[Federal Register Volume 80, Number 38 (Thursday, February 26, 2015)]
[Notices]
[Pages 10528-10536]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-03962]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-74339; File No. SR-FINRA-2014-047]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Instituting Proceedings To Determine Whether To
Approve or Disapprove a Proposed Rule Change To Adopt FINRA Rule 2241
(Research Analysts and Research Reports) in the Consolidated FINRA
Rulebook
February 20, 2015.
I. Introduction
On November 14, 2014, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule to adopt NASD Rule 2711 (Research Analysts and Research
Reports) as a FINRA rule, with several modifications, amend NASD Rule
1050 (Registration of Research Analysts) and Incorporated NYSE Rule 344
to create an exception from the research analyst qualification
requirement, and renumber NASD Rule 2711 as FINRA Rule 2241 in the
consolidated FINRA rulebook. The proposal was published for comment in
the Federal Register on November 24, 2014.\3\ The Commission received
four comments on the proposal.\4\ This order institutes proceedings
under Section 19(b)(2)(B) of the Act \5\ to determine whether to
approve or disapprove the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Exchange Act Release No. 73622 (Nov. 18, 2014); 79 FR 69939
(Nov. 24, 2014) (``Notice''). On January 6, 2015, FINRA consented to
extending the time period for the Commission to either approve or
disapprove the proposed rule change, or to institute proceedings to
determine whether to approve or disapprove the proposed rule change,
to February 20, 2015.
\4\ See Letter from Kevin Zambrowicz, Associate General Counsel
& Managing Director and Sean Davy, Managing Director, SIFMA, dated
Dec. 15, 2014 (``SIFMA''), Letter from Hugh D. Berkson, President-
Elect, Public Investors Arbitration Bar Association, dated Dec. 15,
2014 (``PIABA Equity''), Letter from Stephanie R. Nicholas,
WilmerHale, dated Dec. 16, 2014 (``WilmerHale Equity''), and Letter
from William Beatty, President and Washington (State) Securities
Administrator, North American Securities Administrators Association,
Inc., dated Dec. 19, 2014 (``NASAA Equity'').
\5\ 15 U.S.C. 78s(b)(2)(B).
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II. Description of the Proposed Rule Change
As described more fully in the Notice, FINRA proposed to adopt in
the
[[Page 10529]]
Consolidated FINRA Rulebook NASD Rule 2711 (Research Analysts and
Research Reports) with several modifications as FINRA Rule 2241. The
proposed rule change also would amend NASD Rule 1050 (Registration of
Research Analysts) and Incorporated NYSE Rule 344 (Research Analysts
and Supervisory Analysts) to create an exception from the research
analyst qualification requirements.
FINRA believes that the proposed rule change would retain the core
provisions of the current rules, broaden the obligations on members to
identify and manage research-related conflicts of interest, restructure
the rules to provide some flexibility in compliance without diminishing
investor protection, extend protections where gaps have been
identified, and provide clarity to the applicability of existing rules.
Where consistent with protection of users of research, FINRA believes
that the proposed rule change reduces burdens where appropriate.
As stated above, the Commission received four comments on the
proposal. Of these, three expressed general support for the
proposal,\6\ but one objected to the general formulation of the
proposal as a principles-based rule.\7\
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\6\ SIFMA, PIABA Equity, and WilmerHale Equity.
\7\ NASAA Equity.
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A. Definitions
FINRA proposed to generally maintain the definitions in current
NASD Rule 2711, with a few modifications. These modifications included
(1) minor changes to the definition of ``investment banking services''
to clarify that such services include all acts in furtherance of a
public or private offering on behalf of an issuer; \8\ (2)
clarification in the definition of ``research analyst account'' that
the definition does not apply to a registered investment company over
which a research analyst or member of the research analyst's household
has discretion or control, provided that the research analyst or member
of the research analyst's household has no financial interest in the
investment company, other than a performance or management fee,\9\ (3)
exclusion from the definition of ``research report'' of communications
concerning open-end registered investment companies that are not listed
or traded on an exchange (mutual funds); \10\ and (4) moving into the
definitional section the definitions of ``third-party research report''
and ``independent third-party research report'' that are now in a
separate provision of the rule.\11\
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\8\ See proposed FINRA Rule 2241(a)(5). The current definition
includes, without limitation, many common types of investment
banking services. FINRA proposed to add the language ``or otherwise
acting in furtherance of'' either a public or private offering to
further emphasize that the term ``investment banking services'' is
meant to be construed broadly.
\9\ See proposed FINRA Rule 2241(a)(9).
\10\ See proposed FINRA Rule 2241(a)(11).
\11\ See proposed FINRA Rules 2241(a)(3) and (14). FINRA
believes it creates a more streamlined and user friendly rule to
combine defined terms in a single definitional section.
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One commenter requested that the proposal define the term ``sales
and trading personnel'' as ``persons who are primarily responsible for
performing sales and trading activities, or exercising direct
supervisory authority over such persons.'' \12\ The commenter's
proposed definition is intended to clarify that the proposed
restrictions on sales and trading personnel activities should not
extend to: (1) Senior management who do not directly supervise those
activities but have a reporting line from such personnel (e.g., the
head of equity capital markets); or (2) persons who occasionally
function in a sales and trading capacity.
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\12\ WilmerHale Equity.
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This commenter also asked FINRA to include an exclusion from the
definition of ``research report'' for private placement memoranda and
similar offering-related documents prepared in connection with
investment banking services transactions.\13\ The commenter noted that
such offering-related documents typically are prepared by investment
banking personnel or non-research personnel on behalf of investment
banking personnel. The commenter asserted that absent an express
exception, the proposals could turn investment banking personnel into
research analysts and make the rule unworkable. The commenter noted
that NASD Rule 2711(a) excludes communications that constitute
statutory prospectuses that are filed as part of a registration
statement and contended that the basis for that exception should apply
equally to private placement memoranda and similar offering-related
documents.
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\13\ WilmerHale Equity.
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B. Identifying and Managing Conflicts of Interest
FINRA proposed to create a new section entitled ``Identifying and
Managing Conflicts of Interest.'' This section contains an overarching
provision that requires members to establish, maintain and enforce
written policies and procedures reasonably designed to identify and
effectively manage conflicts of interest related to the preparation,
content and distribution of research reports and public appearances by
research analysts and the interaction between research analysts and
persons outside of the research department, including investment
banking and sales and trading personnel, the subject companies and
customers.\14\ The written policies and procedures must be reasonably
designed to promote objective and reliable research that reflects the
truly held opinions of research analysts and to prevent the use of
research or research analysts to manipulate or condition the market or
favor the interests of the member or a current or prospective customer
or class of customers.\15\ These provisions, FINRA asserted, set out
the fundamental obligation for a member to establish and maintain a
system to identify and mitigate conflicts to foster integrity and
fairness in its research products and services. The proposed rule
change then set forth minimum requirements for those written policies
and procedures. According to FINRA, this approach would allow for some
flexibility to manage identified conflicts, with some specified
prohibitions and restrictions where disclosure does not adequately
mitigate them. FINRA asserted that most of the minimum requirements
have been experience tested and found effective.
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\14\ See proposed FINRA Rule 2241(b)(1).
\15\ See proposed FINRA Rule 2241(b)(2).
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The rule proposal thus would adopt a policies and procedures
approach to identification and management of research-related conflicts
of interest and require those policies and procedures to prohibit or
restrict particular conduct. Commenters expressed several concerns with
this approach.
Two commenters asserted that the mix of a principles-based approach
with prescriptive requirements was confusing in places and posed
operational challenges. In particular, the commenters recommended
eliminating the minimum standards for the policies and procedures.\16\
One of those commenters had previously expressed support for the
proposed policies-based approach with minimum requirements,\17\ but
asserted that the proposed rule text requiring procedures to ``at a
minimum, be reasonably designed to prohibit'' specified conduct is
either superfluous or confusing. Another commenter opposed a shift to a
policies and procedures scheme ``without also maintaining the
[[Page 10530]]
proscriptive nature of the current rules.'' The commenter therefore
favored retaining the proscriptive approach in the current rules and
also requiring that firms maintain policies and procedures designed to
ensure compliance.\18\ One commenter questioned the necessity of the
``preamble'' requiring policies and procedures that ``restrict or limit
activities by research analysts that can reasonably be expected to
compromise their objectivity'' that precedes specific prohibited
activities related to investment banking transactions.\19\
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\16\ SIFMA and WilmerHale Equity.
\17\ Letter from Amal Aly, Managing Director and Associate
General Counsel, SIFMA, to Marcia E. Asquith, Corporate Secretary,
FINRA, dated November 14, 2008 regarding Regulatory Notice 08-55
(Research Analysts and Research Reports).
\18\ NASAA Equity.
\19\ WilmerHale Equity.
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One commenter asked FINRA to refrain from using the concept of
``reliable'' research in the proposals as it may inappropriately
connote accuracy in the context of a research analyst's opinions.\20\
However, another commenter supported the requirement to have policies
and procedures reasonably designed to ensure that research reports are
based on reliable information.\21\
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\20\ SIFMA.
\21\ NASAA Equity.
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1. Prepublication Review
As proposed, the first of these minimum requirements would require
that the policies and procedures prohibit prepublication review,
clearance or approval of research reports by persons engaged in
investment banking services activities and restrict or prohibit such
review, clearance or approval by other persons not directly responsible
for the preparation, content and distribution of research reports,
other than legal and compliance personnel.\22\ No specific comments
were received on this provision.
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\22\ See proposed FINRA Rule 2241(b)(2)(A).
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2. Coverage Decisions
The proposed rule change would require that the policies and
procedures restrict or limit input by the investment banking department
into research coverage decisions to ensure that research management
independently makes all final decisions regarding the research coverage
plan.\23\
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\23\ See proposed FINRA Rule 2241(b)(2)(B).
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One commenter asked FINRA to eliminate as redundant the term
``independently'' from the provisions permitting non-research personnel
to have input into research coverage, so long as research management
``independently makes all final decisions regarding the research
coverage plan.'' \24\ The commenter asserted that inclusion of
``independently'' is confusing since the proposal would permit input
from non-research personnel into coverage decisions.
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\24\ WilmerHale Equity.
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3. Supervision and Control of Research Analysts
The proposed rule change would require that the policies and
procedures prohibit persons engaged in investment banking activities
from supervision or control of research analysts, including influence
or control over research analyst compensation evaluation and
determination.\25\ No specific comments were received on this
provision.
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\25\ See proposed FINRA Rule 2241(b)(2)(C).
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4. Research Budget Determinations
The proposed rule change would require that the policies and
procedures limit determination of the research department budget to
senior management, excluding senior management engaged in investment
banking services activities.\26\ No specific comments were received on
this provision.
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\26\ See proposed FINRA Rule 2241(b)(2)(D).
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5. Compensation
The proposed rule change would require that the policies and
procedures prohibit compensation based upon specific investment banking
services transactions or contributions to a member's investment banking
services activities.\27\ The policies and procedures further would
require a committee that reports to the member's board of directors--or
if none exists, a senior executive officer--to review and approve at
least annually the compensation of any research analyst who is
primarily responsible for preparation of the substance of a research
report. The committee would not be permitted to have representation
from a member's investment banking department. The committee would be
required to consider, among other things, the productivity of the
research analyst and the quality of his or her research and must
document the basis for each research analyst's compensation.\28\ FINRA
stated that these provisions are consistent with the requirements in
current Rule 2711(d). No specific comments were received on this
provision.
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\27\ See proposed FINRA Rule 2241(b)(2)(E).
\28\ See proposed FINRA Rule 2241(b)(2)(F).
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6. Information Barriers
The proposed rule change would require that the policies and
procedures establish information barriers or other institutional
safeguards to ensure that research analysts are insulated from the
review, pressure or oversight by persons engaged in investment banking
services activities or other persons, including sales and trading
personnel, who might be biased in their judgment or supervision.\29\
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\29\ See proposed FINRA Rule 2241(b)(2)(G).
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Some commenters suggested that ``review'' was unnecessary in this
provision because the review of research analysts was addressed
sufficiently in other parts of the proposed rule.\30\ One commenter
further suggested that the terms ``review'' and ``oversight'' are
redundant.\31\ One commenter asked FINRA to clarify that the
information barriers or other institutional safeguards required by the
proposed rule are not intended to prohibit or limit activities that
would otherwise be permitted under other provisions of the rule.\32\
The commenter also asserted that the terms ``bias'' and ``pressure''
are broad and ambiguous on their face and requested that FINRA clarify
that for purposes of the information barriers requirement that they are
intended to address persons who may try to improperly influence
research.\33\ As an example, the commenter asked whether a bias would
be present if an analyst was pressured to change the format of a
research report to comply with the research department's standard
procedures or the firm's technology specifications. One commenter asked
FINRA to modify the information barriers or other institutional
safeguards requirement to conform the provision to FINRA's ``reasonably
designed'' standard for policies and procedures that members must
adopt.\34\
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\30\ SIFMA and WilmerHale Equity.
\31\ WilmerHale Equity.
\32\ WilmerHale Equity.
\33\ WilmerHale Equity.
\34\ WilmerHale Equity.
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7. Retaliation
The proposed rule change would require that the policies and
procedures prohibit direct or indirect retaliation or threat of
retaliation against research analysts employed by the member or its
affiliates by persons engaged in investment banking services activities
or other employees as the result of an adverse, negative, or otherwise
unfavorable research report or public appearance written or made by the
research analyst that may adversely affect the member's present or
prospective business interests.\35\ No specific comments were received
on this provision.
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\35\ See proposed FINRA Rule 2241(b)(2)(H).
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[[Page 10531]]
8. Quiet Periods
The proposed rule change would require that the policies and
procedures define quiet periods of a minimum of 10 days after an
initial public offering (``IPO''), and a minimum of three days after a
secondary offering, during which the member must not publish or
otherwise distribute research reports, and research analysts must not
make public appearances, relating to the issuer if the member has
participated as an underwriter or dealer in the IPO or, with respect to
the quiet periods after a secondary offering, acted as a manager or co-
manager of that offering.\36\
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\36\ See proposed FINRA Rule 2241(b)(2)(I). Consistent with the
Jumpstart Our Business Startups Act (``JOBS Act''), those quiet
periods do not apply following the IPO or secondary offering of an
Emerging Growth Company, as that term is defined in Section 3(a)(80)
of the Act.
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With respect to these quiet-period provisions, the proposed rule
change would reduce the current 40-day quiet period for IPOs to a
minimum of 10 days after the completion of the offering for any member
that participated as an underwriter or dealer, and reduces the 10-day
secondary offering quiet period to a minimum of three days after the
completion of the offering for any member that has acted as a manager
or co-manager in the secondary offering. The proposed rule change also
eliminates the current quiet periods 15 days before and after the
expiration, waiver or termination of a lock-up agreement.
Citing recent enforcement actions in the research area, one
commenter did not support elimination or reduction of the quiet
periods.\37\ Other commenters requested that FINRA retain the
exceptions in NASD Rule 2711(f) that permits: (i) The publication and
distribution of research or a public appearance concerning the effects
of significant news or a significant event on the subject company
during the quiet period; and (ii) the publication of distribution of
research pursuant to Rule 139 under the Securities Act of 1933.\38\
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\37\ NASAA Equity.
\38\ SIFMA, WilmerHale Equity.
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9. Solicitation and Marketing
In addition, the proposed rule change would require firms to adopt
written policies and procedures to restrict or limit activities by
research analysts that can reasonably be expected to compromise their
objectivity.\39\ This would include the existing prohibitions on
participation in pitches and other solicitations of investment banking
services transactions and road shows and other marketing on behalf of
issuers related to such transactions. FINRA noted that consistent with
existing guidance analysts may listen to or view a live webcast of a
transaction-related road show or other widely attended presentation by
investment banking to investors or the sales force from a remote
location, or another room if they are in the same location.\40\
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\39\ See proposed FINRA Rule 2241(b)(2)(L).
\40\ See NASD Notice to Members 07-04 (January 2007) and NYSE
Information Memo 07-11 (January 2007).
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The proposed rule change also would add Supplementary Material .01,
which would codify FINRA's existing interpretation that the
solicitation provision prohibits members from including in pitch
materials any information about a member's research capacity in a
manner that suggests, directly or indirectly, that the member might
provide favorable research coverage.\41\
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\41\ See proposed FINRA Rule 2241.01 and Notice to Members 07-04
(January 2007).
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No specific comments were received on this provision.
10. Joint Due Diligence and Other Interactions With Investment Banking
The proposed rule would establish a new proscription with respect
to joint due diligence activities--i.e., due diligence by the research
analyst in the presence of investment banking department personnel--
during a specified time period. Specifically, proposed Supplementary
Material .02 states that FINRA interprets the overarching principle
requiring members to, among other things, establish, maintain and
enforce written policies and procedures that address the interaction
between research analysts and those outside of the research department,
including investment banking and sales and trading personnel, subject
companies and customers, to prohibit the performance of joint due
diligence prior to the selection of underwriters for the investment
banking services transaction.
The proposed rule would continue to prohibit investment banking
department personnel from directly or indirectly directing a research
analyst to engage in sales or marketing efforts related to an
investment banking services transaction, and directing a research
analyst to engage in any communication with a current or prospective
customer about an investment banking services transaction.\42\
Supplementary Material .03 clarifies that three-way meetings between
research analysts and a current or prospective customer in the presence
of investment banking department personnel or company management about
an investment banking services transaction would be prohibited by this
provision.\43\ FINRA believes that the presence of investment bankers
or issuer management could compromise a research analyst's candor when
talking to a current or prospective customer about a deal.
Supplementary Material .03 would also retain the current requirement
that any written or oral communication by a research analyst with a
current or prospective customer or internal personnel related to an
investment banking services transaction must be fair, balanced and not
misleading, taking into consideration the overall context in which the
communication is made.
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\42\ See proposed FINRA Rule 2241(b)(2)(M).
\43\ See proposed FINRA Rule 2241.03.
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No specific comments were received on this provision.
11. Promises of Favorable Research and Prepublication Review by Subject
Company
FINRA proposed to maintain the current prohibition against promises
of favorable research, a particular research recommendation, rating or
specific content as inducement for receipt of business or
compensation.\44\ The proposed rule would further require policies and
procedures to prohibit prepublication review of a research report by a
subject company for purposes other than verification of facts.\45\
Supplementary Material .05 would maintain the current guidance
applicable to the prepublication submission of a research report to a
subject company. Specifically, sections of a draft research report
would be permitted to be provided to non-investment banking personnel
or the subject company for factual review, provided that: (1) The draft
sections do not contain the research summary, research rating or price
target; (2) a complete draft of the report is provided to legal or
compliance personnel before sections are submitted to non-investment
banking personnel or the subject company; and (3) any subsequent
proposed changes to the rating or price target are accompanied by a
written justification to legal or compliance and receive written
authorization for the change. The member also would be required to
retain copies of any draft and the final version of the report for
three years.\46\ No specific comments were received on this provision.
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\44\ See proposed FINRA Rule 2241(b)(2)(K).
\45\ See proposed FINRA Rule 2241(b)(2)(N).
\46\ See proposed FINRA Rule 2241.05.
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[[Page 10532]]
12. Personal Trading Restrictions
FINRA proposed to require that firms establish written policies and
procedures that restrict or limit research analyst account trading in
securities, any derivatives of such securities and funds whose
performance is materially dependent upon the performance of securities
covered by the research analyst.\47\ Such policies and procedures would
be required to ensure that research analyst accounts, supervisors of
research analysts and associated persons with the ability to influence
the content of research reports do not benefit in their trading from
knowledge of the content or timing of a research report before the
intended recipients of such research have had a reasonable opportunity
to act on the information in the research report.\48\ The proposal
would maintain the current prohibitions on research analysts receiving
pre-IPO shares in the sector they cover and trading against their most
recent recommendations. However, members would be permitted to define
financial hardship circumstances, if any, in which a research analyst
would be permitted to trade against his or her most recent
recommendation.\49\ The proposed rule change includes Supplementary
Material .10, which would provide that FINRA would not consider a
research analyst account to have traded in a manner inconsistent with a
research analyst's recommendation where a member has instituted a
policy that prohibits any research analyst from holding securities, or
options on or derivatives of such securities, of the companies in the
research analyst's coverage universe, provided that the member
establishes a reasonable plan to liquidate such holdings consistent
with the principles in paragraph (b)(2)(J)(i) and such plan is approved
by the member's legal or compliance department.\50\ No specific
comments were received on this provision.
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\47\ See proposed FINRA Rule 2241(b)(2)(J).
\48\ See proposed FINRA Rule 2241(b)(2)(J)(i).
\49\ See proposed FINRA Rule 2241(b)(2)(J)(ii).
\50\ See proposed FINRA Rule 2241.10.
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C. Content and Disclosure in Research Reports
With a couple of modifications, the proposed rule change would
maintain the current disclosure requirements. The proposed rule change
would add a requirement that a member must establish, maintain and
enforce written policies and procedures reasonably designed to ensure
that purported facts in its research reports are based on reliable
information.\51\ FINRA stated that it has included this provision
because it believes members should have policies and procedures to
foster verification of facts and trustworthy research on which
investors may rely. The policies and procedures also must be reasonably
designed to ensure that any recommendation, rating or price target has
a reasonable basis and is accompanied by a clear explanation of any
valuation method used and a fair presentation of the risks that may
impede achievement of the recommendation, rating or price target.\52\
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\51\ See proposed FINRA Rule 2241(c)(1)(A).
\52\ See proposed FINRA Rule 2241(c)(1)(B).
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In addition, the proposed rule change would require a member to
disclose in any research report at the time of publication or
distribution of the report: \53\
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\53\ See proposed FINRA Rule 2241(c)(4).
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If the research analyst or a member of the research
analyst's household has a financial interest in the debt or equity
securities of the subject company (including, without limitation,
whether it consists of any option, right, warrant, future, long or
short position), and the nature of such interest; \54\
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\54\ See proposed FINRA Rule 2241(c)(4)(A).
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If the research analyst has received compensation based
upon (among other factors) the member's investment banking revenues;
\55\
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\55\ See proposed FINRA Rule 2241(c)(4)(B).
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If the member or any of its affiliates: (i) Managed or co-
managed a public offering of securities for the subject company in the
past 12 months; (ii) received compensation for investment banking
services from the subject company in the past 12 months; or (iii)
expects to receive or intends to seek compensation for investment
banking services from the subject company in the next three months;
\56\
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\56\ See proposed FINRA Rule 2241(c)(4)(C).
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If, as of the end of the month immediately preceding the
date of publication or distribution of a research report (or the end of
the second most recent month if the publication or distribution date is
less than 30 calendar days after the end of the most recent month), the
member or its affiliates have received from the subject company any
compensation for products or services other than investment banking
services in the previous 12 months; \57\
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\57\ See proposed FINRA Rule 2241(c)(4)(D).
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If the subject company is, or over the 12-month period
preceding the date of publication or distribution of the research
report has been, a client of the member, and if so, the types of
services provided to the issuer. Such services, if applicable, must be
identified as either investment banking services, non-investment
banking services, non-investment banking securities-related services or
non-securities services; \58\
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\58\ See proposed FINRA Rule 2241(c)(4)(E).
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If the member or its affiliates maintain a significant
financial interest in the debt or equity securities of the subject
company including, at a minimum, if the member or its affiliates
beneficially own 1% or more of any class of common equity securities of
the subject company; \59\
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\59\ See proposed FINRA Rule 2241(c)(4)(F). FINRA stated that
the requirement to disclose beneficial ownership of 1% or more of
any class of common equity securities of the subject company is the
same as NASD Rule 2711(h)(1)(B).
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If the member was making a market in the securities of the
subject company at the time of publication or distribution of the
research report; \60\ and
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\60\ See proposed FINRA Rule 2241(c)(4)(G).
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If the research analyst received any compensation from the
subject company in the previous 12 months.\61\
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\61\ See proposed FINRA Rule 2241(c)(4)(H).
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The proposed rule change would also expand upon the current
``catch-all'' disclosure, which mandates disclosure of any other
material conflict of interest of the research analyst or member that
the research analyst knows or has reason to know of at the time of the
publication or distribution of a research report. The proposed rule
change would go beyond the existing provision by requiring disclosure
of material conflicts known not only by the research analyst, but also
by any ``associated person of the member with the ability to influence
the content of a research report.'' \62\ The proposed rule change
defines a person with the ``ability to influence the content of a
research report'' as an associated person who, in the ordinary course
of that person's duties, has the authority to review the research
report and change that research report prior to publication or
distribution.\63\ FINRA stated that the ``reason to know'' standard in
this provision would not impose a duty of inquiry on the research
analyst or others who can influence the content of a research report.
Rather, it would cover disclosure of those conflicts that should
reasonably be discovered by those persons in the ordinary course of
discharging their functions.
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\62\ See proposed FINRA Rule 2241(c)(4)(I).
\63\ See proposed FINRA Rule 2241.08.
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The proposal would retain the general exception for disclosure that
would reveal material non-public information regarding specific
potential future investment banking transactions of the
[[Page 10533]]
subject company.\64\ The proposal also continues to permit a member
that distributes a research report covering six or more companies
(compendium report) to direct the reader in a clear manner as to where
the applicable disclosures can be found. An electronic compendium
research report may hyperlink to the disclosures. A paper compendium
report may include a toll-free number or a postal address where the
reader may request the disclosures. In addition, paper compendium
reports may include a web address where the disclosures can be
found.\65\
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\64\ See proposed FINRA Rule 2241(c)(5).
\65\ See proposed FINRA Rule 2241(c)(7).
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One commenter opposed as overbroad the proposed expansion of the
current ``catch-all'' disclosure requirement to include ``any other
material conflict of interest of the research analyst or member that a
research analyst or an associated person of the member with the ability
to influence the content of a research report knows or has reason to
know'' at the time of publication or distribution of research
report.\66\ (emphasis added) The commenter expressed concern about the
emphasized language. Another commenter supported the proposed expansion
of the current ``catch-all'' disclosure requirement.\67\
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\66\ WilmerHale Equity.
\67\ NASAA Equity.
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Two commenters opposed the requirement in the equity proposal that
members disclose, in an equity research report, if they or their
affiliates maintain a significant financial interest in the debt of the
research company.\68\ The commenters noted that the debt research
analyst proposal does not contain a dedicated requirement to disclose
significant debt holdings; rather, it relies on the ``catch-all''
provision, which would require disclosure of a firm's debt holdings of
a subject company only where it rises to an actual material conflict of
interest. The commenters asserted that the reasoning in the debt
proposal--e.g., that firms do not have systems to track ownership of
debt securities and that the number and complexity of bonds and the
fact that a firm may be both long and short different bonds of the same
issuer makes real-time disclosure of credit exposure difficult--applies
equally to equity research. Another commenter supported the requirement
in the equity proposal that members disclose, in an equity research
report, if they or their affiliates maintain a significant financial
interest in the debt of the research company.\69\ One commenter also
stated that while FINRA correctly noted that the United Kingdom's
Financial Conduct Authority rules require disclosure of debt holdings
in equity research reports, that requirement is more akin to the
``catch-all'' provision because the disclosure is limited to
circumstances where the holdings ``may reasonably be expected to impair
the objectivity of research recommendations'' or ``are significant in
relation to the research recommendations.''
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\68\ SIFMA, WilmerHale Equity.
\69\ NASAA Equity.
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One commenter also requested confirmation that members may rely on
hyperlinked disclosures for research reports that are delivered
electronically, even if these reports are subsequently printed out by
customers.\70\
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\70\ WilmerHale Equity.
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D. Disclosures in Public Appearances
The proposal groups in a separate provision the disclosures
required when a research analyst makes a public appearance.\71\ The
required disclosures would remain substantively the same as under the
current rules,\72\ with one exception: consistent with the modification
referenced above with respect to disclosure in research reports, a
research analyst is similarly required to disclose in a public
appearance if a member or its affiliates maintain a ``significant
financial interest in the debt or equity of the subject company,''
including, at a minimum, if the member or its affiliates beneficially
own 1% or more of any class of common equity securities of the subject
company, as computed in accordance with Section 13(d) of the Exchange
Act. Unlike in research reports, the ``catch all'' disclosure
requirement in public appearances applies only to a conflict of
interest of the research analyst or member that the research analyst
knows or has reason to know at the time of the public appearance. The
proposal also retains the current requirement in NASD Rule 2711(h)(12)
to maintain records of public appearances sufficient to demonstrate
compliance by research analysts with the applicable disclosure
requirements.\73\ No specific comments were received on this provision
not already discussed in connection with the disclosures that would be
required in research reports.
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\71\ See proposed FINRA Rule 2241(d).
\72\ See NASD Rules 2711(h)(1), (h)(2)(B) and (C), (h)(3), and
(h)(9).
\73\ See proposed FINRA Rule 2241(d)(3).
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E. Disclosure Required by Other Provisions
With respect to both research reports and public appearances,
members and research analysts would continue to be required to comply
with applicable disclosure provisions of FINRA Rule 2210 and the
federal securities laws.\74\ No specific comments were received on this
provision.
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\74\ See proposed FINRA Rule 2241(e).
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F. Termination of Coverage
The proposed rule change retains with non-substantive modifications
the provision in the current rules that requires a member to notify its
customers if it intends to terminate coverage of a subject company.\75\
Such notification would need to be made promptly \76\ using the
member's ordinary means to disseminate research reports on the subject
company to its various customers. Unless impracticable, the notice
would be required to be accompanied by a final research report,
comparable in scope and detail to prior research reports, and include a
final recommendation or rating. If impracticable to provide a final
research report, recommendation or rating, a firm would be required to
disclose to its customers the reason for terminating coverage. No
specific comments were received on this provision.
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\75\ See proposed FINRA Rule 2241(f).
\76\ While current Rule 2711(f)(6) does not contain the word
``promptly,'' FINRA has interpreted the provision to require prompt
notification of termination of coverage of a subject company.
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G. Distribution of Member Research Reports
The proposal would require firms to establish, maintain and enforce
written policies and procedures reasonably designed to ensure that a
research report is not distributed selectively to internal trading
personnel or a particular customer or class of customers in advance of
other customers that the firm has previously determined are entitled to
receive the research report.\77\ The proposal includes further guidance
to explain that firms would be permitted to provide different research
products and services to different classes of customers, provided the
products are not differentiated based on the timing of receipt of
potentially market moving information and the firm discloses its
research dissemination practices to all customers that receive a
research product.\78\
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\77\ See proposed FINRA Rule 2241(g).
\78\ See proposed FINRA Rule 2241.07.
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One commenter supported the provisions regarding different research
products and services as proposed with general disclosure,\79\ while
another
[[Page 10534]]
contended that FINRA should require members to disclose when their
research products and services do, in fact, contain a recommendation
contrary to the research product or service received by other
customers.\80\ The commenter favoring general disclosure asserted that
disclosure of specific instances of contrary recommendations would
impose significant burdens unjustified by the investor protection
benefits. The commenter stated that a specific disclosure requirement
would require close tracking and analysis of every research product or
service to determine if a contrary recommendation exists. The
commenters further stated that the difficulty of complying with such a
requirement would be exacerbated in large firms by the number of
research reports published and research analysts employed and the
differing audiences for research products and services.\81\ They
asserted that some firms may publish tens of thousands of research
reports each year and employ hundreds of analysts across various
disciplines and that a given research analyst or supervisor could not
reasonably be expected to know of all other research products and
services that may contain differing views.
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\79\ WilmerHale Equity.
\80\ PIABA Equity.
\81\ WilmerHale Equity.
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H. Distribution of Third-Party Research Reports
The proposal would maintain the existing third-party disclosure
requirements,\82\ incorporating the change to the ``catch-all''
provision to include material conflicts of interest that an associated
person of the member with the ability to influence the content of a
research report knows or has reason to know at the time of the
distribution of the third-party research report. In addition, the
proposed rule change would require members to disclose any other
material conflict of interest that can reasonably be expected to have
influenced the member's choice of a third-party research provider or
the subject company of a third-party research report.\83\
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\82\ NASD Rule 2711(h)(13)(A) currently requires the
distributing member firm to disclose the following, if applicable:
(1) If the member owns 1% or more of any class of equity securities
of the subject company; (2) if the member or any affiliate has
managed or co-managed a public offering of securities of the subject
company or received compensation for investment banking services
from the subject company in the past 12 months, or expects to
receive or intends to seek compensation for such services in the
next three months; (3) if the member makes a market in the subject
company's securities; and (4) any other actual, material conflict of
interest of the research analyst or member of which the research
analyst knows or has reason to know at the time the research report
is distributed or made available.
\83\ See proposed FINRA Rule 2241(h)(4).
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FINRA stated that the proposal would continue to address
qualitative aspects of third-party research reports. For example, the
proposal would maintain, but in the form of policies and procedures,
the existing requirement that a registered principal or supervisory
analyst review and approve third-party research reports distributed by
a member. To that end, the proposed rule change would require a member
to establish, maintain and enforce written policies and procedures
reasonably designed to ensure that any third-party research it
distributes contains no untrue statement of material fact and is
otherwise not false or misleading. For the purpose of this requirement,
a member's obligation to review a third-party research report would
extend to any untrue statement of material fact or any false or
misleading information that should be known from reading the research
report or is known based on information otherwise possessed by the
member.\84\ The proposal further would prohibit a member from
distributing third-party research if it knows or has reason to know
that such research is not objective or reliable.\85\
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\84\ See proposed FINRA Rules 2241(h)(1) and (h)(3).
\85\ See proposed FINRA Rule 2241(h)(2).
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The proposal would maintain the existing exceptions for
``independent third-party research reports.'' Specifically, such
research would not require principal pre-approval or, where the third-
party research is not ``pushed out,'' the third-party disclosures.\86\
As to the latter, a member would not be considered to have distributed
independent third-party research where the research is made available
by the member: (a) Upon request; (b) through a member-maintained Web
site; or (c) to a customer in connection with a solicited order in
which the registered representative has informed the customer, during
the solicitation, of the availability of independent research on the
solicited equity security and the customer requests such independent
research.
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\86\ See proposed FINRA Rule 2241(h)(5) and (6).
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Finally, under the proposed rule change, members would be required
to ensure that a third-party research report is clearly labeled as such
and that there is no confusion on the part of the recipient as to the
person or entity that prepared the research report.\87\
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\87\ See proposed FINRA Rule 2241(h)(7).
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No specific comments were received on this provision.
I. Exemption for Firms With Limited Investment Banking Activity
The current rule exempts firms with limited investment banking
activity--those that over the previous three years, on average per
year, have managed or co-managed 10 or fewer investment banking
transactions and generated $5 million or less in gross revenues from
those transactions--from the provisions that prohibit a research
analyst from being subject to the supervision or control of an
investment banking department employee because the potential conflicts
with investment banking are minimal.\88\ However, those firms remain
subject to the provision that requires the compensation of a research
analyst to be reviewed and approved annually by a committee that
reports to a member's board of directors, or a senior executive officer
if the member has no board of directors.\89\ That provision further
prohibits representation on the committee by investment banking
department personnel and requires the committee to consider the
following factors when reviewing a research analyst's compensation: (1)
The research analyst's individual performance, including the research
analyst's productivity and the quality of research; (2) the correlation
between the research analyst's recommendations and the performance of
the recommended securities; and (3) the overall ratings received from
clients, the sales force and peers independent of investment banking,
and other independent ratings services.\90\ The proposed rule change
would extend the exemption for firms with limited investment banking
activity so that such firms would not be subject to the compensation
committee provision. The proposal would still prohibit these firms from
compensating a research analyst based upon specific investment banking
services transactions or contributions to a member's investment banking
services activities.\91\
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\88\ See NASD Rule 2711(k).
\89\ See NASD Rule 2711(d)(2).
\90\ See NASD Rule 2711(d) and (k).
\91\ See proposed FINRA Rules 2241(b)(2)(E) and (i).
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The proposed rule change would further exempt firms with limited
investment banking activity from the provisions restricting or limiting
research coverage decisions and budget determination. In addition, the
proposal would exempt eligible firms from the requirement to establish
information barriers or other institutional safeguards to insulate
research analysts from the review or oversight by investment banking
personnel or other persons,
[[Page 10535]]
including sales and trading personnel, who may be biased in their
judgment or supervision. However, those firms would still be required
to establish information barriers or other institutional safeguards
reasonably designed to ensure that research analysts are insulated from
pressure by investment banking and other non-research personnel who
might be biased in their judgment or supervision.
No specific comments were received on this provision.
J. Exemption From Registration Requirements for Certain ``Research
Analysts''
The proposed rule change would amend the definition of ``research
analyst'' for the purposes of the registration and qualification
requirements to limit the scope to persons who produce ``research
reports'' and whose primary job function is to provide investment
research (e.g., registered representatives or traders generally would
not be included).\92\ FINRA stated that the revised definition is not
intended to carve out anyone for whom the preparation of research is a
significant component of their job. Rather, it is intended to provide
relief for those who produce research reports on an occasional basis.
The existing research rules, in accordance with the mandates of the
Sarbanes-Oxley Act of 2002 (``Sarbanes-Oxley''), are constructed such
that the author of a communication that meets the definition of a
``research report'' is a ``research analyst,'' irrespective of his or
her title or primary job.
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\92\ See proposed NASD Rule 1050(b) and proposed Incorporated
NYSE Rule 344.10.
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No specific comments were received on this provision.
K. Attestation Requirement
The proposed rule change would delete the requirement to attest
annually that the firm has in place written supervisory policies and
procedures reasonably designed to achieve compliance with the
applicable provisions of the rules, including the compensation
committee review provision. No specific comments were received on this
provision.
L. Obligations of Persons Associated With a Member
Supplementary Material .09 clarifies the obligations of each
associated person under those provisions of the proposed rule change
that require a member to restrict or prohibit certain conduct by
establishing, maintaining and enforcing particular written policies and
procedures. Specifically, the rule provides that, consistent with FINRA
Rule 0140, persons associated with a member would be required to comply
with such member's policies and procedures as established pursuant to
proposed FINRA Rule 2241.\93\ Failure of an associated person to comply
with such policies and procedures would constitute a violation of the
rule itself. In addition, consistent with Rule 0140, the rule states
that it would be a rule violation for an associated person to engage in
the restricted or prohibited conduct to be addressed through the
establishment, maintenance and enforcement of policies and procedures
required by provisions of Rule 2241, including applicable Supplementary
Material, that embed in the policies and procedures specific
obligations on individuals.
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\93\ See proposed FINRA Rule 2241.09. FINRA Rule 0140(a), among
other things, provides that persons associated with a member shall
have the same duties and obligations as a member under the Rules.
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Some commenters suggested FINRA eliminate language in the
supplementary material that provides that the failure of an associated
person to comply with the firm's policies and procedures constitutes a
violation of the proposed rule itself.\94\ These commenters argued that
because members may establish policies and procedures that go beyond
the requirements set forth in the rule, the provision may have the
unintended consequence of discouraging firms from creating standards in
their policies and procedures that extend beyond the rule. One of those
commenters suggested that the remaining language in the supplementary
material adequately holds individuals responsible for engaging in
restricted or prohibited conduct covered by the proposals.\95\
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\94\ SIFMA and WilmerHale Equity.
\95\ WilmerHale Equity.
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M. General Exemptive Authority
The proposed rule change would provide FINRA, pursuant to the Rule
9600 Series, with authority to conditionally or unconditionally grant,
in exceptional and unusual circumstances, an exemption from any
requirement of the proposed rule for good cause shown, after taking
into account all relevant factors and provided that such exemption is
consistent with the purposes of the rule, the protection of investors,
and the public interest.\96\
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\96\ See proposed FINRA Rule 2241(j).
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One commenter opposed this provision.\97\ The commenter stated that
the provision had not been sufficiently justified by, among other
things, providing examples of where an exemption would be justified.
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\97\ NASAA Equity.
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N. Other General Comments
One commenter asked FINRA to confirm in any Regulatory Notice
announcing adoption of the proposed rule change that provisions
relating to research coverage and budget decisions and joint due
diligence are intended to supersede the corresponding terms of the
Global Research Analyst Settlement (``Global Settlement'').\98\
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\98\ WilmerHale Equity.
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Also, one commenter requested that the implementation date be at
least 12 months after Commission approval of the proposed rule
change.\99\ Another commenter similarly requested that FINRA provide a
``grace period'' of one year or the maximum time permissible, if that
is less than one year, between the adoption of the proposed rule and
the implementation date.\100\
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\99\ SIFMA.
\100\ WilmerHale Equity.
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III. Proceedings To Determine Whether To Approve or Disapprove SR-
FINRA-2014-047
The Commission is instituting proceedings pursuant to Section
19(b)(2)(B) of the Act to determine whether the proposals should be
approved or disapproved.\101\ Institution of such proceedings is
appropriate at this time in view of the legal and policy issues raised
by the proposal. Institution of proceedings does not indicate that the
Commission has reached any conclusions with respect to any of the
issues involved. Rather, as described below, the Commission seeks and
encourages interested persons to comment on the proposed rule change.
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\101\ 15 U.S.C. 78s(b)(2). Section 19(b)(2)(B) of the Act
provides that proceedings to determine whether to disapprove a
proposed rule change must be concluded within 180 days of the date
of publication of notice of the filing of the proposed rule change.
The time for conclusion of the proceedings may be extended for up to
an additional 60 days if the Commission finds good cause for such
extension and publishes its reasons for so finding or if the self-
regulatory organization consents to the extension.
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Pursuant to Section 19(b)(2)(B) of the Act,\102\ the Commission is
providing notice of the grounds for disapproval under consideration.
The Commission is instituting proceedings to allow for additional
analysis of the proposed rule change's consistency with Section
15A(b)(9) of the Act,\103\ which requires that FINRA's rules be
designed to, among other things, promote just and
[[Page 10536]]
equitable principles of trade, remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest, and Section
15D of the Act,\104\ which requires rules reasonably designed to
address conflicts of interest that can arise when research analysts
recommend equity securities in research reports and public appearances.
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\102\ 15 U.S.C. 78s(b)(2).
\103\ 15 U.S.C. 78o-3(b)(6).
\104\ 15 U.S.C. 78o-6.
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IV. Procedure: Request for Written Comments
The Commission requests that interested persons provide written
submissions of their views, data, and arguments with respect to the
concerns identified above, as well as any others they may have with the
proposed rule change. In particular, the Commission invites the written
views of interested persons concerning whether the proposed rule change
is inconsistent with Sections 15A(b)(9) and 15D, or any other provision
of the Act, or the rules and regulation thereunder. Although there do
not appear to be any issues relevant to approval or disapproval which
would be facilitated by an oral presentation of views, data, and
arguments, the Commission will consider, pursuant to Rule 19b-4, any
request for an opportunity to make an oral presentation.\105\
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\105\ Section 19(b)(2) of the Act, as amended by the Securities
Act Amendments of 1975, Pub. L. 94-29 (June 4, 1975), grants the
Commission flexibility to determine what type of proceeding--either
oral or notice and opportunity for written comments--is appropriate
for consideration of a particular proposal by a self-regulatory
organization. See Securities Act Amendments of 1975, Senate Comm. on
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st
Sess. 30 (1975).
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Interested persons are invited to submit written data, views, and
arguments regarding whether the proposed rule changes should be
approved or disapproved by March 19, 2015. Any person who wishes to
file a rebuttal to any other person's submission must file that
rebuttal by April 2, 2015.
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-FINRA-2014-047 on the subject line.
Paper Comments
Send paper comments in triplicate to Brent J. Fields,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2014-047. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of FINRA. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly. All
submissions should refer to File Number SR-FINRA-2014-047 and should be
submitted on or before March 19, 2015.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\106\
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\106\ 17 CFR 200.30-3(a)(57).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2015-03962 Filed 2-25-15; 8:45 am]
BILLING CODE 8011-01-P