings to persons related to the selling entity, preventing affiliated arrangements that would function as undisclosed preferential pricing.
- The SEC-approved framework recognized a limited “bona fide research” pathway for sales at the stated public offering price, subject to tight definitions and interpretive constraints.
- The overall effect was to prohibit underwriting recapture in fixed-price offerings and to formalize that prohibition as part of NASD’s rulebook.

## Legal Principles

- Under Exchange Act §§ 15A and 19(b), the SEC may approve SRO rules that are designed to protect investors and the public interest and to support fair dealing in securities transactions.
- In fixed-price offerings, SRO rules may lawfully require that securities be sold at the stated public offering price and may prohibit structures that confer an undisclosed economic advantage equivalent to a better price.
- Rules barring underwriting recapture in fixed-price offerings are permissible when the practice functions as an undisclosed concession or allowance that compromises fixed-price offering integrity and creates conflicts of interest.
- Exceptions that could permit preferential economics in fixed-price offerings may be allowed only when narrowly limited and structured to preserve payment of the full stated public offering price (including through strict definitions of qualifying “bona fide research” arrangements).

## Conclusion

The SEC’s order approved NASD’s Papilsky rules, validating a regulatory scheme for fixed-price offerings that bars underwriting recapture and related affiliate sales or allowances that would produce undisclosed price advantages, while allowing only narrowly defined exceptions that maintain the stated public offering price.


In re Nat’l Ass’n of Sec. Dealers, Inc., Exchange Act Release No. 17371 (Dec. 12, 1980)