[Federal Register Volume 83, Number 239 (Thursday, December 13, 2018)]
[Rules and Regulations]
[Pages 64180-64222]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-26613]
[[Page 64179]]
Vol. 83
Thursday,
No. 239
December 13, 2018
Part II
Securities and Exchange Commission
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17 CFR Parts 230, 242, 249, et al.
Covered Investment Fund Research Reports; Final Rule
Federal Register / Vol. 83 , No. 239 / Thursday, December 13, 2018 /
Rules and Regulations
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 242, 249, and 270
[Release Nos. 33-10580; 34-84710; IC-33311; File No. S7-11-18]
RIN 3235-AM24
Covered Investment Fund Research Reports
AGENCY: Securities and Exchange Commission.
ACTION: Final rules and technical amendment.
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SUMMARY: The Commission is adopting a new rule under the Securities Act
of 1933 to establish a safe harbor for an unaffiliated broker or dealer
participating in a securities offering of a covered investment fund to
publish or distribute a covered investment fund research report. If the
conditions in the rule are satisfied, the publication or distribution
of a covered investment fund research report would be deemed not to be
an offer for sale or offer to sell the covered investment fund's
securities for purposes of sections 2(a)(10) and 5(c) of the Securities
Act of 1933. The Commission is also adopting a new rule under the
Investment Company Act of 1940 to exclude a covered investment fund
research report from the coverage of section 24(b) of the Investment
Company Act, except to the extent the research report is otherwise not
subject to the content standards in self-regulatory organization rules
related to research reports. We are also adopting a conforming
amendment to rule 101 of Regulation M, and a technical amendment to
Form 12b-25.
DATES: This rule is effective January 14, 2019 except that amendatory
instruction 4 amending Sec. 230.139b(a)(1)(i)(A)(1) is effective May
1, 2020. Comments regarding the collection of information requirements
within the meaning of the Paperwork Reduction Act of 1995 should be
received on or before February 11, 2019.
FOR FURTHER INFORMATION CONTACT: Asaf Barouk, Attorney-Adviser, John
Lee, Senior Counsel; Amanda Hollander Wagner, Branch Chief; Thoreau
Bartmann, Senior Special Counsel; or Brian McLaughlin Johnson,
Assistant Director, at (202) 551-6792, Investment Company Regulation
Office, Division of Investment Management; Steven G. Hearne, Senior
Special Counsel, at (202) 551-3430, Division of Corporation Finance;
Laura Gold or Samuel Litz, Attorney-Advisers; or John Guidroz, Branch
Chief, at (202) 551-5777, Office of Trading Practices, Division of
Trading and Markets, Securities and Exchange Commission, 100 F Street
NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is adopting 17 CFR 230.139b
(``new rule 139b'') under the Securities Act of 1933 [15 U.S.C. 77a et
seq.]; 17 CFR 270.24b-4 (``new rule 24b-4'') under the Investment
Company Act of 1940 [15 U.S.C. 80a-1 et seq.]; a conforming amendment
to 17 CFR 242.101(a) (rule 101) of Regulation M [17 CFR 242.100-
242.105]; and a technical amendment to Form 12b-25 under the Securities
Exchange Act of 1934 [15 U.S.C. 78a et seq.].
Table of Contents
I. Introduction
II. Discussion
A. Scope of Rule 139b
1. Definition of ``Covered Investment Fund Research Report''
2. Definition of ``Research Report''
3. Definition of ``Covered Investment Fund''
4. Non-Exclusivity of Safe Harbor
B. Conditions for the Safe Harbor
1. Issuer-Specific Research Reports
2. Industry Research Reports
C. Presentation of Performance Information in Research Reports
About Registered Investment Companies
D. Role of Self-Regulatory Organizations
1. SRO Content Standards and Filing Requirements for Covered
Investment Fund Research Reports
2. SRO Limitations
E. Conforming and Technical Amendments
III. Economic Analysis
A. Introduction
B. Baseline
1. Market Structure and Market Participants
2. Regulatory Structure
C. Costs and Benefits
1. FAIR Act Statutory Mandate
2. Rule 139b
3. Rule 24b-4
4. Amendments to Rule 101 of Regulation M and Form 12b-25
5. Effects on Efficiency, Competition, and Capital Formation
6. Alternatives Considered
IV. Paperwork Reduction Act
V. Final Regulatory Flexibility Act Analysis
A. Need for, and Objectives of, the Rules and Rule Amendments
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Rules
D. Reporting, Recordkeeping, and Other Compliance Requirements
E. Agency Action To Minimize Effect on Small Entities
VI. Statutory Authority
I. Introduction
As directed by the Fair Access to Investment Research Act of
2017,\1\ we are adopting new rule 139b \2\ under the Securities Act of
1933 (the ``Securities Act'') to extend the current safe harbor
available under rule 139 to a ``covered investment fund research
report.'' \3\ Rule 139 provides a safe harbor for the publication or
distribution of research reports \4\ concerning one or more issuers by
a broker or dealer (a ``broker-dealer'') participating in a registered
offering of one of the covered issuers' securities.\5\ Rule 139's safe
harbor currently is not available for a broker-dealer's publication or
distribution of research reports pertaining to specific registered
investment companies or business development companies (``BDCs'').\6\
The
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FAIR Act requires us to revise rule 139 to extend the safe harbor to
broker-dealers' publication or distribution of covered investment funds
upon such terms, conditions, or requirements, as we may determine
necessary or appropriate in the public interest, for the protection of
investors, and for the promotion of capital formation.\7\
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\1\ Fair Access to Investment Research Act of 2017, Public Law
115-66, 131 Stat. 1196 (2017) (the ``FAIR Act'').
\2\ See Covered Investment Fund Research Reports, Securities Act
Release No. 10498 (May 23, 2018) [83 FR 26788 (June 8, 2018)]
(``Proposing Release'').
\3\ See section 2(a) of the FAIR Act; see also Proposing
Release, supra note 2, at section I.B. The FAIR Act also includes an
interim effectiveness provision that became effective as of July 3,
2018 and by its terms will terminate upon the adoption of new rule
139b. See section 2(d) of the FAIR Act.
\4\ See Proposing Release, supra note 2, at 26789 n.11 and
accompanying text. See also infra notes 5-6.
\5\ Specifically, rule 139 provides that a broker-dealer's
publication or distribution of research reports--whether about a
particular issuer or multiple issuers, including within the same
industry--that satisfy certain conditions under the rule are
``deemed for purposes of sections 2(a)(10) and 5(c) of the
[Securities] Act not to constitute an offer for sale or offer to
sell.'' Rule 139(a) under the Securities Act [17 CFR 230.139(a)]. A
broker-dealer's publication or distribution of a research report in
reliance on rule 139 would therefore be deemed not to constitute an
offer that otherwise could be a non-conforming prospectus in
violation of section 5 of the Securities Act. Sections 5(a) and 5(c)
of the Securities Act generally prohibit any person (including
broker-dealers) from using the mails or interstate commerce as a
means to sell or offer to sell, either directly or indirectly, any
security unless a registration statement is in effect or has been
filed with the Commission as to the offer and sale of such security,
or an exemption from the registration provisions applies. See 15
U.S.C. 77e(a) and (c). Section 5(b)(1) of the Securities Act
requires that any ``prospectus'' relating to a security to which a
registration statement has been filed must comply with the
requirements of section 10 of the Securities Act. See 15 U.S.C.
77e(b)(1). Section 5(b)(2) of the Securities Act requires that any
sale of securities (or delivery after sale) must be accompanied or
preceded by a prospectus meeting the requirements of section 10(a)
of the Securities Act. See 15 U.S.C. 77e(b)(2).
\6\ For example, rule 139 is available for research reports
regarding issuers that meet the registrant requirements for
securities offerings on Form S-3 or Form F-3. See rule
139(a)(1)(i)(A)(1). In contrast, registered investment companies
register their securities offerings on forms such as Forms N-1A, N-
2, N-3, N-4, and N-6. To the extent that commodity- or currency-
based trusts or funds (as defined in section II.A.3 below) register
their securities offering under the Securities Act and meet the
eligibility requirements of Forms S-3 or F-3, as well as the other
conditions of rule 139, the rule 139 safe harbor is currently
available for a broker-dealer's publication or distribution of
research reports pertaining to these issuers.
Section 2(a)(3) of the Securities Act provides a safe harbor
for broker-dealers with respect to research reports about ``emerging
growth companies,'' as defined in section 2(a)(19) of the Securities
Act. Broker-dealers may therefore currently rely on this safe harbor
with respect to research reports about BDCs that are emerging growth
companies.
\7\ See section 2(a) of the FAIR Act.
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In May of 2018 we proposed new rules and rule amendments designed
to meet the requirements of the FAIR Act. We received seven comment
letters on the proposal.\8\ Commenters generally supported our proposed
implementation of the FAIR Act. However, most commenters requested that
we consider eliminating or modifying certain of the conditions in
current rule 139, as applied to covered investment fund research
reports (such as the minimum public float requirement and the
requirement to publish research reports in the regular course of
business).\9\ Other commenters raised concerns about the potential
conflicts of interest that may arise in the context of a broker-
dealer's receipt of compensation from covered investment funds included
in research reports, and commenters disagreed on the best ways of
mitigating these conflicts.\10\ Finally, commenters expressed varying
views on our request for input on whether research reports that include
performance information should be required to present that performance
information consistently with the way fund performance must be
presented in fund advertisements pursuant to rule 482 and related
requirements.\11\
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\8\ Comment Letter of Morningstar, Inc. (July 5, 2018)
(``Morningstar Comment Letter''); Comment Letter of BlackRock, Inc.
(July 9, 2018) (``BlackRock Comment Letter''); Comment Letter of
Eversheds Sutherland (US) LLP (July 9, 2018) (``Sutherland Comment
Letter''); Comment Letter of Fidelity Investments (July 9, 2018)
(``Fidelity Comment Letter''); Comment Letter of the Investment
Company Institute (July 9, 2018) (``ICI Comment Letter''); Comment
Letter of the Securities Industry and Financial Markets Association
(July 9, 2018) (``SIFMA Comment Letter I''); Comment Letter of the
Securities Industry and Financial Markets Association (Sept. 14,
2018) (``SIFMA Comment Letter II'').
\9\ See, e.g., SIFMA Comment Letter I; ICI Comment Letter; see
also BlackRock Comment Letter.
\10\ See, e.g., Morningstar Comment Letter; Fidelity Comment
Letter.
\11\ See, e.g., SIFMA Comment Letter I; ICI Comment Letter; see
also BlackRock Comment Letter.
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II. Discussion
Rule 139b's framework is modeled after and generally tracks rule
139. However, rule 139b differs from rule 139 in certain respects. Some
of these differences are specifically directed or contemplated by the
FAIR Act.\12\ Others, while not specifically directed by the FAIR Act,
clarify and tailor the provisions of rule 139 more directly or
specifically to the context of broker-dealers' publication or
distribution of covered investment fund research reports.\13\ For the
reasons described below, we believe that the provisions of rule 139b
that differ from the provisions of rule 139, and that are not
specifically contemplated in the FAIR Act, are necessary or appropriate
in the public interest, for the protection of investors, and for the
promotion of capital formation.\14\ We believe that maintaining a
similar approach in rule 139b to rule 139 with modifications to the
extent necessary or appropriate is consistent with the FAIR Act's
directive to revise rule 139 to extend the current safe harbor
available under rule 139 to broker-dealer's publication or distribution
of covered investment fund research reports. We do not believe that the
FAIR Act intended for us to make a new or disparate regulatory regime
for research reports on covered investment funds that subjects these
funds to different conditions where it is not necessary or appropriate
for differentiation from research reports on other issuers published
under rule 139. Therefore, we have sought to maintain similar treatment
and conditions for funds under rule 139b and other issuers subject to
rule 139 unless we believed that a deviation was necessary or
appropriate for the particular operational or structural
characteristics of a type of covered investment fund. In addition to
rule 139b, we are also adopting rule 24b-4, a conforming amendment to
rule 101 of Regulation M, and a technical amendment to Form 12b-25.\15\
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\12\ See, e.g., infra section II.A.1 (discussing the ``affiliate
exclusion'' (defined below)).
\13\ See, e.g., infra section II.B.1.a (discussing reporting
history and timeliness requirements for issuer-specific research
reports).
\14\ See supra note 7 and accompanying text.
\15\ If any of the provisions of these rules, or the application
thereof to any person or circumstance, is held to be invalid, such
invalidity shall not affect other provisions or application of such
provisions to other persons or circumstances that can be given
effect without the invalid provision or application.
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A. Scope of Rule 139b
Rule 139b establishes a safe harbor for the publication or
distribution of ``covered investment fund research reports'' by
unaffiliated broker-dealers (as described below) participating in a
securities offering of a ``covered investment fund.'' \16\ We define
the term ``covered investment fund research report,'' as well as the
``covered investment fund'' and ``research report'' components of this
definition.
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\16\ Under the safe harbor, such publication or distribution is
deemed not to constitute an offer for sale or offer to sell the
covered investment fund's securities for purposes of sections
2(a)(10) and 5(c) of the Securities Act. The safe harbor is
available even if the broker-dealer is participating or may
participate in a registered offering of the covered investment
fund's securities.
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1. Definition of ``Covered Investment Fund Research Report''
We are adopting the definition of ``covered investment fund
research report'' as proposed.\17\ The definition is consistent with
the FAIR Act, which defined the term ``covered investment fund research
report'' to mean a research report published or distributed by a
broker-dealer about a covered investment fund or any securities issued
by the covered investment fund, but does not include a research report
to the extent that the research report is published or distributed by
the covered investment fund or any affiliate \18\ of the covered
investment fund, or any research report published or distributed by any
broker or dealer that is an investment adviser (or an affiliated person
\19\ of an investment adviser) for the covered investment fund (the
``affiliate exclusion'').\20\
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\17\ See rule 139b(c)(3).
\18\ ``Affiliate'' is defined in rule 405 under the Securities
Act. See 17 CFR 230.405; Proposing Release, supra note 2, at 26790.
\19\ ``Affiliated person'' is defined in section 2(a) of the
Investment Company Act of 1940 (the ``Investment Company Act''). See
15 U.S.C. 80a-2(a); Proposing Release, supra note 2, at 26790;
section 2(f)(1) of the FAIR Act and rule 139b(c)(1).
\20\ See section 2(f)(3) of the FAIR Act.
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The affiliate exclusion prohibits two separate categories of
research reports from being deemed to be ``covered investment fund
research reports'' under rule 139b's safe harbor. The first category
covers research reports published or distributed by the covered
investment fund or any affiliate of the covered investment fund. This
exclusion prevents such persons from indirectly using the safe harbor
to avoid the applicability of the Securities Act prospectus
requirements and other provisions applicable to written offers by such
persons. The second category covers research reports published or
distributed by any broker-dealer that is an investment adviser (or an
affiliated
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person of an investment adviser) for the covered investment fund.\21\
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\21\ Like the first category of exclusion, this second category
of exclusion addresses the concern that a person covered by the
affiliate exclusion may be able to circumvent the disclosure and
prospectus delivery requirements of the Securities Act. For example,
this second category helps to limit a person covered by the
affiliate exclusion from publishing or distributing communications
indirectly through the third-party broker-dealer that otherwise
would have to be included in a statutory prospectus meeting the
requirements of section 10 of the Securities Act. It also addresses
the concern that a broker-dealer that is a covered investment fund's
adviser or an affiliated person of a fund's adviser may have
financial incentives that could give rise to a conflict of interest.
For example, a broker-dealer that is an affiliated person of the
fund's adviser may have an incentive to promote the covered
investment fund's securities relative to other securities because
sales of the covered investment fund's securities may benefit not
only the fund but also the broker-dealer.
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As we noted in the Proposing Release, one factor to consider in
evaluating whether a research report has been published or distributed
by a person covered by the affiliate exclusion is the extent of such
person's involvement in the preparation of the research report.\22\
These determinations would necessarily be based on the extent to which
a person covered by the affiliate exclusion, or any person acting on
its behalf, has been involved in preparing the information or
explicitly or implicitly endorsed or approved the information, also
known as the entanglement theory and adoption theory, respectively.\23\
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\22\ See Proposing Release, supra note 2, at 26791-92.
\23\ See Securities Offering Reform, Securities Act Release No.
8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)] (``Securities
Offering Reform Adopting Release'') (noting that ``[l]iability under
the entanglement theory depends upon the level of pre-publication
involvement in the preparation of the information''). See Use of
Electronic Media, Securities Act Release No. 7856 (Apr. 28, 2000)
[65 FR 25843 (May 4, 2000)] (``2000 Electronics Release'')
(interpretive release on the use of electronic media); Asset-Backed
Securities, Securities Act Release No. 8518 (Dec. 22, 2004) [70 FR
1506 (Jan. 5, 2005)] (``Asset-Backed Securities Adopting Release'')
(adopting asset-backed securities regulations).
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While we did not receive comments on the definition of ``covered
investment fund research report,'' we received comments on the
affiliate exclusion embedded in the definition.\24\ One commenter
raised concerns about the incorporation of the adoption and
entanglement theories, which could prohibit broker-dealers from
engaging in certain activities designed to ensure the accuracy of
research reports.\25\ Other commenters suggested that while the
entanglement theory may have relevance to research reports under
proposed rule 139b, the adoption theory may not.\26\ Some commenters
requested clarification on whether certain conduct--for example, a
covered investment fund providing information or confirmation of
certain factual matters such as performance data, holdings, or
investment objectives or strategies--is prohibited by the affiliate
exclusion.\27\
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\24\ See Morningstar Comment Letter; Fidelity Comment Letter;
ICI Comment Letter; SIFMA Comment Letter I; see also BlackRock
Comment Letter.
\25\ See SIFMA Comment Letter I.
\26\ See Fidelity Comment Letter; ICI Comment Letter; see also
BlackRock Comment Letter.
\27\ See ICI Comment Letter; SIFMA Comment Letter I; see also
BlackRock Comment Letter.
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As we noted in the Proposing Release, the entanglement and adoption
theories are helpful guideposts in establishing whether a research
report about a covered investment fund was published or distributed by
the fund.\28\ However, those theories of liability have been set forth
by courts in interpreting the federal securities laws, and how a court
would apply such theories with respect to covered investment fund
research reports would be based on the facts and circumstances
presented.\29\
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\28\ See Proposing Release, supra note 2, at 26792.
\29\ See 2000 Electronics Release, supra note 23 (with respect
to entanglement theory cases, citing Elkind v. Liggett & Myers,
Inc., 635 F.2d 156 (2d Cir. 1980); In the Matter of Syntex Corp.
Sec. Litig., 855 F.Supp. 1086 (N.D. Cal. 1993); In the Matter of
Caere Corp. Sec. Litig., 837 F. Supp. 1054 (N.D. Cal. 1993) and with
respect to adoption theory cases, citing In the Matter of Cypress
Semiconductor Sec. Litig., 891 F. Supp. 1369, 1377 (N.D. Cal. 1995),
aff'd sub nom. Eisenstadt v. Allen, 113 F.3d 1240 (9th Cir. 1997);
In the Matter of Presstek, Inc., Exchange Act Release No. 39472
(Dec. 22, 1997)). See also Asset-Back Securities Adopting Release,
supra note 23.
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Under rule 139b, we believe it would be inappropriate for any
person covered by the affiliate exclusion, or for any person acting on
its behalf, to publish or distribute a research report indirectly that
the person could not publish or distribute directly under the rule.\30\
For example, if a broker-dealer distributes a research report including
materials that a person covered by the affiliate exclusion authorized
or approved for inclusion in the report, this could (depending on the
facts and circumstances) inappropriately circumvent the affiliate
exclusion in rule 139b.
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\30\ See Proposing Release, supra note 2, at 26791. See also
section 5(a), 5(b), and 5(c) of the Securities Act [15 U.S.C.
77e(a), (b), and (c)] (prohibiting both direct and indirect
violations of the prospectus requirements); section 48(a) of the
Investment Company Act [15 U.S.C. 80a-47(a)] (It shall be unlawful
for any person, directly or indirectly, to cause to be done any act
or thing through or by means of any other person which it would be
unlawful for such person to do under the provisions of this
subchapter or any rule, regulation, or order thereunder.); section
208(d) of the Investment Advisers Act of 1940 [15 U.S.C. 80b-8(d)]
(It shall be unlawful for any person indirectly, or through or by
any other person, to do any act or thing which it would be unlawful
for such person to do directly under the provisions of this
subchapter or any rule or regulation thereunder.).
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Also in relation to the affiliate exclusion, one commenter
suggested that the proposal did not adequately address conflicts of
interest such as revenue sharing agreements.\31\ Other commenters
disagreed stating that self-regulatory organization (``SRO'') rules and
federal securities laws addressing conflicts of interest would apply to
covered investment fund research reports.\32\ One commenter stated that
additional restrictions are unnecessary because the proposed affiliate
exclusion would be broad and effective.\33\ One commenter recommended
that the final rule should not have any specific revenue sharing
agreement requirements, but suggested that if the Commission believes
it should address such potential conflicts in the final rule, the final
rule should require a general disclosure similar to mutual fund
prospectus disclosure alerting investors of potential revenue sharing
agreements.\34\
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\31\ Morningstar Comment Letter (stating that SRO rules would be
inadequate in this respect and that the Commission should require
elimination or mitigation of these conflicts).
\32\ See Fidelity Comment Letter; ICI Comment Letter; SIFMA
Comment Letter I; see also BlackRock Comment Letter.
\33\ See ICI Comment Letter; see also BlackRock Comment Letter.
\34\ See Fidelity Comment Letter.
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While we appreciate the concerns noted with respect to potential
conflicts of interest, and specifically those arising from revenue
sharing agreements, we are not adding additional explicit conflicts-of-
interest-related restrictions in the final rule. The antifraud
provisions of the federal securities laws and certain existing
Commission and SRO rules continue to apply to covered investment fund
research reports, some of which, depending on the facts and
circumstances, may require disclosure of such conflicts.\35\ For
example, many covered investment fund research reports may be subject
to FINRA's research report rules, which require disclosure in a
research report if the member or its affiliates have received
compensation from the subject company other than for investment banking
services in the previous year.\36\
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Depending on the facts and circumstances, covered investment fund
research reports may also need to include information about the
compensation received by the broker-dealer from covered investment
funds included in the report if such compensation is of the type
covered by section 17(b) of the Securities Act.\37\
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\35\ We note that the FAIR Act expressly stated that research
reports published or distributed under its provisions would continue
to be subject to the antifraud and anti-manipulation provisions of
the federal securities laws, and rules adopted thereunder, including
section 17 of the Securities Act, section 34(b) of the Investment
Company Act, and sections 9 and 10 of the Exchange Act. See section
2(c)(1) of the FAIR Act.
\36\ See, e.g., FINRA rule 2241(c)(4)(D). See also, e.g., FINRA
rule 2210(d)(1)(A) (requiring all member communications with the
public to be based on principles of fair dealing and good faith, be
fair and balanced, and provide a sound basis for evaluating the
facts in regards to any particular security; and barring members
from omitting any material fact or qualification if the omission, in
light of the context of the material presented, would cause the
communication to be misleading).
\37\ See 15 U.S.C. 77q(b) (making it unlawful for any person, by
the use of any means or instruments of transportation or
communication in interstate commerce or by the use of the mails to
publish, give publicity to, or circulate any notice, circular,
advertisement, newspaper, article, letter, investment service, or
communication which, though not purporting to offer a security for
sale, describes such security for a consideration received or to be
received, directly or indirectly, from an issuer, underwriter, or
dealer, without fully disclosing the receipt, whether past or
prospective, of such consideration and the amount thereof).
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We understand that disclosure about conflicts of interest created
by the receipt of compensation by the broker-dealer from covered
investment funds is consistent with current industry practices in
communications that are Securities Act section 10(b) prospectuses and
are currently styled as ``research reports'' subject to the
requirements of rule 482.\38\ Considering current industry practice,
and the protections offered by the other regulatory provisions
discussed above, we do not believe that additional conflict-of-interest
requirements are necessary in rule 139b. Accordingly, we are adopting
the definition of covered investment fund research report as proposed.
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\38\ 17 CFR 230.482. An investment company advertisement that
complies with rule 482 is deemed to be a section 10(b) prospectus
(also known as an ``advertising prospectus'' or ``omitting
prospectus'') for purposes of section 5(b)(1) of the Securities Act.
As a section 10(b) prospectus, an investment company advertisement
is subject to liability under section 12(a)(2) of the Securities
Act, as well as the antifraud provisions of the federal securities
laws.
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2. Definition of ``Research Report''
We are defining, as proposed,\39\ the term ``research report'' in
rule 139b as a written communication, as defined in rule 405 under the
Securities Act, that includes information, opinions, or recommendations
with respect to securities of an issuer or an analysis of a security or
an issuer, whether or not it provides information reasonably sufficient
upon which to base an investment decision.\40\ This definition is
identical to the corresponding definition of ``research report'' in
rule 139.\41\ As discussed in the Proposing Release, while this
definition is not identical to that in the FAIR Act, it is consistent
with the FAIR Act because we interpret it to have the same meaning as
the FAIR Act's definition of ``research report.'' \42\ We received one
comment agreeing with this definition.\43\
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\39\ See Proposing Release, supra note 2, at 26792-93.
\40\ See rule 139b(c)(6). Rule 405 defines ``written
communication'' to mean that ``[e]xcept as otherwise specifically
provided or the context otherwise requires, a written communication
is any communication that is written, printed, a radio or television
broadcast, or a graphic communication as defined in [rule 405].'' 17
CFR 230.405.
\41\ See rule 139(d) [17 CFR 230.139(d)]. Rule 139 defines
``research report'' to mean a written communication, as defined in
Rule 405, that includes information, opinions, or recommendations
with respect to securities of an issuer or an analysis of a security
or an issuer, whether or not it provides information reasonably
sufficient upon which to base an investment decision. See rule
139(d) [17 CFR 230.139(d)]. A ``written communication,'' as defined
in rule 405, includes a ``graphic communication.'' As further
defined in rule 405, a ``graphic communication'' includes all forms
of electronic media, including electronic communications except
those, which at the time of the communication, originate in real-
time to a live audience and does not originate in recorded form or
otherwise as a graphic communication, although it is transmitted
through graphic means. See rule 405 [17 CFR 230.405].
\42\ See section 2(f)(6) of the FAIR Act; see also Proposing
Release, supra note 2, at 26792-93 (explaining that the rule 139b
definition tracks the FAIR Act definition except that it does not
expressly reference ``electronic communications'' and that
consistent with Commission rules on electronic communications, rule
139b definition's reference to a ``written communication,'' as
defined in rule 405, includes a ``graphic communication,'' which in
turn includes electronic communications (other than telephone and
other live communications)).
\43\ See SIFMA Comment Letter I (stating that it would reduce
potential interpretive confusion for market participants who are
familiar with the rule 139 definition).
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3. Definition of ``Covered Investment Fund''
The FAIR Act defines the term ``covered investment fund'' to
include registered investment companies, BDCs, and certain commodity-
or currency-based trusts or funds.\44\ We are adopting a definition of
the term ``covered investment fund'' in rule 139b that is substantially
the same as the one used in the FAIR Act, with the addition that the
definition specifies that the term ``investment company'' includes ``a
series or class thereof.'' \45\ We received no comments on this
proposed definition. The final rule adopts the definition as proposed.
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\44\ See section 2(f)(2)(B) of the FAIR Act. The term also
includes other persons issuing securities in an offering registered
under the Securities Act (i) whose securities are listed for trading
on a national securities exchange, (ii) whose assets consist
primarily of commodities, currencies, or derivative instruments that
reference commodities or currencies or interests in the foregoing,
and (iii) whose registration statement reflects that its securities
are purchased or redeemed, subject to certain conditions or
limitations, for a ratable share of its assets (such exchange-listed
funds or trusts, ``commodity- or currency-based trusts or funds'').
See section 2(f)(2)(B) of the FAIR Act. Based on the definition in
section 2(f)(2) of the FAIR Act, the term ``covered investment
fund'' would not include an investment company that is registered
solely under the Investment Company Act, such as certain master
funds in a master-feeder structure.
\45\ See rule 139b(c)(2). This approach reflects the approach
taken in other Commission rules that define the term ``fund'' to
include a separate series of an investment company. See, e.g., rule
22e-4(a)(4) under the Investment Company Act [17 CFR 270.22e-
4(a)(4)]; rule 22c-1(a)(3)(v)(A) under the Investment Company Act
[17 CFR 270.22c-1(a)(3)(v)(A)].
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4. Non-Exclusivity of Safe Harbor
Broker-dealers publishing or distributing research reports for some
covered investment funds, such as commodity- or currency-based trusts
or funds that have a class of securities registered under the
Securities Exchange Act of 1934 (the ``Exchange Act''), rather than
relying on new rule 139b, instead may be able to rely on rule 139. Rule
139b does not preclude a broker-dealer from relying on existing rule
139 if applicable. In order to clarify that a broker-dealer may rely on
existing research safe harbors, we proposed that rule 139b state that
it does not affect the availability of any other exemption or exclusion
from sections 2(a)(10) or 5(c) of the Securities Act that may be
available to a broker-dealer.\46\ We received no comments on this
aspect of the proposed rule and are adopting it as proposed.\47\
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\46\ See proposed rule 139b(a); see also addition to rule 139(a)
(for purposes of the Fair Access to Investment Research Act of 2017
[Pub. L. 115-66, 131 Stat. 1196 (2017)], a safe harbor has been
established for covered investment fund research reports, and the
specific terms of that safe harbor are set forth in rule 139b (Sec.
230.139b)).
\47\ See rule 139b(a).
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B. Conditions for the Safe Harbor
As discussed in the Proposing Release, the Commission has
previously acknowledged the value of research reports in providing the
market and investors with information about reporting issuers.\48\ To
mitigate the risk of research reports being used to circumvent the
prospectus requirements of the Securities Act,\49\ the Commission
[[Page 64184]]
has placed conditions on a broker-dealer's publication or distribution
of research reports.\50\ Under Rule 139, these conditions include
restrictions on the issuers to which the research may relate, as well
as requirements that such reports be published in the regular course of
business. These conditions vary depending on whether a research report
covers a specific issuer (``issuer-specific research reports'') or a
substantial number of issuers in an industry or sub-industry
(``industry research reports''). Rule 139b carries over these
conditions for covered investment fund research reports and
incorporates certain modifications intended to adapt these conditions
to covered investment funds that we discuss below.
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\48\ See Proposing Release, supra note 2, at 26794 (for example,
the Commission has recognized that, for public operating entities
that are well-followed, the research-report-related rules enhance
the efficiency of the markets by allowing a greater number of
research reports to provide a continuous flow of essential
information about reporting entities into the marketplace).
\49\ See supra note 5 and accompanying text (noting that the
rule 139 safe harbor permits a broker-dealer to publish or
distribute a research report without this publication or
distribution being deemed to constitute an offer that otherwise
could be a non-conforming prospectus in violation of section 5 of
the Securities Act). See also Securities Offering Reform Adopting
Release, supra note 23 (discussing how the Sarbanes-Oxley Act,
Regulation AC, and a global research analyst settlement required
structural changes and increased disclosures in connection with
certain abuses identified with analyst research); supra notes 35-36
and accompanying text (discussing certain rules and regulations
under the federal securities laws, as well as certain SRO rules,
that help address certain conflicts of interest and abuses
identified with analyst research).
\50\ Many research reports that broker-dealers publish or
distribute in reliance on the rule 139 safe harbor may also be
subject to other federal securities rules and regulations under the
Exchange Act and SRO rules governing their content and use. See
supra notes 35-36.
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1. Issuer-Specific Research Reports
a. Reporting History and Timeliness Requirements
In order for a broker-dealer to include a covered investment fund
in a research report published or distributed in reliance on the rule
139b safe harbor, the fund must meet certain reporting history and
timeliness requirements. We are adopting as proposed that any such
covered investment fund must have been subject to the relevant
requirements under the Investment Company Act and/or the Exchange Act
to file certain periodic reports for at least 12 calendar months prior
to a broker-dealer's reliance on rule 139b and that these reports have
been filed in a timely manner.\51\ This requires covered investment
funds that are registered investment companies to have been subject to
the reporting requirements of the Investment Company Act for a period
of at least 12 calendar months prior to a broker-dealer's reliance on
the new rule and to have filed in a timely manner all required reports,
as applicable, on Forms N-CSR,\52\ N-Q,\53\ N-PORT,\54\ N-MFP,\55\ and
N-CEN \56\ during the immediately preceding 12 calendar months.\57\ If
the covered investment fund is not a registered investment company, it
must have been subject to the reporting requirements under section 13
or section 15(d) of the Exchange Act for a period of at least 12
calendar months and have filed all required reports in a timely manner
on Forms 10-K \58\ and 10-Q \59\ and 20-F \60\ during the immediately
preceding 12 calendar months.\61\
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\51\ Rule 139b(a)(1)(i)(A). We believe that this condition also
gives effect to FAIR Act section 2(e), which makes the safe harbor
contemplated by the FAIR Act unavailable with respect to broker-
dealers' publication or distribution of research reports about
closed-end registered investment companies BDCs during these covered
investment fund issuers' first year of operation. See section 2(e)
of the FAIR Act (The safe harbor under subsection (a) of the FAIR
Act shall not apply to the publication or distribution by a broker-
dealer of a covered investment fund research report, the subject of
which is a BDC or a registered closed-end investment company, during
the time period described in 17 CFR 230.139(a)(1)(i)(A)(1), except
where expressly permitted by the rules and regulations of the
Commission under the federal securities laws.).
\52\ 17 CFR 249.331 and 17 CFR 274.128.
\53\ 17 CFR 249.332 and 17 CFR 274.130. Form N-Q will be
rescinded May 1, 2020. Larger fund groups will begin submitting
reports on Form N-PORT by April 30, 2019, and smaller fund groups by
April 30, 2020. See Investment Company Reporting Modernization,
Investment Company Act Release No. 32314 (Oct. 13, 2016) [81 FR
81870 (Nov. 18, 2016)] (``Reporting Modernization Release'');
Investment Company Reporting Modernization, Investment Company Act
Release No. 32936 (Dec. 8, 2017) [82 FR 58731 (Dec. 14, 2017)]. At
the time of these compliance dates, covered investment funds would
no longer be required to file reports on Form N-Q, and filing these
reports would not be required as a condition to rely on the rule
139b safe harbor. Accordingly, rule 139b, as adopted, will be
amended effective May 1, 2020 by removing the reference to Form N-Q.
See infra section VI (instruction 4 under Text of Proposed Rules and
Amendments).
\54\ 17 CFR 274.150. Form N-PORT will be filed with the
Commission on a monthly basis, but only information reported for the
third month of each fund's fiscal quarter on Form N-PORT will be
publicly available (and not until 60 days after the end of the
fiscal quarter). See Reporting Modernization Release, supra note 53.
Therefore, we would consider Form N-PORT to have been timely filed
for purposes of the timeliness requirement if the public filing of
Form N-PORT every third month is timely filed and publicly
available.
\55\ 17 CFR 274.201.
\56\ 17 CFR 249.330 and 17 CFR 274.101.
\57\ Rule 139b(a)(1)(i)(A)(1). As discussed in the Proposing
Release, Form N-SAR was rescinded on June 1, 2018, which is the
compliance date for Form N-CEN. As such, reliance on new rule 139b
is not conditioned on covered investment funds reporting on Form N-
SAR and the reference to Form N-SAR, as proposed, is not included in
paragraph (a)(1)(i)(A)(1) of rule 139b. See id.; see also Proposing
Release, supra note 2, at 26794.
\58\ 17 CFR 249.310.
\59\ 17 CFR 249.308a.
\60\ 17 CFR 249.220f.
\61\ Rule 139b(a)(1)(i)(A)(2).
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Reporting History
Several commenters requested we eliminate the reporting history
requirement for issuer-specific research reports under rule 139b.\62\
One commenter suggested that the requirement is unnecessary because
funds have ``detailed and comprehensive regulatory filing and
disclosure obligations'' providing investors with ``a wealth of
information about funds.'' \63\ Another commenter argued that the
reporting history requirement should be eliminated because ensuring
compliance with the requirement would create ``operational hurdles''
for broker-dealers that provide investors with research on a large
numbers of funds on a largely automated basis.\64\ Commenters also
argued that the reporting history requirement unduly restricts research
on newer funds.\65\
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\62\ See Fidelity Comment Letter; ICI Comment Letter; SIFMA
Comment Letter I; see also BlackRock Comment Letter.
\63\ See ICI Comment Letter; see also BlackRock Comment Letter.
\64\ See Fidelity Comment Letter.
\65\ See ICI Comment Letter; SIFMA Comment Letter I; see also
BlackRock Comment Letter.
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As discussed in the Proposing Release, rule 139b tracks the
reporting history requirement of rule 139.\66\ We believe satisfying
such a requirement indicates a likelihood that more current and timely
information has been disseminated to and digested by the marketplace to
inform investors of material information about the fund, including
risks, and provides investors with SEC-filed information to compare
against the contents of the research report.\67\ We also continue to
believe that maintaining a reporting history requirement is consistent
with the FAIR Act, which permits a reporting history requirement so
long as it does not exceed the period required in rule 139.\68\
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\66\ Rule 139 predicates issuer-specific research reports on an
issuer's eligibility to use Form S-3 or F-3, which are short form or
shelf registration statements that are available to register an
issuer's securities offering only after it has been subject to and
in compliance with the Exchange Act periodic reporting requirements
for at least 12 months.
\67\ See Proposing Release, supra note 2, at 26795 nn.75-78 and
accompanying text. The safe harbor would be unavailable to broker-
dealers' publication or distribution of research reports about
closed-end registered investment companies or BDCs during these
covered investment fund issuers' first year of operation. See supra
note 51.
\68\ See Proposing Release, supra note 2, at 26795 n.77
(explaining the reporting and timeliness requirements of rule 139).
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We do not believe that funds should be treated differently from
other issuers subject to the reporting requirement of rule 139. The
Commission included a reporting history requirement in rule
[[Page 64185]]
139 because it helps to ensure that the market has information, beyond
the research report, to allow investors to weigh how much value they
will assign to the research report. The fund's reporting history should
be particularly important when the broker-dealer publishing the
research report is participating or may participate in the fund's
offering, as is the case under rule 139b (similar to rule 139). As
noted above, one commenter suggested that the reporting history
requirement is unnecessary because funds' ``detailed and comprehensive
regulatory filing and disclosure obligations'' provide investors ``a
wealth of information about funds.'' \69\ Eliminating the reporting
history requirement would reduce the information available to investors
when evaluating research reports published or distributed by broker-
dealers when those broker-dealers are also participating in the
offering of the fund's shares. The requirement also allows time for the
market to absorb the previously released periodic reports and for
investors to assess an issuer's track record.
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\69\ See ICI Comment Letter; see also BlackRock Comment Letter.
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Corporate issuers are subject to, under rule 139, filing and
disclosure obligations similar to what is required of covered
investment funds under rule 139b. Although funds differ from corporate
issuers in many respects, investors would benefit similarly from having
access to fund information to evaluate the research reports on which
they may consider relying. Accordingly, for the same reasons the
Commission determined to include this requirement in rule 139, we have
determined to include this requirement in rule 139b.
We also believe that broker-dealers will be able to comply with the
reporting history requirement in a manner similar to how they comply
with the parallel requirement in rule 139 and that the effect of the
requirement on new funds would be similar to the effect on new issuers
under rule 139.\70\ Other issuers also have ``detailed and
comprehensive regulatory and disclosure obligations'' much like funds.
In this regard, we are not persuaded that there is a material
difference between covered investment funds and other issuers that
would justify treating them in a disparate fashion. We continue to
believe that the concerns underlying the reporting history requirement
of rule 139 apply to research reports issued under rule 139b, and
therefore are not persuaded that the reporting history requirement
should be eliminated from rule 139b as suggested by some commenters.
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\70\ We believe that a broker-dealer would be relying on rule
139 or rule 139b because it would be involved in distributing
securities of the issuer covered in the report, and would therefore
have information about the issuer to confirm it has been subject to
filing obligations for the preceding 12 calendar months. For
example, this information is accessible through the Commission's
publicly available Electronic Data Gathering Analysis, and Retrieval
(``EDGAR'') system. Moreover, we believe that broker-dealers that
choose to automate publication of research reports may invest in
technologies to implement this automation including by leveraging
their existing technological infrastructures to verify the reporting
history requirement for covered investment funds.
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One commenter also requested the reporting history requirement be
shortened from 12 months to 25 days after a fund initially starts
offerings shares. The commenter argued that this would align with
broker-dealers' market practice of waiting 25 days after an initial
public offering.\71\
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\71\ See SIFMA Comment Letter I; SIFMA Comment Letter II.
Additionally, this commenter presented an example of a new ETF based
on a new industry classification standard that has garnered interest
from the market and satisfies the minimum public market value
requirement, but would be unable to satisfy a 12-month reporting
history requirement. See SIFMA Comment Letter II. This situation and
result equally occurs in the operating company context, where a
well-followed operating company that has an initial public offering
might satisfy the minimum public market value requirement, but not
the reporting history requirement, and thus could not be covered as
a rule 139 issuer-specific research report until the 12-month
reporting history requirement is also satisfied.
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Rule 139 is available only to broker-dealers that both publish or
distribute a research report on an issuer and are participating or will
participate in a registered offering of the issuer's securities. The
25-day standard referenced by the commenter relates to the issuance of
a research report after the prospectus delivery obligation in an
initial public offering ends, not while the offering is ongoing and the
broker-dealer is participating in it. Accordingly, the prospectus
delivery obligation described by the commenter is distinct from the
delivery obligation that applies to continuous offerings. Thus, the
commenter's suggested provision and rationale do not appropriately
apply to a broker-dealer participating in a continuous offering. The
25-day standard referenced by the commenter is premised on statutory
provisions addressing prospectus delivery, a different investor
protection consideration from rules 139 and 139b. Accordingly, we
believe the 25-day standard is inapposite to rule 139b, as rule 139b
applies to broker dealers that are participating in the offering of the
subject fund's securities, not after the offering has ended. For these
reasons, we are adopting the reporting history provision as proposed.
Timeliness
Two commenters opposed the proposed timeliness requirement for
issuer-specific research reports.\72\ They argued that broker-dealers
would face operational hurdles in confirming a covered investment
fund's timely filing of periodic reports.\73\ One commenter suggested
that broker-dealer firms be allowed to accept compliance
representations from covered investment funds for the reporting history
and timeliness requirements.\74\ The other commenter requested that the
timeliness requirement apply only when a broker-dealer initiates
research coverage on a fund, rather than for each research report.\75\
Alternatively, the commenter also requested the Commission to permit
broker-dealers to rely on the lack of any Form 12b-25 (indicating that
a filing is late) filed by covered investment funds within the prior 12
months.\76\
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\72\ See Fidelity Comment Letter; SIFMA Comment Letter I; SIFMA
Comment Letter II.
\73\ See Fidelity Comment Letter; SIFMA Comment Letter I. In a
subsequent letter, one commenter noted the difficulty broker-dealers
would have in identifying reports filed by registered investment
companies that are part of series companies, pointing to a lack of
functionality in EDGAR's mutual-fund specific search page. See SIFMA
Comment Letter II. All registered investment company filings are
available on EDGAR, however, and there are multiple ways to search
the EDGAR system in addition to the mutual-fund specific page the
commenter identified--including using a fund's filing number, which
can be found in a fund's prospectus, or by using a Central Index Key
(``CIK'') number.
\74\ See Fidelity Comment Letter.
\75\ See SIFMA Comment Letter I.
\76\ See SIFMA Comment Letter II.
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Satisfaction of the timeliness requirement indicates a greater
likelihood that a covered investment fund will make information
available in a timely manner to inform investors of material
information about the fund, including risks. We believe it is important
for covered investment fund investors to have timely information from
the fund when evaluating research reports, as it is for operating
company investors. Rule 139 requires that an issuer satisfy the
reporting history and timeliness requirements at the time the broker-
dealer publishes or distributes a research report.\77\ Modifying rule
139b to allow confirming the timeliness of a fund's reporting only upon
initiation of coverage, or to accept the compliance representations of
covered investment funds, would provide less protection to investors
than the Commission determined to be appropriate in rule 139. We also
do not believe providing disparate treatment between funds and other
issuers with respect to reporting
[[Page 64186]]
history and timeliness conditions is necessitated by operational or
structural differences between the issuer types. As with the 12-month
reporting history requirement, we believe that confirming the
timeliness of periodic filings for covered investment funds would be
substantially similar to confirming the timeliness of periodic filings
in the operating company context.\78\ We do, however, agree with the
commenter that a fund filing a Form 12b-25 (or lack thereof) would
serve as a useful indication of the fund's timeliness. We believe that
a broker-dealer may rely on the lack of a Form 12b-25 filing as
confirmation that a fund's filings are timely under the rule unless the
broker-dealer is actually aware through other means that the issuer has
not in fact made timely filings. Accordingly, we are adopting the
timeliness requirement as proposed.
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\77\ See rule 139(a)(1)(i)(A)(1)-(2).
\78\ See Proposing Release, supra note 2, at 26794-95. A broker-
dealer has diligence and investigative obligations under section 11
of the Securities Act in order to be able to claim a due diligence
defense available thereunder. See Securities Offering Reform
Adopting Release, supra note 23; rule 176 of the Securities Act [17
CFR 230.176]. Like the reporting history requirement, broker-dealers
could confirm the timeliness of a covered investment fund's reports
through a check of the Commission's EDGAR system, which is free and
readily available. This may allow the leveraging of operating
efficiencies for broker-dealers already familiar with the
requirement.
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b. Market Following Requirement
We are adopting a requirement that, in order for broker-dealers to
use the rule 139b safe harbor to publish or distribute issuer-specific
research reports, the covered investment fund that is the subject of a
report must satisfy a minimum public market value threshold at the date
of reliance on the new rule (the ``float requirement''). Specifically
we are adopting a requirement that the aggregate market value of a
covered investment fund, or the net asset value \79\ in the case of a
registered open-end investment company (other than an exchange-traded
fund (``ETF'')) \80\ i.e., a mutual fund, must equal or exceed the
aggregate market value required by General Instruction I.B.1 to Form S-
3.\81\ This amount is currently $75 million.\82\ The FAIR Act permits
us to set a float requirement for covered investment funds, as long as
the minimum public float is not greater than what is required by rule
139.\83\
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\79\ For mutual funds, net asset value would be computed using
the investment company's current net asset value, as used in
determining its share price. See rule 22c-1 under the Investment
Company Act [17 CFR 270.22c-1] (requiring registered mutual funds,
their principal underwriters, and dealers in the investment
company's shares (and certain others) to sell and redeem the
investment company's shares at a price determined at least daily
based on the current net asset value next computed after receipt of
an order to buy or redeem).
\80\ See rule 139b(a)(1)(i)(B); rule 139b(c)(4) (defining
``exchange-traded fund'' for purposes of the new rule to have the
meaning given the term in General Instruction A to Form N-1A).
\81\ The new rule refers to General Instruction I.B.1 to Form S-
3. Under this instruction, aggregate market value is ``computed by
use of the price at which the common equity was last sold, or the
average of the bid and asked prices of such common equity, in the
principal market for such common equity as of a date within 60 days
prior to the date of filing.'' General Instruction I.B.1 to Form S-
3. The definition of ``market price'' in the General Instructions of
Form N-1A contemplates valuing an ETF's shares similarly. See
General Instruction A to Form N-1A.
\82\ General Instruction I.B.1 to Form S-3.
\83\ See section 2(b)(2)(B) of the FAIR Act.
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We are adopting the float requirement and level as proposed.
However, as discussed below, the final rule includes two changes to the
float calculation methodology for most covered investment funds. First,
the final rule generally no longer requires that the fund issuer's
aggregate market value or net asset value be calculated net of its
affiliates' holdings.\84\ Second, the minimum float requirement must be
satisfied at the initiation (or reinitiation) of research coverage and
then once a quarter thereafter. The proposal, on the other hand, would
have required that the minimum float requirement be satisfied each time
a broker or dealer relied on the safe harbor to publish or distribute a
research report on a covered investment fund.
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\84\ However, as discussed below, this change would not apply to
the calculation of a commodity- or currency-based trust or fund's
float.
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Float Level
Several commenters argued that a float requirement should be
eliminated or reduced in the context of covered investment funds
because such a requirement would limit the extent of research that
could be produced.\85\ Two commenters argued that for funds, NAV
relates to the underlying value of the portfolio and therefore makes it
an inapt proxy for market following.\86\ Historically, the Commission
has used public float as an approximate measure of a security's market
following, through which the market absorbs information that is
reflected in the price of the security.\87\ We continue to view as
significant the relationship between public float, information
dissemination to the market, and following by investment
institutions.\88\ While market following for funds that price at or
near NAV may not have the same degree of impact on the price of the
fund shares that it may have for other issuers, market following serves
other purposes as well, including ensuring that a mix of information
about the fund's securities is available. We believe that providing a
different calculation method for mutual funds is necessary to achieve
the intent of the FAIR Act and is also consistent with the goals of the
float requirement in rule 139. We also do not believe there is a reason
to set the level of the minimum public float requirement based on a
different set of considerations than for operating companies (i.e., the
level of the security's market following).
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\85\ See SIFMA Comment Letter; ICI Comment Letter; Fidelity
Comment Letter.
\86\ See SIFMA Comment Letter; ICI Comment Letter.
\87\ See, e.g., Revisions To The Eligibility Requirements For
Primary Securities Offerings On Forms S-3 and F-3, Securities Act
Release No. 8878 (Dec. 19, 2007) [72 FR 73533 (Dec. 27, 2007)] (``S-
3 Revisions Adopting Release''); see also Securities Offering
Reform, Securities Act Release No. 8501 (Nov. 3, 2004) [69 FR 67391
(Nov. 17, 2004)] (discussing public float of a certain level as a
factor indicating that an issuer has a demonstrated market
following).
\88\ See, e.g., S-3 Revisions Adopting Release, supra note 87.
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As noted by commenters, we recognize that the minimum public float
requirement may impact the amount of research on covered investment
funds. However, we continue to believe that this requirement is
consistent with rule 139's framework and intent.\89\ As discussed
previously, we believe that the intent of the FAIR Act was to extend
the rule 139 framework to covered investment funds in a manner
consistent with the treatment of other issuers subject to rule 139,
except where necessary or appropriate. We do not believe it is
necessary or appropriate to treat covered investment funds and other
issuers differently here, except with respect to the calculation method
for mutual funds as discussed below. We also believe that concern about
coverage for smaller issuers--and balancing that concern with investor
protection concerns when the broker-dealer distributing the report is
participating in the issuer's offering--is not unique to covered
investment funds. As discussed in the Proposing Release, in the context
of covered investment funds, we would expect market information to be
most limited for new funds (which the reporting history and timeliness
requirements could help to address) and for funds that are marketed to
a limited segment of investors (which the float requirement could help
to address).\90\ The float requirement is designed to protect investors
by excluding research reports on covered
[[Page 64187]]
investment funds with a relatively small amount of total assets, which
serves as a reasonable proxy for a limited market following.\91\
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\89\ See Proposing Release, supra note 2, at 26796.
\90\ See id.
\91\ We believe that conditioning the availability of the safe
harbor on the aforementioned reporting history and market valuation
requirements will help restrict the availability of the safe harbor
in situations where we expect the information environment to be most
limited: For new funds and for funds with limited trading or
interest. See also infra discussion in the Economic Analysis at
notes 350-354.
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With respect to the level of the minimum public float, the float
requirement is not intended to include or exclude a certain percentage
of funds or other issuers from research coverage. The float requirement
is intended to act as a proxy for market following. As we have
previously analyzed in other contexts, analyst research coverage of an
issuer is one indicia of market following. We have previously observed
that analyst coverage drops off significantly with smaller issuers, and
few if any issuers with less than $75 million in public float have
significant analyst coverage.\92\ Moreover, while certain data
aggregators provide analyst research report coverage for a number of
funds, most funds are not followed by dedicated research analysts akin
to the analyst coverage that we have previously identified as being one
indicia of market interest and following for operating companies.\93\
As a consequence, we have observed that covered investment fund issuers
with a public float of less than $75 million generally do not have a
market following that would add to the mix of information in the
marketplace. Some commenters suggested using a lower public float
requirement for funds on the basis of seeking to equalize the
percentage of funds that would be subject to coverage with the
percentage of issuers similarly subject to coverage in rule 139.\94\
Market following, however, appears to be a characteristic related to
the size of a particular issuer, not to the statistical distribution of
issuers in the market. In other words, there is no reason to believe
that equalizing the percentage of issuers covered under rule 139 with
the percentage of funds covered under rule 139b would result in a
meaningful indication of market following because the result would
depend on the distribution of issuers and funds by size. In addition,
using a minimum public market value threshold that is the same as the
parallel threshold in rule 139 may benefit market participants through
regulatory consistency and reduce opportunities for investor
confusion.\95\
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\92\ See Simplification of Registration Procedures for Primary
Securities Offerings, Securities Act Release No. 6943 (July 16,
1992) [57 FR 32461 (July 22, 1992)] (stating that one indicia of
market interest and following of a company is the number of research
analysts covering the company and that approximately two-thirds of
the newly eligible companies, based on the reduction of the float
requirement to $75 million, are followed by at least three research
analysts). See also Securities Offering Reform Adopting Release,
supra note 23, at 44728 n.53 (stating that issuers with a market
capitalization of between $75 million and $200 million, in most
cases, have between zero to five analysts following them, with
approximately 50% having zero to two analysts following them).
\93\ The Commission and the staff intend to monitor changes in
analyst research coverage of funds and the impact of the minimum
public market value requirement on the availability of research on
covered investment funds and may in the future reduce, change, or
eliminate the requirement to the extent that empirical evidence
demonstrates that a lower threshold or different metric would be
consistent with investor protection.
\94\ See Fidelity Comment Letter; SIFMA Comment Letter I.
\95\ See infra discussion following note 319.
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While a broker-dealer publishing a research report about a fund
that does not meet the minimum public float could not rely on rule
139b, other methods may be available to provide information about these
funds by a broker-dealer participating in the offering, such as
choosing to cover a smaller fund in a rule 482 communication.\96\ In
addition, the public market value requirement is limited to issuer-
specific research reports, and does not apply to industry research
reports.
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\96\ See rule 482 [17 CFR 230.482]. Rule 482 sets forth certain
filing and other investor protection requirements. Id.
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Float Calculation
While we continue to believe that the float requirement serves a
useful purpose, we recognize that the proposed float requirement could
pose unique operational challenges for analysts covering certain
covered investment funds. Accordingly, as discussed below, we are
making certain changes to the timing and method of the float
calculation that are designed to address these concerns for covered
investment funds.
One commenter stated that calculating a covered investment fund's
public float, and determining the specific amount of affiliate holdings
to be excluded in calculating the public float as proposed, is a
practical challenge for broker-dealers because it was not clear to the
commenter that third-party vendors or filings on EDGAR contain data
regarding the value of covered investment funds, net of value held by
affiliates.\97\ This commenter also noted that broker-dealers are
unlikely to have information about beneficial owners of funds that are
affiliates but hold the fund's shares through another record owner.
Commenters also stated that the proposed float requirement more
generally creates operational challenges given the need to track and
test fluctuating market values to comply with it, given that many funds
are continuously offered.\98\
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\97\ See SIFMA Comment Letter II. This commenter stated that
broker-dealers satisfy the parallel minimum public float requirement
under rule 139 by relying upon third-party data vendors, such as
Bloomberg. We understand that third-party service providers do not
currently calculate this number for covered investment funds,
although they may do so in the future.
\98\ See Fidelity Comment Letter; SIFMA Comment Letter I.
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We appreciate these concerns and are therefore adopting two
modifications to the final rule. First, the final rule does not require
that the fund's aggregate market value or net asset value be calculated
net of affiliates' holdings for most covered investment funds.\99\
However, the final rule, like the proposal, would require that a
commodity- or currency-based trust or fund's public float be calculated
net of affiliate holdings, as under rule 139. Broker-dealers today can
rely on rule 139 to publish research reports regarding these covered
investment funds and we believe it appropriate to maintain consistency
for issuers that can be covered under both rules, where consistent with
the FAIR Act. Otherwise, exactly the same activity could be subject to
different standards based on the rule that a broker-dealer chose to
use. One commenter argued that determining affiliate ownership for such
funds based on Forms 10-K and S-1 may quickly become outdated.\100\ We
believe that for purposes of calculating affiliate ownership when
determining a covered investment fund's public float, broker-dealers
may rely on the covered investment fund's most recent ownership
disclosures filed with the Commission for identifying the beneficial
owners, despite the potential data limitations. As a consequence, we
believe that a broker-dealer need not seek to identify unknown
beneficial owners held through disclosed record owners, and also does
not need to generally exclude record owners from the calculation of
public float, except to the extent that they represent known beneficial
owners. We believe this approach is reasonable and comparable to that
used in the operating company context.
---------------------------------------------------------------------------
\99\ See rule 139b(a)(1)(i)(B).
\100\ See SIFMA II Comment Letter.
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Unlike rule 139, rule 139b does not permit affiliates of covered
investment funds to rely on the safe harbor,
[[Page 64188]]
mitigating the risk that a fund with significant affiliate holdings
would be the subject of market moving research by those same
affiliates. We also appreciate that there is more limited information
currently available regarding the holdings of affiliates of covered
investment funds relative to operating companies, as noted by
commenters.\101\ That many covered investment fund are continuously
offered also adds operational challenges. A covered investment fund's
investor base, and thus potential affiliates, may change day to day,
making it more difficult to identify affiliate holdings. In addition,
covered investment funds are subject to unique legal provisions that
generally restrict affiliate ownership and provide additional legal
protections when affiliate ownership is permitted.\102\ Accordingly,
not requiring a broker-dealer to identify and exclude affiliate
holdings is designed to address these challenges and appropriately
tailors this requirement for covered investment funds.\103\
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\101\ See SIFMA Comment Letter II (noting that third party
vendors do not currently provide float information net of affiliates
for funds, and that for certain funds whose ownership is held in
street name, affiliate ownership may be ``unknowable'').
\102\ See, e.g., Investment Company Act sections 12, 17, and 57
and rules thereunder.
\103\ The instructions to Form S-3 discuss methodologies for
calculating float net of affiliates. When calculating float for
purposes of rule 139b, those instructions related to the exclusion
of affiliate ownership must be disregarded.
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Second, the final rule will permit a broker-dealer to satisfy the
minimum float requirement when it initiates (or reinitiates) coverage
and then once a quarter thereafter (so long as it continues issuing or
distributing research on that fund), rather than each time the broker-
dealer publishes or distributes a research report, as proposed.\104\ We
recognize that in the operating company context where most issuers are
not engaged in a continuous distribution, broker-dealers can rely on
other research report rules that do not include a public float
requirement. The requirement in proposed rule 139b that a covered
investment fund have the requisite public float each time the broker-
dealer publishes a research report could therefore have involved
greater operational challenges than those associated with the
corresponding requirement in rule 139. A broker-dealer would generally
only need to comply with the requirement in rule 139 for a discrete
period of time while the issuer is in distribution, but would have been
required to comply with the corresponding requirement in rule proposed
139b every time the broker-dealer published a research report about a
covered investment fund that was in continuous distribution where the
broker-dealer is participating in the offering. We believe that
requiring a broker-dealer to determine the float upon initiation or
reinitiation of coverage will ensure that the float requirement is met
at the outset of research coverage. We are requiring a quarterly re-
assessment of the float requirement to mitigate the risk that a covered
investment fund's float declines over time and no longer meets the
float requirement. We believe a quarterly assessment is appropriate as
it aligns with the quarterly reporting schedule of most funds, and
balances the risks of only periodically verifying a fund's float with
the costs of more frequent or continuous assessments.
---------------------------------------------------------------------------
\104\ See rule 139b(a)(1)(i)(B). If a broker-dealer were to
cease publication or distribution of a covered fund research report
and then initiate coverage again, this provision would require the
fund's float to be above the minimum at the time that the broker or
dealer begins relying on the safe harbor provided by rule 139b once
more.
---------------------------------------------------------------------------
We believe these adjustments appropriately tailor rule 139 to
covered investment funds. For the reasons discussed below, we believe
that the changes to the calculation and time of testing of the minimum
public float requirement for covered investment funds under rule 139b
are necessary or appropriate in the public interest, and for the
protection of investors, and for the promotion of capital formation as
they allow appropriately tailoring of rule 139 in applying it to
covered investment funds while considering their unique structure and
operational aspects.
We proposed that the float threshold be calculated in terms of NAV
rather than aggregate market value for mutual funds in order to reflect
the market structure differences between mutual funds and all other
covered investment funds.\105\ Absent this modification, the float
requirement would categorically exclude broker-dealers from relying on
rule 139b in their publication or distribution of mutual fund issuer-
specific research reports, which would appear inconsistent with the
FAIR Act's directives. Mutual funds redeem their shares each day and
therefore must compute their net asset value each day, providing a
timely and reliable measure of the fund's size, akin to other issuers'
public float; and investors' ability to purchase and redeem fund shares
at net asset value provides timely share prices akin to the price
discovery that occurs in a public trading market. As discussed further
below, for other types of covered investment funds, such as closed-end
funds and BDCs, which may or may not have public float, we believe it
is appropriate, and consistent with the FAIR Act, to provide the same
public float requirements--the manner of calculation and amount--as
applies to issuer-specific research reports under rule 139.
Accordingly, we are adopting this NAV calculation method as proposed.
---------------------------------------------------------------------------
\105\ Id. at 26796 n.86.
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Non-Traded Funds
Finally, one commenter suggested that we revise rule 139b to permit
an issuer-specific research report to cover a non-traded closed-end
fund or BDC that does not have a ``public float,'' and thus which,
under proposed rule 139b, could not be included in an issuer-specific
research report.\106\ This commenter noted that the proposed rule did
not extend the NAV calculation method beyond open-end funds, but
pointed to a footnote in the proposal that discussed the potential for
non-traded BDCs or CEFs to be able to use a variant of the NAV
approach, and asked that we amend the final rule to allow them to do
so.\107\
---------------------------------------------------------------------------
\106\ See Sutherland Comment Letter.
\107\ Id. The commenter argued that all non-traded covered
investment funds that have a net asset value (less the value of
shares held by affiliates) that equals or exceeds the aggregate
market value required in General Instruction I.B.1. to Form S-3
should be covered by new rule 139b.
---------------------------------------------------------------------------
Although under the proposed rule the NAV calculation method was
only available to mutual funds, we acknowledge that the Proposing
Release discussion was inconsistent with the proposed rule text in that
the Proposing Release discussed the possibility of non-traded BDCs and
CEFs calculating a NAV based on their last publicly disclosed share
price for purposes of proposed rule 139b.\108\
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\108\ Compare Proposing Release, supra note 2, at 26796 n.83
(``For covered investment funds that are not actively traded (such
as non-traded closed-end funds and non-traded business development
companies), we anticipate that, for purposes of proposed rule 139b,
net asset value and aggregate market value would be calculated based
on the fund's last publicly-disclosed share price (for non-traded
business development companies, this would be the common equity
share price).'') with proposed rule 139b(a)(1)(i)(B): ``The
aggregate market value of voting and non-voting common equity held
by non-affiliates of the covered investment fund, or, in the case of
a registered open-end investment company (emphasis added) (other
than an exchange-traded fund) its net asset value (subtracting the
value of shares held by affiliates), equals or exceeds the aggregate
market value specified in General Instruction I.B.1 of Form S-3.''
---------------------------------------------------------------------------
We decline to amend the rule text to allow the NAV calculation
method for non-traded BDCs and closed-end funds. We believe that it is
inappropriate for non-traded BDCs and closed-end funds to satisfy the
float requirement using a
[[Page 64189]]
NAV calculation because doing so would undermine the purpose of the
requirement. As discussed previously, historically, the Commission has
used public float as a proxy for a security's market following.\109\ We
believe that the NAV method for mutual funds acts as an effective proxy
for market following for mutual funds because mutual funds redeem their
shares daily and therefore must compute their net asset value each day,
providing a timely and reliable measure of the fund's size, akin to
other issuers' public float; and investors' ability to purchase and
redeem fund shares at net asset value provides timely share prices akin
to the price discovery that occurs in a public trading market. Non-
traded BDCs and CEFs do not have an equivalent daily metric available,
and often compute NAV on a significantly more infrequent basis, such as
quarterly.
---------------------------------------------------------------------------
\109\ See supra note 87 and accompanying text.
---------------------------------------------------------------------------
In addition, we do not believe that providing a different
calculation method for non-traded closed-end funds and non-traded BDCs
is appropriate, because such funds do not have the same kind of
structural differences that necessitate different treatment provided to
open-end funds. For example, unlike mutual funds, non-traded closed-end
funds and BDCs could meet the float requirement if they chose to be
listed and would not have to undertake any structural changes. By
opting not to list, non-traded BDCs and closed-end funds are similar to
non-listed operating company issuers that, by choosing not to list,
cannot meet the public float requirement of rule 139.
Finally, we do not believe that our approach is inconsistent with
the statute or congressional intent. Specifically, we note that the
FAIR Act includes an interim effectiveness provision, whereby if the
Commission has not adopted a covered investment fund research report
rule within 270 days of the Act's enactment, broker-dealers could begin
publishing or distributing covered investment fund research reports
provided that certain rule 139 conditions are satisfied.\110\ One such
specified condition is that an issuer-specific research report about a
covered investment fund must satisfy the existing public float
requirement of rule 139 during this interim effectiveness. As such,
even during the interim effectiveness period provided under the FAIR
Act and as a result of the conditions in rule 139, non-traded BDCs and
CEFs would not be able to satisfy the public float requirement and thus
by congressional design would not receive the benefit of the FAIR Act's
safe harbor. In light of the reasons discussed above, we have
determined not to amend the proposed rule text as the commenter
recommended to expressly include non-traded BDCs and CEFs within the
safe harbor.
---------------------------------------------------------------------------
\110\ See supra note 3; section 2(d) of the FAIR Act. The FAIR
Act's interim effectiveness provision became effective as of July 3,
2018 and by its terms will terminate upon the adoption of a covered
investment fund research report rule. Currently, at least one
broker-dealer is issuing covered investment fund research reports in
reliance on the interim effectiveness provision. See, e.g., Rachel
Evans, In a Passive World, Bank of America's New ETF Team Picks
Stocks (Oct. 17, 2018), available at https://www.bloomberg.com/news/articles/2018-10-17/in-a-passive-world-bank-of-america-s-new-etf-team-picks-stocks?srnd=etfs.
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c. Regular-Course-of-Business Requirement
We are adopting as proposed a condition to rule 139b that a broker-
dealer's publication or distribution of research reports be ``in the
regular course of its business'' \111\ (the ``regular-course-of-
business'' requirement). Although the regular-course-of-business
requirement is generally similar to the existing provisions of rule
139, it differs in one respect as required by the FAIR Act. Rule 139
provides, in addition to the requirement that a broker-dealer ``publish
or distribute research reports in the regular course of its business,''
that such publication or distribution may not represent either the
initiation of publication of research reports about the issuer or its
securities or the reinitiation of such publication following a
discontinuation thereof (the ``initiation or reinitiation''
requirement).\112\
---------------------------------------------------------------------------
\111\ Rule 139b(a)(1)(ii).
\112\ Rule 139(a)(1)(iii) [17 CFR 230.139(a)(1)(iii)].
---------------------------------------------------------------------------
The FAIR Act, however, provides that the safe harbor shall not
apply the ``initiation or reinitiation'' requirement to a report
concerning a covered investment fund with a class of securities ``in
substantially continuous distribution.'' \113\ Accordingly, rule 139b
incorporates the ``initiation or reinitiation'' requirement from rule
139 and specifies that it applies only to research reports regarding a
covered investment fund that does not have a class of securities in
substantially continuous distribution.\114\ Determining whether a class
of securities is in substantially continuous distribution would be
based on an analysis of the relevant facts and circumstances.
---------------------------------------------------------------------------
\113\ Section 2(b)(1) of the FAIR Act.
\114\ See rule 139b(a)(1)(ii).
---------------------------------------------------------------------------
One commenter asked for clarification that the scope and meaning of
``substantially continuous distribution'' includes traded registered
closed-end investment companies and BDCs engaged in at-the-market
(``ATM'') offering programs over consecutive quarters pursuant to rule
415(a)(4) under the Securities Act.\115\ Determining whether a class of
securities is in ``substantially continuous distribution'' is an
analysis based on the relevant facts and circumstances. With respect to
traded funds that offer ATM programs over consecutive quarters pursuant
to rule 415(a)(4) under the Securities Act, we believe that a covered
investment fund that engages in ongoing distributions of its shares on
a frequency consistent with open-end investment companies is in
substantially continuous distribution, but one that does so on a less
frequent basis may not be.
---------------------------------------------------------------------------
\115\ See Sutherland Comment Letter. This commenter also asked
for clarification regarding non-traded registered closed-end
investment companies and non-traded BDCs offering shares on a
continuous basis under Securities Act rule 415(a)(1)(ix). Although
these funds would not be covered in issuer-specific research reports
because they would not have the requisite public float, we believe
that a ``continuous'' offering under rule 415(a)(1)(ix) would
include a ``substantially continuous offering'' for purposes of rule
139b. See infra section II.B.2.b.
---------------------------------------------------------------------------
One commenter asked that we clarify whether broker-dealers that
have published and distributed communications styled as ``research
reports'' in compliance with rule 482 would meet the regular-course-of-
business requirement.\116\ This commenter also mentioned that some
broker-dealers have published and distributed research reports on other
issuers (such as non-covered investment funds, or on operating
companies) in reliance on the rule 139 safe harbor. We believe that a
broker-dealer can satisfy the regular-course-of-business requirement
through either of the methods discussed by this commenter.\117\ A
broker-dealer publishing or distributing an issuer-specific research
report can satisfy the regular-course-of-business requirement if at the
time of reliance on rule 139b it has distributed or published at least
one research report about the issuer or its securities, or has
distributed or published at least one such report following a period of
discontinued coverage. In addition, the condition may be satisfied by
publishing or distributing research reports on a covered investment
fund when a broker-dealer is
[[Page 64190]]
not participating in the offering of that fund.\118\
---------------------------------------------------------------------------
\116\ See Fidelity Comment Letter.
\117\ See also Securities Offering Reform Adopting Release,
supra note 23, at 44763-64. There is no minimum time period for the
broker or dealer to have distributed or published research reports,
only that the particular broker or dealer has initiated or
reinitiated coverage. Id.
\118\ This would also include other types of research or rule
482 stylized ``research reports,'' discussed below.
---------------------------------------------------------------------------
One commenter indicated that broker-dealers should not be required
to have a traditional research department in order to rely on the
rule.\119\ A traditional research department is not a requirement to
meet the condition, but would be a factor in indicating compliance with
the regular-course-of-business requirement. We discussed a number of
other factors that may evidence compliance with this condition in the
Proposing Release.\120\
---------------------------------------------------------------------------
\119\ See SIFMA Comment Letter I (also asking the Commission to
clarify that the regular-course-of-business requirement would
definitively be satisfied where the research is produced by
traditional research analysts within a traditional research
department--regardless of whether it previously produced research on
a particular type of security).
\120\ See Proposing Release, supra note 2, at 26796-99 (These
factors included whether the broker-dealer: Has a compliance
structure in place with relevant policies and procedures governing
their publication of research and their distribution of registered
investment company advertisements; has a research department with
research analysts covering particular issuers or industries;
maintains policies and procedures governing its research protocols;
and regularly publishes or distributes research on any other type of
company or business other than covered investment funds.).
---------------------------------------------------------------------------
Several commenters expressed concerns that the regular-course-of-
business requirement was too restrictive.\121\ For example, one
commenter stated that requiring broker-dealers to satisfy the regular-
course-of-business requirement by having a history of publishing or
distributing research on the same types of securities as covered in the
research report is inconsistent with the FAIR Act and congressional
intent, and may preclude coverage by new broker-dealer entrants.\122\
We do not believe that the regular-course-of-business requirement is
inconsistent with the FAIR Act, congressional intent, or would preclude
new broker-dealer entrants from relying on the rule 139b safe harbor,
as suggested by the commenter. We believe the FAIR Act and
congressional intent are clear in their directive to extend the rule
139 safe harbor to covered investment fund research reports. Rule 139
includes a regular-course-of-business requirement, and we believe it is
appropriate for rule 139b to also include the same type of requirement.
Commenters did not identify, and we are not aware of, any
distinguishable differences in the operation of covered fund issuers
that would necessitate different treatment from other issuers subject
to rule 139 with respect to a regular-course-of-business requirement.
---------------------------------------------------------------------------
\121\ See SIFMA Comment Letter I; ICI Comment Letter; Fidelity
Comment Letter; see also BlackRock Comment Letter.
\122\ See SIFMA Comment Letter I.
---------------------------------------------------------------------------
Moreover, broker-dealers that wish to newly begin publishing or
distributing research reports on funds could meet this condition
through any of the methods discussed above.\123\ Once a broker-dealer
has established a history of issuing such research reports pursuant to
any of these (or potentially other) methods in the regular course of
business, it could satisfy the condition and begin relying on rule
139b.
---------------------------------------------------------------------------
\123\ See supra notes 116-118 and accompanying text.
---------------------------------------------------------------------------
Similarly, another commenter stated that in place of the regular-
course-of-business requirement, we should require broker-dealers'
policies and procedures to include rule 139b compliance.\124\ We are
not incorporating this suggested change. Maintaining policies and
procedures to comply with rule 139b is one of several factors we would
assess in determining whether the broker-dealer has engaged in research
report publication and distribution in the regular course of business,
but such a factor alone does not establish that the regular-course-of-
business requirement has been met.
---------------------------------------------------------------------------
\124\ See ICI Comment Letter; see also BlackRock Comment Letter.
---------------------------------------------------------------------------
Since rule 139 was first adopted, the regular-course-of-business
requirement has been a condition for a broker-dealer's publication or
distribution of research reports in reliance on the rule.\125\ We
continue to believe requiring that research reports be published or
distributed in the regular course of a broker-dealer's business under
rule 139b, consistent with the requirements of rule 139, could reduce
the potential that covered investment fund research reports could be
used to circumvent the prospectus requirements of the Securities
Act.\126\ For the reasons discussed in this section, we are adopting
the regular-course-of-business requirement as proposed.
---------------------------------------------------------------------------
\125\ See Adoption of Rules Relating to Publication of
Information and Delivery of Prospectus by Broker-Dealers Prior to or
After the Filing of a Registration Statement Under the Securities
Act of 1933, Securities Act Release No. 5105 (Nov. 19, 1970) [35 FR
18456 (Dec. 4, 1970)].
\126\ See Proposing Release, supra note 2, at 26797; see also
Securities Offering Reform Adopting Release, supra note 23.
---------------------------------------------------------------------------
2. Industry Research Reports
Rule 139b sets forth conditions for industry research reports that
parallel the corresponding conditions under rule 139 and are intended
to provide appropriate parameters to address the risk of circumvention
of the prospectus requirements of the Securities Act.\127\
---------------------------------------------------------------------------
\127\ See supra notes 49-50 and accompanying text; see also
supra paragraph accompanying notes 12-15.
---------------------------------------------------------------------------
a. Reporting Requirement
Under the rule 139b safe harbor, each covered investment fund
included in an industry research report must be subject to the
reporting requirements of section 30 of the Investment Company Act (or,
for covered investment funds that are not registered investment
companies under the Investment Company Act, the reporting requirements
of section 13 or section 15(d) of the Exchange Act). This reporting
requirement generally tracks an existing requirement for industry
research reports under rule 139 but has been modified so that it would
be applicable to industry research reports that include covered
investment fund issuers.\128\ Like the parallel provision of rule 139,
the reporting requirement under rule 139b helps ensure that there is
publicly available information about the relevant issuers and that
investors are able to use such information in making their investment
decisions. Commenters did not present any concerns regarding the
reporting requirement for purposes of industry research reports, and we
are adopting it as proposed.
---------------------------------------------------------------------------
\128\ See rule 139(a)(2)(i) [17 CFR 230.139(a)(2)(i)] (The
issuer is required to file reports pursuant to section 13 or section
15(d) of the Securities Exchange Act of 1934 or satisfies the
conditions in paragraph (a)(1)(i)(B) of this section.).
---------------------------------------------------------------------------
b. Regular-Course-of-Business Requirement
Under rule 139b, as proposed, a broker-dealer must publish or
distribute research reports in the regular course of its business in
order to rely on the new rule's safe harbor.\129\ The regular-course-
of-business requirement for industry research reports similarly applies
to issuer-specific research reports,\130\ and it also tracks an
existing requirement for industry research reports under rule 139.\131\
---------------------------------------------------------------------------
\129\ Rule 139b(a)(2)(iv) (the broker-dealer publishes or
distributes research reports in the regular course of its business
and, at the time of the publication or distribution of the research
report (in the case of a research report regarding a covered
investment fund that does not have a class of securities in
substantially continuous distribution) is including similar
information about the issuer or its securities in similar reports).
\130\ See supra section II.B.1.c.
\131\ See rule 139(a)(2)(v) [17 CFR 230.139(a)(2)(v)].
---------------------------------------------------------------------------
Like the parallel provision in rule 139, rule 139b's regular-
course-of-business requirement for industry research reports includes
the requirement that, at the time of publication or distribution of the
[[Page 64191]]
industry research report, the broker-dealer is including similar
information about the issuer or its securities in similar reports.\132\
However, unlike rule 139, the ``similar information'' requirement under
rule 139b applies only to circumstances in which a broker-dealer is
publishing or distributing a research report regarding a covered
investment fund that does not have a class of securities in
substantially continuous distribution. As discussed above, the FAIR Act
provides that the safe harbor shall not apply the ``initiation or
reinitiation'' requirement to a research report concerning a covered
investment fund with a class of securities ``in substantially
continuous distribution.'' \133\ We believe that the ``similar
information'' requirement is akin to the ``initiation or reinitiation''
requirement, in that both would have the effect of limiting a broker-
dealer's ability to rely on the rule 139b safe harbor to publish or
distribute a research report about a particular covered investment fund
if the broker-dealer had not previously published research on that
issuer. Therefore, as in the ``initiation or reinitiation''
requirement, we are also excluding covered investment funds from the
``similar information'' requirement if they have a class of securities
in substantially continuous distribution.
---------------------------------------------------------------------------
\132\ Rule 139b(a)(2)(iv).
\133\ See supra notes 113-114 and accompanying text.
---------------------------------------------------------------------------
We provided guidance in section II.B.1.c above on how a broker-
dealer can meet the regular-course-of-business requirement in the
context of issuer-specific research reports, and such guidance would be
equally applicable in meeting the requirement in the context of
industry research reports. We are adopting the requirement as proposed
for the reasons discussed in this section and in the similar section
for issuer-specific research reports.
c. Content Requirements for Industry Research Reports
Rule 139b's safe harbor for publication or distribution of industry
research reports is also conditioned on certain content requirements.
We are adopting these requirements as proposed.
Specifically, under rule 139b, industry research reports either
must include similar information about a substantial number of covered
investment fund issuers of the same type or investment focus (the
``industry representation requirement''),\134\ or alternatively contain
a comprehensive list of covered investment fund securities currently
recommended by the broker-dealer (the ``comprehensive list
requirement'').\135\ These requirements are designed to result in
industry research reports that cover a broad range of investment
companies or securities.\136\ At the same time, the comprehensive list
requirement would permit a different presentation of research about
multiple covered investment funds than the industry representation
requirement would permit.\137\ Because the affiliate exclusion applies
to all covered investment fund research reports--i.e., both issuer-
specific research reports and industry research reports--a broker-
dealer seeking to rely on rule 139b by satisfying either the industry
representation requirement or the comprehensive list requirement cannot
include any covered investment fund issuer that is an affiliate of the
broker-dealer, or for which the broker-dealer serves as an investment
adviser (or is an affiliated person of the investment adviser) in a
covered investment fund research report, including industry research
reports.\138\
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\134\ Rule 139b(a)(2)(ii)(A).
\135\ Rule 139b(a)(2)(ii)(B).
\136\ See Research Reports, Securities Act Release No. 6492
(Oct. 6, 1983) [48 FR 46801 (Oct. 14, 1983)].
\137\ Under rule 139b, a ``comprehensive list'' research report
would have to include a list of all of the broker's currently-
recommended covered investment fund securities, whereas an
``industry representation'' report would not be required to list
each currently-recommended security but instead could cover a more
limited number of issuers as long as a ``substantial number'' of
covered investment fund issuers of the same type or investment focus
were included.
\138\ See rule 139b(a)(2)(ii)(B) (excluding from the
comprehensive list securities of a covered investment fund that is
an affiliate of the broker-dealer, or for which the broker-dealer
serves as investment adviser (or for which the broker-dealer is an
affiliated person of the investment adviser)); see also supra
section II.A.1. In the final rule, we also made a change to rule
139b(a)(2)(ii) to clarify that the industry research report
provisions are with respect to covered investment fund research
reports and the affiliate exclusion set forth therein. Thus, a
broker-dealer cannot include a covered investment fund issuer in any
industry specific report (i.e., industry representation requirement
or the comprehensive list requirement) if the broker-dealer's
relationship to the issuer meets any of the affiliations designated
in the affiliated exclusion.
---------------------------------------------------------------------------
Several commenters argued that a broker-dealer should be able to
include affiliated funds in industry research reports about covered
investment funds.\139\ Another commenter argued that industry research
reports with a substantial number of funds should satisfy the purposes
of the affiliate exclusion if they contain similar information about
each fund and no particular fund is afforded materially greater space
or prominence.\140\ Another commenter suggested that, in some
instances, because affiliated funds may be as or more suitable than
non-affiliated funds, broker-dealers should be allowed to include
affiliated funds in industry research reports.\141\ Several commenters
also argued that we should permit broker-dealers to include both
affiliated and non-affiliated funds in industry research reports, but
only provide the rule 139b safe harbor for the non-affiliated funds
included in the report. They suggested that any information about
affiliated funds included in such a report not benefit from the safe
harbor, and thus any discussions of those funds be subject to the
requirements of rule 482.\142\
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\139\ See ICI Comment Letter; Fidelity Comment Letter; SIFMA
Comment Letter I; see also BlackRock Comment Letter.
\140\ See SIFMA Comment Letter I.
\141\ See Fidelity Comment Letter.
\142\ See SIFMA Comment Letter I; Fidelity Comment Letter.
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We believe extending the rule 139b safe harbor to affiliated funds
in industry research reports (whether industry representation or
comprehensive list reports) would not be consistent with the intent and
plain language of section 2(f)(3) of the FAIR Act.\143\ We also believe
that allowing for a mix of affiliated funds and non-affiliated funds to
appear together in a single research report, as suggested by
commenters, in reliance on two separate and distinct characterizations
of that communication (i.e., under rule 139b such a research report
would be deemed not an offer under the Securities Act, and under rule
482 such a research report would be deemed to be a 10(b) omitting
prospectus) would be an untenable regulatory framework. Not only would
there be differing presentation, liability, and filing standards for
the different portions of the report, but we believe that it could
create challenges for regulators and others and confusion for investors
because the information presented for each type of fund would likely
differ.\144\
[[Page 64192]]
Accordingly, we clarify that broker-dealers may not selectively apply
the rule 139b safe harbor to certain aspects of a research report. The
safe harbor must apply to the entirety of the report or it does not
apply at all. Broker-dealers may, however, instead choose to issue a
rule 482 communication that is styled as an industry research report
about affiliated funds or about affiliated and non-affiliated funds; in
either case, such a communication would be subject to the requirements
of rule 482 and not gain the benefit of the rule 139b safe harbor.
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\143\ This section excludes from the definition of covered
investment fund research report any research report to the extent
that the research report is published or distributed by the covered
investment fund or any affiliate of the covered investment fund, or
any research report published or distributed by any broker-dealer
that is an investment adviser (or an affiliated person of an
investment adviser) for the covered investment fund.
\144\ For example, communications subject to rule 482 must be
filed with the Commission pursuant to section 24(b) of the
Investment Company Act. 15 U.S.C. 80a-24(b). Rule 24b-3 under the
Investment Company Act deems these materials to have been filed with
the Commission if filed with FINRA. 17 CFR 270.24b-3. Unless the
entirety of the research report was filed, reviewing isolated and
selective portions of a research report related to affiliated funds
may not allow for effective review of such materials.
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One commenter raised the concern that excluding affiliated funds
from an industry research report subject to the comprehensive list
requirement may create a false impression that an affiliated fund is
excluded because it does not meet an investor's criteria.\145\ We
acknowledge this possibility. If a broker-dealer is concerned that a
research report purporting to include a comprehensive list of funds may
confuse investors, the broker-dealer could include an explanation of
why affiliated funds are excluded from the research report. For
example, a broker-dealer could include a statement in the report
indicating that it does not include information about affiliated funds
due to relevant securities regulations.
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\145\ See Fidelity Comment Letter.
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One commenter argued that rule 139b should not include industry
report content requirements because covered investment funds do not
have the same market conditioning or ``gun-jumping'' concerns as
securities covered in research reports published or distributed in
reliance on rule 139.\146\ Since many covered investment funds
continuously distribute their securities, conditioning the market
concerns can remain throughout the offering for issuers covered under
rule 139b. Market conditioning is a concern that information about a
fund or its securities might supersede the information provided in
their offering prospectus. With respect to research reports, this
concern is heightened for issuer-specific research reports and
therefore they are subject to more stringent conditions than industry
research reports. Market conditioning, however, remains a concern for
industry research reports, as well. The content requirements for
industry reports are designed to help ensure that industry reports
become a part of the mix of information in the marketplace, rather than
circumventing the prospectus requirements of the Securities Act or the
issuer-specific conditions.
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\146\ See ICI Comment Letter (citing an SEC staff report issued
in 1969 noting that ``gun-jumping'' concerns primarily arise during
the pre-filing stage of a securities offering and casting doubt on
the doctrine's applicability to non-participants in a securities
offering). This commenter made the same argument regarding industry
report presentation requirements. See infra note 152. See also
BlackRock Comment Letter. Rule 139b is not limited to non-
participants. Broker-dealers participating in the distribution of
the covered investment fund's securities may rely on the rule
provided the applicable conditions are satisfied.
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The language from rule 139's industry representation requirement is
replicated in rule 139b, with modifications designed to apply the
language to the covered investment fund context. Under rule 139's
corresponding requirement, an industry research report must include
``similar information with respect to a substantial number of issuers
in the issuer's industry or sub-industry.'' \147\ As discussed in the
Proposing Release, while operating companies are typically grouped
based on their business category, entities that are included in the
definition of ``covered investment fund'' are typically grouped based
either on their type or investment focus.\148\ Therefore, the industry
representation requirement would require an industry research report to
include similar information about a substantial number of issuers
either of the same type (e.g., ETFs or mutual funds that are large cap
funds, bond funds, balanced funds, money market funds, etc.) or
investment focus (e.g., primarily invested in the same industry or sub-
industry, or the same country or geographic region).\149\ We believe
that this requirement tracks rule 139 to the extent practicable and
appropriate, and we did not receive comments on this aspect of the
proposal. For the reasons discussed above, we are adopting the industry
research report content requirements as proposed.
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\147\ Rule 139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)].
\148\ See Proposing Release, supra note 2, at 26800.
\149\ Rule 139b(a)(2)(ii)(A).
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d. Presentation Requirement for Industry Research Reports
As proposed, the rule 139b safe harbor for industry research
reports is conditioned on a presentation requirement. Under the new
rule, analysis of any covered investment fund issuer or its securities
included in an industry research report cannot be given materially
greater space or prominence in the publication than that given to any
other covered investment fund issuer or its securities.\150\
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\150\ Rule 139b(a)(2)(iii).
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We believe that the concerns underlying the rule 139 presentation
requirements apply equally in the context of covered investment fund
research reports.\151\ The industry should already be familiar with
this long-established and well-understood condition, and therefore we
believe implementing a similar presentation condition for industry
research reports on covered investment funds would be straightforward.
---------------------------------------------------------------------------
\151\ See Proposing Release, supra note 2, at 26801.
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One commenter argued that rule 139b should not include industry
report presentation requirements because covered investment funds do
not have the same market conditioning or ``gun-jumping'' concerns as
those securities covered in research reports published or distributed
in reliance of rule 139.\152\ As discussed above, market conditioning
remains a concern for industry research reports.\153\ The presentation
requirements for industry reports are designed to help ensure that
industry reports become a part of the mix of information in the
marketplace, rather than circumventing the prospectus requirements of
the Securities Act or the issuer-specific conditions. For the same
reasons discussed above, we disagree with this commenter.\154\
Accordingly, we are adopting this requirement as proposed.
---------------------------------------------------------------------------
\152\ See ICI Comment Letter; see also BlackRock Comment Letter.
\153\ See supra note 146 and accompanying paragraph.
\154\ See id.
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C. Presentation of Performance Information in Research Reports About
Registered Investment Companies
The proposed rule would not have required standardized performance
presentation for covered investment fund research reports. However, the
Commission requested comment on whether the final rule should require
research reports about registered investment companies to be subject to
standardized performance presentation requirements. The Commission
expressed its concern that not including standardized performance
measures in research reports could lead to investor confusion. The
Commission also noted its longtime recognition that investors tend to
consider investment performance to be a particularly significant factor
in evaluating or comparing investment companies and had previously
identified a number of circumstances in which performance could be
disclosed in a misleading manner.\155\
---------------------------------------------------------------------------
\155\ See Proposing Release, supra note 2, at 26802.
Additionally, the Commission noted its concern that rule 482 or rule
34b-1 could be circumvented by recasting registered investment
company advertisements or selling materials as research reports. Id.
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[[Page 64193]]
In a change from the proposal, we are adopting a condition in rule
139b that if fund performance information is included in a research
report, it must be presented in accordance with certain standardized
presentation requirements dependent on the type of covered investment
fund covered.\156\ For research reports that include registered open-
end fund performance, we are requiring that fund performance be
presented according to the presentment and timeliness requirements of
rule 482.\157\ For research reports that include closed-end fund
performance, one commenter argued for standardized presentation
requirements for all covered investment funds and recommended that
closed-end funds comply with the requirements of Form N-2 instead of
rule 482, which does not offer any standardized performance
requirements for closed-end funds.\158\ We agree with the commenter,
and are therefore requiring that closed-end fund performance be
presented in a manner that is in accordance with the instructions to
item 4.1(g) of Form N-2, although other historical measures of
performance may also be included if any other measurement is set out
with no greater prominence.
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\156\ Rule 139b(a)(3).
\157\ See id. (requiring that a research report discussing fund
performance of a registered open-end management investment company
must present it in accordance with the performance requirements of
paragraphs (d) and (e) of rule 482 [17 CFR 230.482] and must also
comply with the timeliness requirement of performance data in
paragraph (g) of rule 482).
\158\ See ICI Comment Letter; see also BlackRock Comment Letter.
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Specific statutory provisions and rules apply to advertising the
performance of registered investment companies.\159\ An advertisement
about a covered investment fund that is a registered investment company
is deemed a section 10(b) prospectus (also known as an ``advertising
prospectus'' or ``omitting prospectus'') for purposes of section
5(b)(1) of the Securities Act so long as it complies with rule
482.\160\ Therefore, a broker-dealer's publication or distribution of a
research report that complies with the requirements of rule 482 would
not be deemed a non-conforming prospectus in violation of section 5 of
the Securities Act.\161\ As discussed in the Proposing Release, given
the breadth of the definition of ``research report'' under the FAIR Act
(and the definition of ``research report'' under rule 139b), certain
communications by broker-dealers that historically have been treated as
advertisements for registered investment companies under rule 482 now
could be considered covered investment fund research reports subject to
the rule 139b safe harbor.\162\ Among other things, rule 482 requires
standardized presentation of performance data included in registered
open-end investment company advertisements.\163\ Alternatively, if
other performance measures are presented, they must be accompanied by
certain standardized performance data.\164\
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\159\ See, e.g., section 24(g) of the Investment Company Act [15
U.S.C. 80a-24(g)] (directing the Commission to adopt rules or
regulations that permit registered investment companies to use
prospectuses that (i) include information the substance of which is
not included in the statutory prospectus, and (ii) are deemed to be
permitted by section 10(b) of the Securities Act); rule 34b-1 under
the Investment Company Act [17 CFR 270.34b-1] (requiring that, in
order not to be misleading, investment company sales literature must
include certain information, including with respect to performance
information by incorporating certain related provisions of rule 482
of the Securities Act); rule 156 of the Securities Act [17 CFR
230.156] (providing guidance on what statements or omissions of
material fact may be misleading in investment company sales
literature); rule 482 of the Securities Act [17 CFR 230.482]
(setting forth that for an investment company advertisement to be
deemed a prospectus under section 10(b) of the Securities Act, it
must meet certain requirements thereunder, including with respect to
standardized performance information presentation).
\160\ See rule 482 under the Securities Act [17 CFR 230.482].
\161\ See id. FINRA content standards also would generally
require a member's publication or distribution of such a
communication (to the extent it presents performance data as
permitted by rule 482) to include certain of the standardized
performance information specified under rule 482. See FINRA rule
2210(d)(5)(A).
\162\ See Proposing Release, supra note 2, at 26801.
\163\ See rule 482(d)(1)-(4) under the Securities Act (for open-
end investment companies other than money market funds) [17 CFR
230.482(d)(1)-(4)]; rule 482(e) under the Securities Act (for money
market funds) [17 CFR 230.482(e)].
\164\ See rule 482(d)(5) [17 CFR 230.482(d)(5)]. These other
performance measures are not subject to any prescribed method of
computation, but must reflect all elements of return and be
accompanied by quotations of standardized measures of total return
as provided for in paragraphs (d)(3) and (d)(4) of the rule. Rule
482(d)(5) also includes other requirements for the inclusion of non-
standardized performance data, such as presentation and prominence
requirements. See id.
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Because a broker-dealer's publication or distribution of a covered
investment fund research report under rule 139b is deemed not to
constitute an offer for purposes of sections 2(a)(10) and 5(c) of the
Securities Act, a covered investment fund research report would no
longer need to be deemed to be a section 10(b) prospectus (such as an
advertising prospectus under rule 482) for purposes of section 5(b)(1)
of the Securities Act. In addition, some communications that previously
were considered supplemental sales literature under rule 34b-1 under
the Investment Company Act that must be accompanied or preceded by a
statutory prospectus now could be considered covered investment fund
research reports (which need not be preceded or accompanied by a
statutory prospectus).\165\ Rule 34b-1 incorporates many of the rule
482 requirements relating to performance disclosure and makes these
requirements applicable to supplemental sales literature.\166\ As
discussed in the Proposing Release, we are concerned that this shift in
regulatory treatment of research reports about registered investment
companies could result in investor confusion if a communication were
not easily recognizable as research as opposed to an advertising
prospectus or supplemental sales literature. Although there are
multiple provisions in proposed rule 139b that aim to limit the risk
that broker-dealers could use the proposed safe harbor to circumvent
the prospectus requirements of the Securities Act,\167\ there could be
circumstances where, under rule 139b, broker-dealers publish or
distribute communications that historically have been viewed as
registered investment company advertisements or selling materials.
---------------------------------------------------------------------------
\165\ See section 2(a)(10)(a) of the Securities Act; rule
139b(a). See also rule 34b-1 under the Investment Company Act [17
CFR 270.34b-1]. Rule 34b-1 provides that any advertisement,
pamphlet, circular, form letter, or other sales literature addressed
to or intended for distribution to prospective investors that is
required to be filed with the Commission by section 24(b) of the
Investment Company Act will have omitted to state a fact necessary
in order to make the statements made therein not materially
misleading unless it includes certain specified information.
\166\ See rule 34b-1(b)(1)-(2) [17 CFR 270.34b-1(b)(1)-(2)].
\167\ See, e.g., supra sections II.A.1 (affiliate exclusion) and
II.B.1.c and II.B.2.b (regular-course-of-business requirements).
Certain covered investment fund research reports that meet the
definition of ``research report'' in Regulation AC would be subject
to the requirements of Regulation AC. Similarly, covered investment
fund research reports that meet the definition of ``research
report'' in FINRA rule 2241 or the definition of ``debt research
report'' in FINRA rule 2242 would be subject to the content
requirements in those rules as applicable. See infra section II.D.1.
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We received two comment letters addressing this issue.\168\ One
commenter suggested that the presentation of performance information in
research reports about registered investment companies should not be
subject to the standardized performance requirements of rule 482.\169\
This commenter stated that because rule 482 is intended to apply to
advertisements, such presentation requirements might undermine analysis
or insights that a
[[Page 64194]]
research analyst may seek to convey about one or more covered
investment funds by highlighting a particular aspect of performance
information. This commenter also stated that SRO rules would address
the investor confusion concern raised by the Commission. We disagree
that applying standardized performance presentation requirements would
undermine a research analyst's analysis or insights because rule 482
does not preclude non-standardized performance information. Rather, it
requires standardized performance information to be presented if non-
standardized performance information is presented. We believe SRO rules
may address some investor confusion concerns, but we believe requiring
presentation performance requirements would more fully address these
concerns.
---------------------------------------------------------------------------
\168\ See SIFMA Comment Letter I; ICI Comment Letter; see also
BlackRock Comment Letter.
\169\ SIFMA Comment Letter I.
---------------------------------------------------------------------------
Another commenter stated that the Commission should require that
fund-specific performance information in covered investment fund
research reports be presented in accordance with the applicable
standardization requirements.\170\ This commenter stated that investors
tend to consider fund performance a significant factor in evaluating or
comparing funds and that standardized fund performance reporting
requirements have served investors well. Furthermore, this commenter
noted that discrepancies in performance between a broker-dealer's
research report and what a fund may report or disclose in regulatory
filings or advertisements would risk confusing investors. We agree with
both of the commenter's points. This commenter also noted that if the
final rule does not require standardized presentation requirements for
fund performance information, the Commission should require a clear and
prominent disclosure whenever fund-specific performance is not in
accordance with these standards.
---------------------------------------------------------------------------
\170\ ICI Comment Letter. This commenter also suggested the
disclosure of Form N-2 performance data for closed-end funds. See
also BlackRock Comment Letter.
---------------------------------------------------------------------------
The final rule thus requires that a research report that includes
open-end fund performance information must present this information in
accordance with rule 482 presentment and timeliness requirements. A
research report must present closed-end fund performance information in
accordance with the instructions to item 4.1(g) set forth in Form N-2
(although other historical measures of performance may also be included
if the other measurement is set out with no greater prominence than the
measurement that is in accordance with the instructions to item 4.1(g)
of Form N-2).
Rule 139b(a)(3) requirements would not preclude research report
analysts from presenting performance information in their preferred
manner; rather, it requires that standardized performance information
also be included if non-standardized performance information is
presented. To satisfy this requirement, analysts may choose to present
non-standardized performance information in a way they believe
highlights a particular insight or analysis, so long as it is presented
alongside the standardized performance information consistent with rule
482 requirements or Form N-2, if applicable.\171\
---------------------------------------------------------------------------
\171\ See rule 139b(a)(3).
---------------------------------------------------------------------------
As noted in the proposal, covered investment fund research reports
relying on the rule 139b safe harbor are subject to the antifraud
provisions of the federal securities laws.\172\ The Commission has
previously articulated guidance on factors to be weighed in considering
whether statements involving a material fact in registered investment
company advertisements and sales literature, which are also subject to
the antifraud provisions of the federal securities laws, could be
misleading.\173\ This guidance provided factors to be weighed when
determining whether fund performance in sales literature is adequately
disclosed. The guidance factors in rule 156 \174\ are informative in
evaluating whether any presentations of registered investment company
performance in these research reports could be misleading because they
reflect principles that would help guide this analysis (such as
providing information to investors that is informative and that does
not create unrealistic investor expectations \175\). We believe that
incorporating these rule 482 and Form N-2 presentation standards in
rule 139b reduces the potential for confusion between (i) registered
open-end management investment company advertisements and selling
materials covered by rule 482 and registered closed-end investment
company selling materials covered by Form N-2 and (ii) rule 139b
research reports. Moreover, we believe it would reduce the potential
for investor confusion resulting from divergent standards in the
presentation of performance data.
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\172\ See section 2(c)(1) of the FAIR Act (stating that nothing
in the FAIR Act shall be construed as in any way limiting the
applicability of the antifraud or anti-manipulation provisions of
the federal securities laws and rules adopted thereunder to a
covered investment fund research report, including section 17 of the
Securities Act, section 34(b) of the Investment Company Act, and
sections 9 and 10 of the Exchange Act).
\173\ See Amendments to Investment Company Advertising Rules,
Securities Act Release No. 8294 (Sept. 29, 2003) [68 FR 57759 (Oct.
6, 2003)]; see also rule 156 under the Securities Act [17 CFR
230.156].
\174\ Rule 156(b) under the Securities Act provides guidance
factors concerning misleading statements in investment company sales
literature including: (i) Statements and omissions generally
(including in light of general economic or financial conditions or
circumstances), (ii) representations about past or future investment
performance, and (iii) statements involving a material fact about an
investment company's characteristics or attributes.
\175\ See Amendments to Investment Company Advertising Rules,
Securities Act Release No. 8101 (May 17, 2002) [67 FR 36712 (May 24,
2002)].
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D. Role of Self-Regulatory Organizations
1. SRO Content Standards and Filing Requirements for Covered Investment
Fund Research Reports
SRO Content Standards
The FAIR Act contemplates that SRO content standards applicable to
research reports would apply to covered investment fund research
reports.\176\ Specifically, the FAIR Act provides that, unless covered
investment fund research reports are subject to the content standards
in the rules of any SRO related to research reports, these research
reports may still be subject to the filing requirements of section
24(b) of the Investment Company Act for the review of investment
company sales literature.\177\ As discussed in more detail below, we
are adopting rule 24b-4 to implement this provision of the FAIR Act.
New rule 24b-4 provides that a covered investment fund research report
about a registered investment company will not be subject to section
24(b) of the Investment Company Act (or the rules and regulations
thereunder), except to the extent the
[[Page 64195]]
research report is otherwise not subject to the content standards in
SRO rules related to research reports, including those contained in the
rules governing communications with the public regarding investment
companies or substantially similar standards.\178\
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\176\ See section 2(b)(4) of the FAIR Act (A covered investment
fund research report shall not be subject to section 24(b) of the
Investment Company Act or the rules and regulations thereunder,
except that such report may still be subject to such section and the
rules and regulations thereunder to the extent that it is otherwise
not subject to the content standards in the rules of any self-
regulatory organization related to research reports, including those
contained in the rules governing communications with the public
regarding investment companies or substantially similar standards.).
This provision is relevant only to research reports on covered
investment funds that are investment companies subject to section
24(b) of the Investment Company Act. For example, registered closed-
end investment companies, BDCs, and commodity- or currency-based
trusts or funds are covered investment funds that are not subject to
section 24(b) of the Investment Company Act. A covered investment
fund research report that is not subject to section 24(b) of the
Investment Company Act would not be subject to filing requirements
under that section even if research reports concerning the covered
investment fund were not subject to the content standards in the
rules of any self-regulatory organization related to research
reports.
\177\ See id.
\178\ See rule 24b-4.
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Currently, the SRO content standards relevant to communications
that would be considered covered investment fund research reports under
rule 139b include the applicable content standards of FINRA rules 2210,
2241, and 2242.\179\ FINRA's rule governing communications with the
public (FINRA rule 2210) contains general content standards that apply
broadly to member communications,\180\ including broker-dealer research
reports. These general content standards require, among other things,
that all member communications ``must be based on principles of fair
dealing and good faith, must be fair and balanced, and must provide a
sound basis for evaluating the facts in regard to any particular
security or type of security, industry or service.'' \181\
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\179\ See infra note 183 (discussing the scope of these rules in
more detail, including noting that the scope of certain provisions
of FINRA rule 2210, and the scope of FINRA rules 2241(c)(1) and
2242(c)(2) generally, apply only to a certain subset of
communications that would be considered covered investment fund
research reports under rule 139b).
\180\ See FINRA rule 2210(d)(1).
\181\ See FINRA rule 2210(d)(1)(A). FINRA rule 2210's general
content standards also provide, among other things, that FINRA
members may not ``make any false, exaggerated, unwarranted,
promissory or misleading statement or claim in any communication''
nor ``publish, circulate or distribute any communication that the
member knows or has reason to know contains any untrue statement of
a material fact or is otherwise false or misleading.'' See FINRA
rule 2210(d)(1)(B).
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The FAIR Act does not explicitly refer to specific content
standards in SRO rules. It refers more generally to ``the content
standards in the rules of any self-regulatory organization related to
research reports, including those contained in the rules governing
communications with the public regarding investment companies or
substantially similar standards.'' \182\ In order to provide clarity
and facilitate consistent and predictable application of rule 24b-4, we
interpret section 2(b)(4) of the FAIR Act as excluding covered
investment fund research reports from section 24(b) of the Investment
Company Act so long as they continue to be subject to the general
content standards in FINRA rule 2210(d)(1) (or substantially similar
SRO rules). Accordingly, by operation of rule 24b-4, covered investment
fund research reports under rule 139b that otherwise would be subject
to section 24(b) of the Investment Company Act would not be subject to
that section so long as they remain subject to the general content
standards of FINRA rule 2210(d)(1).\183\ This interpretation is
consistent with our belief that it is important for SRO content
standards to continue to apply to covered investment fund research
reports, especially if, as discussed below, research reports about
registered investment companies would no longer be required to be filed
pursuant to section 24(b) of the Investment Company Act or rule 497
under the Securities Act,\184\ and therefore would no longer be subject
to routine review.\185\ We received no comments on SRO content
standards specifically, but some commenters suggested that FINRA rules
(particularly with respect to definitions and filing requirements
thereunder) be modified or harmonized with rule 139b, which we discuss
below.\186\
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\182\ Section 2(b)(4) of the FAIR Act.
\183\ A subset of communications that would fall within the
definition of ``covered investment fund research report'' under rule
139b also would be subject to additional content-related
requirements under FINRA rules that are applicable to certain
research reports, but that are more narrowly applicable than the
general content standards of FINRA rule 2210(d)(1). However, under
our interpretation, whether or not these additional content
standards apply to any given covered investment fund research report
would not determine the applicability of section 24(b) to that
research report under proposed rule 24b-4. A different
interpretation could lead to results that we believe could be
inconsistent with section 2(b)(4) of the FAIR Act (i.e., if only
communications that are subject to additional FINRA content
standards discussed in this footnote (e.g., those applicable to
retail communications) were excluded from section 24(b) filing
requirements).
Additional FINRA content-related requirements include the
content standards of FINRA rule 2210 that apply only to retail
communications (or retail communications and correspondence, as
those terms are defined in FINRA rule 2210(a)). See, e.g., FINRA
rules 2210(d)(2) (Comparisons), 2210(d)(3) (Disclosure of Member's
Name). Accordingly, covered investment fund research reports that
would meet the definition of institutional communications would not
be subject to some of the content standards of FINRA rule 2210.
These additional requirements also include the content
standards incorporated in FINRA rules 2241 and 2242, which apply to
certain research reports defined in these FINRA rules. The scope of
FINRA rules 2241 and 2242 only includes research reports or debt
research reports as defined in these rules, and the definitions of
``research report'' and ``debt research report'' in these rules are
different than the definitions of ``research report'' set forth in
rule 139 and new rule 139b. Under FINRA rule 2241, ``research
report'' is defined as any written (including electronic)
communication that includes an analysis of equity securities of
individual companies or industries (other than an open-end
registered investment company that is not listed or traded on an
exchange) and that provides information reasonably sufficient upon
which to base an investment decision; similarly, under FINRA rule
2242, ``debt research report'' is defined as any written (including
electronic) communication that includes an analysis of a debt
security or an issuer of a debt security and that provides
information reasonably sufficient upon which to base an investment
decision, excluding communications that solely constitute an equity
research report as defined in FINRA rule 2241(a)(11). See FINRA
rules 2241(a)(11), 2242(a)(3).
\184\ See infra notes 187-189 and accompanying text.
\185\ Broker-dealer communications that are excluded from, or
otherwise not subject to FINRA's filing requirements may still be
reviewed by FINRA, for example, through examinations, targeted
sweeps or spot-checks. FAIR Act section 2(c)(2) provides that
nothing in the Act shall be construed as in any way limiting ``the
authority of any self-regulatory organization to examine or
supervise a member's practices in connection with such member's
publication or distribution of a covered investment fund research
report for compliance with applicable provisions of the Federal
securities laws or self-regulatory organization rules related to
research reports, including those contained in rules governing
communications with the public.'' See also, e.g., FINRA rule
2210(c)(6) (``In addition to the foregoing requirements, each
member's written (including electronic) communications may be
subject to a spot-check procedure. Upon written request from
[FINRA's Advertising Regulation] Department, each member must submit
the material requested in a spot-check procedure within the time
frame specified by the Department.'').
\186\ See, e.g., Fidelity Comment Letter; SIFMA Comment Letter
I.
---------------------------------------------------------------------------
Filing Requirements for Covered Investment Fund Research Reports
Rule 24b-4, as adopted, modifies the filing requirements that
currently apply to certain broker-dealer communications regarding
registered investment companies. Today, registered investment company
sales literature, including rule 482 omitting prospectus
advertisements, are required to be filed with the Commission under
section 24(b) of the Investment Company Act \187\ and rule 497 under
the Securities Act.\188\ Rule 24b-3 under the Investment Company Act
and rule 497(i) deem these materials to have been filed with the
Commission if filed with FINRA.\189\
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\187\ See supra note 144.
\188\ See rule 497 of the Securities Act [17 CFR 230.497]. Rule
497, which generally requires investment company prospectuses,
including investment company advertisements deemed to be a section
10(b) prospectus pursuant to rule 482, to be filed with the
Commission.
\189\ See supra note 144; see also 17 CFR 230.497(i).
---------------------------------------------------------------------------
As discussed in the Economic Analysis below, we anticipate that
certain communications that historically have been treated as
investment company sales literature, including rule 482 ``omitting
prospectus'' advertisements, would be published or distributed by a
broker-dealer as covered investment fund research reports pursuant to
the rule 139b safe harbor.\190\ Such communications styled
[[Page 64196]]
as ``research reports'' that previously had been subject to the filing
requirements of section 24(b) of the Investment Company Act no longer
would be subject to these requirements by operation of rule 24b-4, as
adopted, because they would be subject to the general content standards
of FINRA rule 2210(d)(1).\191\
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\190\ See infra section III.C.3.
\191\ A communication that previously had been subject to the
filing requirements of rule 497 also would no longer be subject to
the rule 497 filing requirements if it were published or distributed
by a broker-dealer as a covered investment fund research report,
because it would no longer be considered to be a section 10(b)
prospectus. See supra paragraph accompanying notes 165-167.
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FINRA rule 2210 requires the filing of certain communications,
including retail communications that promote or recommend a specific
registered investment company or family of registered investment
companies.\192\ However, FINRA provides a number of exclusions from the
filing requirements.\193\ For example, with respect to research reports
(as that term is defined in FINRA rule 2241), FINRA currently excludes
from filing those that concern only securities that are listed on a
national securities exchange, other than research reports required to
be filed with the Commission pursuant to section 24(b) of the
Investment Company Act.\194\ Because covered investment fund research
reports are not required to be filed with the Commission pursuant to
section 24(b), as directed by the FAIR Act, rule 24b-4 could have the
effect of narrowing the types of communications that would be filed
with FINRA (under current FINRA rule 2210) regarding registered
investment companies.
---------------------------------------------------------------------------
\192\ See FINRA rule 2210(c)(3) (broker-dealers must file,
within 10 business days of first use or publication, retail
communications that promote or recommend a specific registered
investment company or family of registered investment companies).
See generally FINRA rule 2210(c)(1)-(3). In addition to these FINRA
filing requirements, as discussed above, such communications would
be required to be filed with the Commission (and are deemed to have
been filed with the Commission if filed with FINRA). See supra notes
187-189 and accompanying text.
\193\ See generally FINRA rule 2210(c)(7).
\194\ See FINRA rule 2210(c)(7)(O).
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However, the FAIR Act's rules of construction provide that the Act
shall not be construed as limiting the authority of an SRO to require
the filing of communications with the public if the purpose of such
communications ``is not to provide research and analysis of covered
investment funds.'' \195\ Therefore, even if the exclusion of covered
investment fund research reports from the provisions of section 24(b)
affects the applicability of the filing requirements or exclusions
under FINRA rule 2210 with respect to covered investment fund research
reports, it would not affect FINRA's authority to require the filing of
a communication that is included in the FAIR Act's definition of
``covered investment fund research report'' but whose purpose is not to
provide research and analysis.\196\ In addition, a covered investment
fund research report would continue to be subject to FINRA
recordkeeping requirements applicable to communications with the
public, even if the broker-dealer would not be required to file the
research report with FINRA or the Commission.\197\
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\195\ See section 2(c)(2) of the FAIR Act.
\196\ Id. See also 15 U.S.C. 80a-24(b); FINRA rule 2210.
\197\ See FINRA rule 2210(b)(4)(A) (requiring members to
maintain all retail communications and institutional communications
for the retention period required by Exchange Act rule 17a-4(b) and
in a format and media that comply with Exchange Act rule 17a-4).
---------------------------------------------------------------------------
Two commenters requested that FINRA's filing requirements be
modified in light of the FAIR Act.\198\ One commenter recommended that
the Commission work with FINRA to harmonize FINRA's research rules with
rule 139b and that broker-dealers relying on rule 139b be exempted from
FINRA's filing requirements with respect to covered investment fund
research reports.\199\ Another commenter suggested that the relevant
statutory language of the FAIR Act \200\ should be interpreted to be
limited to covered investment fund research reports made in reliance of
the 139b safe harbor that only provide ``information'' that a user
would not be able to use for research and analysis.\201\ This commenter
asserted that only covered investment fund research reports that solely
provide information would fall within the scope of what an SRO could
require to be filed under its authority. Moreover, one commenter argued
that because the definition of ``research report'' under the FAIR Act
was broader than FINRA's definition of research report, that this may
cause confusion and conflicting interpretive views on what
communications are deemed research for purposes of the safe harbor and
filing exclusion.\202\
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\198\ See SIFMA Comment Letter I; Fidelity Comment Letter.
\199\ See Fidelity Comment Letter.
\200\ The FAIR Act provides that the Act does not limit the
authority of any self-regulatory organization to require the filing
of communications with the public the purpose of which is not to
provide research and analysis of covered investment funds. See
section 2(c)(2) of the FAIR Act.
\201\ SIFMA Comment Letter I.
\202\ See Fidelity Comment Letter.
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As we discussed above, section 2(c)(2) of the FAIR Act states that
nothing in the FAIR Act shall be construed as in any way limiting the
authority of an SRO, which includes FINRA, to require the filing of
communications with the public, including covered investment fund
research reports, the purpose of which is not to provide research and
analysis of covered investment funds. To the extent FINRA would seek to
amend its rules, any such proposed rule changes would be filed with the
Commission pursuant to section 19(b)(1) of the Exchange Act and rule
19b-4 thereunder.
2. SRO Limitations
The FAIR Act also directs us to provide that SROs may not maintain
or enforce any rule that would (i) prohibit the ability of a member to
publish or distribute a covered investment fund research report solely
because the member is also participating in a registered offering or
other distribution of any securities of such covered investment fund;
or (ii) prohibit the ability of a member to participate in a registered
offering or other distribution of securities of a covered investment
fund solely because the member has published or distributed a covered
investment fund research report about such covered investment fund or
its securities.\203\ Proposed rule 139b incorporated this provision of
the FAIR Act, and we received no comments on this aspect of the
proposal. We note that these limitations on an SRO and any rules
relating to research reports that an SRO might adopt would not affect
the safe harbor provided by rule 139b. To provide additional context
for the safe harbor, however, and in light of Congress's direction that
we provide these limitations in implementing the rulemaking required by
the FAIR Act, we have set forth these SRO limitations in rule 139b as
proposed.\204\
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\203\ Section 2(b)(3) of the FAIR Act.
\204\ See rule 139b(b).
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E. Conforming and Technical Amendments
Rule 101 of Regulation M under the Exchange Act \205\ prohibits any
person who participates in a distribution from attempting to induce
others to purchase securities covered by the rule during a specified
period. It provides an exception for certain research activities--
namely, the publication or dissemination of any information, opinion,
or recommendation--if the conditions of Securities Act rule 138 or rule
139 are satisfied. We proposed, in connection with our adoption of
Securities Act rule 139b, a conforming
[[Page 64197]]
change to the exception contained within rule 101(b)(1) of Regulation M
to permit the publication or dissemination of any information, opinion,
or recommendation so long as the conditions of rule 139b are satisfied.
---------------------------------------------------------------------------
\205\ 17 CFR 242.101(a).
---------------------------------------------------------------------------
The conforming amendment is intended to align the treatment of
research under rule 139b with the treatment of research under rules 138
and 139 for purposes of Regulation M. In the absence of the conforming
amendment, rule 101 could prevent the publication or dissemination of a
covered investment fund research report under the rule 139b safe harbor
by a broker-dealer that is participating in a distribution that is
covered by Regulation M. We believe that such a result would be
contrary to the mandate of the FAIR Act. The conforming amendment is
intended to harmonize treatment of research under the Securities Act
and Exchange Act rules. We received no comments on this aspect of the
proposal. We are adopting the conforming amendment as proposed.
In October 2016, the Commission adopted new rules and forms and
amended other rules and forms under the Investment Company Act to
modernize the reporting and disclosure of information by registered
investment companies.\206\ The Commission, among other things, adopted
Form N-CEN, a new form for registered investment companies to report
census-type information to the Commission, and rescinded Form N-SAR, a
form on which the Commission had previously collected census-type
information on management investment companies and unit investment
trusts. To implement these changes, the Commission revised references
to rules and forms to remove references to Form N-SAR and replace them
with references to Form N-CEN, but inadvertently did not revise Form
12b-25. We are making a technical amendment to Form 12b-25 to replace
references to Form N-SAR with references to Form N-CEN and to remove
the checkbox and accompanying text related to transition reports on
Form N-SAR.\207\
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\206\ See Reporting Modernization Release, supra note 53.
\207\ Transition reports on Form N-SAR were covered by rule
30b1-3 under the Investment Company Act, which was rescinded by the
Reporting Modernization Adopting Release. See Reporting
Modernization Adopting Release, supra note 53, at 81929 n.781 and
accompanying and following text.
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III. Economic Analysis
A. Introduction
We are mindful of the costs and benefits of our rules. Section 2(b)
of the Securities Act, section 3(f) of the Exchange Act, and section
2(c) of the Investment Company Act state that when the Commission is
engaging in rulemaking under such titles and is required to consider or
determine whether an action is necessary or appropriate in (or, with
respect to the Investment Company Act, consistent with) the public
interest, the Commission shall consider, in addition to the protection
of investors, whether the action will promote efficiency, competition,
and capital formation.\208\ Additionally, Exchange Act section 23(a)(2)
requires us, when making rules or regulations under the Exchange Act,
to consider, among other matters, the impact that any such rule or
regulation would have on competition and states that the Commission
shall not adopt any such rule or regulation which would impose a burden
on competition that is not necessary or appropriate in furtherance of
the Exchange Act.\209\
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\208\ 15 U.S.C. 77b(b); 15 U.S.C. 78c(f); 15 U.S.C. 80a-2(c); 15
U.S.C. 80b-2(c).
\209\ 15 U.S.C. 78w(a)(2).
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The economic analysis proceeds as follows. We begin with a
discussion of the baseline used in the analysis. We then discuss the
costs and benefits of the rules we are adopting, as well as the effects
of these rules on efficiency, competition, and capital formation
compared to the baseline. Where possible, we attempt to quantify the
economic effects we discuss, although in many cases we are unable to do
so and instead rely on qualitative characterizations. In the Proposing
Release, we requested comment on our analysis of these effects.\210\ We
did not receive comments that provided any additional quantification of
these effects, nor did commenters provide data that could facilitate a
more quantitative analysis. We therefore continue to be unable to
produce reasonable quantitative estimates for most of the economic
effects, and--as in the Proposing Release--rely on qualitative economic
assessments instead.\211\
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\210\ See Proposing Release, supra note 2.
\211\ See id.
---------------------------------------------------------------------------
B. Baseline
The Commission's economic analysis evaluates the costs and benefits
of the rules being adopted relative to a baseline that represents the
best assessment of relevant markets and market participants in the
absence of these rules. In this section, we begin by characterizing the
relevant market structure and participants.\212\ We then proceed to
describe the relevant regulatory structure.
---------------------------------------------------------------------------
\212\ To characterize the baseline, we rely on data from year-
end 2017 where possible; however, in some cases, timing issues
related to data availability require us to rely on data from prior
periods.
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1. Market Structure and Market Participants
The rules we are adopting directly affect broker-dealers, but their
indirect effects extend to covered investment funds, other producers of
research on covered investment funds, and consumers of information
about covered investment funds.\213\
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\213\ The rules we are adopting, through their effects on
capital formation, may also affect securities issuers more broadly.
See infra section III.C.5.
---------------------------------------------------------------------------
a. Covered Investment Funds
The ``covered investment fund'' definition in the FAIR Act and rule
139b has the effect of capturing five common types of investment
vehicles: Mutual funds, ETFs, certain currency and commodity exchanged
traded products (``ETPs''), \214\ closed-end funds, and BDCs.\215\ As
shown in Figure 1, the universe of covered investment funds is large.
At the end of 2017, there were 11,924 such entities, including 9,564
mutual funds, 1,629 ETFs and ETPs, 596 closed-end funds, and 135
BDCs.\216\ The total public market value of covered investment funds
exceeds $20 trillion. Of this total, $17 trillion is held through
shares issued by open-end mutual funds, $3 trillion through shares of
ETFs and ETPs, $317 billion through shares of closed-end funds, and $27
billion through shares of BDCs.\217\
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\214\ Exchange-traded trusts with assets consisting primarily of
commodities, currencies, or derivative instruments that reference
commodities or currencies (commonly referred to as currency ETPs and
commodity ETPs) and which are not registered under the Investment
Company Act; see rule 139b(c)(2)(ii).
\215\ See supra section II.A.3.
\216\ Mutual fund, ETF, and ETP statistics are based on data
from CRSP mutual fund database (2017Q4). Closed-end fund statistics
are based on data from CRSP monthly stock file (Dec. 2017). BDC
statistics are based on the Commission's listing of registered BDCs.
Securities and Exchange Commission, Business Development Company
Report: January 2012-July 2018 (Sept. 28, 2018), available at
https://www.sec.gov/open/datasets-bdc.html.
\217\ See supra note 216. Market value of BDC shares are based
on information obtained from CRSP, Compustat, and Audit Analytics.
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BILLING CODE 8011-01-P
[[Page 64198]]
[GRAPHIC] [TIFF OMITTED] TR13DE18.000
[[Page 64199]]
[GRAPHIC] [TIFF OMITTED] TR13DE18.001
Covered investment fund shares represent a significant fraction of
investment assets held by U.S. residents. Approximately one-third of
U.S. corporate equity issues, one-quarter of U.S. municipal securities,
one-fifth of corporate debt, one-fifth of U.S. commercial paper, and
one-tenth of U.S. treasury and agency securities are held through
covered investment funds.\218\ Mutual funds comprise the bulk (84%) of
covered investment funds.\219\ Nearly half of U.S. households hold
mutual fund shares \220\ and the vast majority (89%) of mutual fund
shares are held through retail accounts (i.e., accounts of retail
investors, or households).\221\ Consequently, at least 75% of the
public market value of all covered investment funds is held through
retail accounts. By analyzing institutional holdings from year-end 2017
Form 13F filings we estimate that across ETF and ETPs, the mean
institutional holding \222\ was 45%.\223\ For BDCs, we estimate the
mean institutional holding was 30%, while for closed-end funds, we
estimate the mean institutional holding was 21%. Based on these
figures, we further estimate that shares representing 86% of the public
market value of all covered investment funds are held through retail
accounts.\224\
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\218\ See Investment Company Institute, 2017 Investment Company
Fact Book (2017), available at http://www.icifactbook.org/ (``ICI
Fact Book'').
\219\ See supra note 217.
\220\ See Investment Company Institute, Ownership of Mutual
Funds, Shareholder Sentiment, and Use of the internet (2017),
available at https://www.ici.org/pdf/per23-07.pdf.
\221\ Percentage by value. See ICI Fact Book, supra note 218, at
30. Excluding money market funds (``MMF''), mutual fund shares held
in retail accounts make up an even larger fraction (95%) of mutual
fund shares.
\222\ We calculated ``institutional holding'' as the sum of
shares held by institutions (as reported on Form 13F filings)
divided by shares outstanding (as reported in CRSP).
\223\ Year-end 2017 Form 13F filings were used to estimate
institutional ownership. Closed-end funds were matched to reported
holdings based on CUSIP. We note that there are long-standing
questions around the reliability of data obtained from 13F filings.
See Anne M. Anderson & Paul Brockman, Form 13F (Mis)Filings, SSRN
Scholarly Paper. Rochester, NY: Social Science Research Network
(Oct. 15, 2016), available at https://papers.ssrn.com/abstract=2809128. See also Securities and Exchange Commission,
Office of Inspector General, Office of Audits, Review of the SEC's
Section 13(f) Reporting Requirements (Sept. 27, 2010), available at
https://www.sec.gov/files/480.pdf.
\224\ Staff calculated the percentage of net asset value held by
institutions reported on Form 13F for ETFs, ETPs and BDCs as public
market value of shares held by institutions divided by public market
value of all shares. Mutual funds shares are generally not required
to be reported on Form 13F. We estimate institutional ownership of
non-MMF mutual funds using ICI Fact Book estimate (95%). See supra
note 221 and accompanying text.
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[[Page 64200]]
As depicted in Figure 3, the covered investment fund market is
dynamic. In 2017, 638 covered investment funds were created, while 853
were closed or merged into other covered investment funds.\225\
[GRAPHIC] [TIFF OMITTED] TR13DE18.002
b. Broker-Dealers
---------------------------------------------------------------------------
\225\ See supra note 216.
---------------------------------------------------------------------------
The broker-dealers directly affected by the rules we are adopting
are those who participate in registered offerings of covered investment
funds while at the same time publishing or distributing information
about those funds. The Commission does not have comprehensive data on
the number or characteristics of broker-dealers currently publishing
and distributing communications about covered investment funds, the
extent of their communications, and their distribution arrangements
with covered investment funds. Therefore we rely on inferences based on
the data that are available \226\ and make certain assumptions when
characterizing the baseline.
---------------------------------------------------------------------------
\226\ We rely here primarily on broker-dealers' quarterly FOCUS
reports.
---------------------------------------------------------------------------
We believe that broker-dealers that do not derive revenues from the
distribution of covered investment funds are less likely to be directly
affected by the rules we are adopting.\227\ As discussed above,
registered investment companies represent the vast majority of covered
investment funds.\228\ Broker-dealers report revenues from the
distribution of investment company shares in regulatory filings,\229\
and we use this to estimate broker-dealers' revenues from distribution
of covered investment funds. We estimate that for the 3,882 broker-
dealers active in 2017, revenues related to distribution of covered
investment funds exceeded $28 billion, or 9% of total broker-dealers'
revenues. Of these 3,882 broker-dealers, 1,417 reported revenues from
the distribution of investment company shares. These 1,417 ``affected''
broker-dealers accounted for 74% of total broker-dealer revenues and
59% of total broker-dealer assets.\230\ As shown in
[[Page 64201]]
Figure 4, among the affected broker-dealers, the importance of revenues
from the distribution of covered investment funds varies widely.\231\
However, in aggregate, these revenues accounted for 13% of affected
broker-dealers' total revenues.\232\ For comparison, among the affected
broker-dealers, revenues from brokerage trading commissions and account
management accounted for 9%, and 20% of total revenues, respectively,
while revenues from propriatery trading and underwriting accounted for
4% and 8% of total revenues, respectively.
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\227\ We believe that broker-dealers that do not participate in
the distribution of covered investment funds are less likely to
publish or distribute research reports about such funds and--to the
extent that they do--may not derive significant benefits from the
safe harbor of rule 139b.
\228\ See supra section III.B.1.a.
\229\ The sum of FOCUS Supplemental Statement of Income items:
13970 (``revenues from sales of investment company shares''), 11094
(``12b-1 fees''), and 11095 (``mutual fund revenue other than
concessions or 12b-1 fees'').
\230\ We describe these dealers as ``affected,'' but the degree
to which they are affected will vary based on individual
characteristics. Other things being equal, we expect broker-dealers
that are currently more active in the marketing of covered
investment funds would be more affected.
\231\ This suggests that the degree to which the ``affected''
broker-dealers are affected by the rule will also vary widely.
\232\ Estimates are based on staff analysis of FOCUS filings.
[GRAPHIC] [TIFF OMITTED] TR13DE18.003
BILLING CODE 8011-01-C
c. Research on Covered Investment Funds
The Commission does not have comprehensive data on broker-dealers
that publish or distribute research reports on entities that are
included within the definition of ``covered investment fund'' under
rule 139b.\233\ The Commission estimates that in 2017, there were 1,417
broker-dealers that reported revenues from the distribution of covered
investment funds.\234\ We assume that these broker-dealers will have
incentives to publish or distribute research reports about covered
investment funds. However, due to the large number of covered
investment funds, we do not expect that many broker-dealers' in-house
research departments (if they have such departments) are currently
capable of providing research on a large percentage of covered
investment funds. Most covered investment funds are not followed by
dedicated research analysts akin to the analyst coverage that the
Commission has previously identified as being one indicator of market
interest and following for operating companies.
---------------------------------------------------------------------------
\233\ See supra section III.B.1.b.
\234\ See id.
---------------------------------------------------------------------------
Existing Commission and SRO rules do not delineate a category of
``research reports'' pertaining to covered investment funds.
Consequently, it is not possible to identify with precision broker-
dealer communications under the baseline that would be considered
``research reports'' as defined in rule 139b. However, we understand
that some broker-dealers have published and distributed communications
styled as ``research reports'' in compliance with rule 482 under the
Securities Act.\235\ FINRA member firms--the vast majority \236\ of
broker-dealers--file these communications with FINRA.\237\ The number
of communications filed with FINRA help to provide an estimate of the
number of communications currently published or distributed by broker-
dealers that could potentially be considered ``research reports'' under
rule 139b. FINRA staff has reported reviewing 47,707 filings subject to
rule 482 in 2017. FINRA staff reviewed an additional 8,528
communications that are subject to Investment Company Act
[[Page 64202]]
rule 34b-1, for a total of 56,235 communications.\238\ There are
several factors that limit our ability to extrapolate from these
estimates the number of communications that broker-dealers currently
publish or distribute that would satisfy the definition of ``covered
investment fund research report'' under rule 139b. First, these data do
not reflect the affiliate exclusion incorporated in the rule 139b
definition of ``covered investment fund research report,'' which has
the effect of excluding from the safe harbor research reports that are
published or distributed by persons covered by the affiliate
exclusion.\239\ Second, the data do not include communications about
entities that would be considered ``covered investment funds,'' but
that do not need to comply with the requirements of rule 482 (e.g.,
commodity- or currency-based trusts or funds). Third, for those
communications that are currently filed as rule 482 advertising
prospectuses or rule 34b-1 supplemental sales literature, we are
uncertain what percentage of these communications broker-dealers would
continue to structure as rule 482 advertising prospectuses or rule 34b-
1 supplemental sales literature, as opposed to publishing or
distributing them as covered investment fund research reports under the
rule 139b safe harbor.
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\235\ See supra note 162 and accompanying text.
\236\ Based on staff analysis of FOCUS filings, we estimate that
as of year-end 2017, there were 3,882 registered broker-dealers,
3,755 of which were members of FINRA.
\237\ See supra note 189 and accompanying text.
\238\ Under rule 34b-1, ``sales literature'' required to be
filed by section 24(b) shall have omitted to state a fact necessary
in order to make the statements made therein not materially
misleading unless the sales literature includes certain specified
information. See rule 34b-1 [17 CFR 270.34b-1]; see also supra note
165.
Of the 47,707 filings subject to rule 482, 229 were also subject
to rule 34b-1. These 229 are not included in the 8,528 figure.
Statistics provided by FINRA.
\239\ See supra notes 18-21 and accompanying text.
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We have also analyzed the number of ``research reports'' as defined
under FINRA rules 2241 and 2242 that FINRA staff reviewed in 2017.
However, for reasons discussed below, we also believe that these data
have limited value in assessing the number of covered investment fund
research reports whose publication or distribution could be eligible
for the safe harbor under rule 139b. FINRA reviewed 354 filings in 2017
that were identified as ``research reports'' as defined in FINRA rules
2241 and 2242. However, the definitions of ``research report'' and
``debt research report'' under FINRA rules 2241 and 2242, respectively,
do not correspond in every respect to the term ``research report'' as
defined in the FAIR Act and rule 139b.
Under FINRA rule 2241, the term ``research report'' includes any
written communication that includes an analysis of equity securities
(other than mutual fund securities) and that provides information
reasonably sufficient upon which to base an investment decision.\240\
Under FINRA rule 2242, the term ``debt research report'' includes any
written communication that includes an analysis of a debt security or
an issuer of a debt security and that provides information reasonably
sufficient upon which to base an investment decision.\241\ As discussed
above, the FAIR Act and the rule 139b definition of ``research report''
do not require a communication to provide information reasonably
sufficient upon which to base an investment decision.\242\ Also, unlike
the definition of ``research report'' in FINRA rule 2241, the FAIR Act
and the rule 139b definitions of ``research report'' include
communications about mutual funds. Thus, while the number of ``research
reports'' as defined in FINRA rules 2241 and 2242 that FINRA staff has
historically reviewed provides an estimate of a subset of
communications currently being styled as ``research reports'' whose
publication or distribution could be eligible for the rule 139b safe
harbor, this number would represent only a small portion of the
complete universe of research reports whose publication or distribution
could be eligible for this safe harbor. We also understand that the
reported number of ``research reports'' as defined in FINRA rules 2241
and 2242 that FINRA staff has historically reviewed also could relate
to research reports for securities products other than entities that
would be considered ``covered investment funds'' (e.g., certain stocks,
bonds, or master limited partnership interests).
---------------------------------------------------------------------------
\240\ See FINRA rule 2241(a)(11).
\241\ See FINRA rule 2242(a)(3).
\242\ See supra note 40 and accompanying text.
---------------------------------------------------------------------------
In addition to broker-dealers, various firms that are independent
of the offering process currently provide data and analysis on
different subsets of the covered investment fund universe (e.g.,
through subscription services or through licensing agreements with
broker-dealers). Data aggregators provide various forms of information
and analysis about covered investment funds, ranging from automated
fund rankings, to analyst research reports.\243\ Because data and
analysis provided by these firms play an important role in investors'
information environment under the baseline, these firms will be
affected by changes to the competitive environment resulting from the
rules we are adopting.\244\ We understand that communications styled as
``research reports'' on covered investment funds distributed by broker-
dealers may rely on information obtained from these independent
sources. In particular, we understand that information that is commonly
provided by these independent firms may include: (1) Information
obtained from regulatory filings, such as narrative descriptions of
fund objectives, information about key personnel, performance history,
fees, and top holdings; (2) statistics and other information derived
from public, proprietary, and licensed data sources, such as risk
exposures (e.g., geographic, sectoral), quantitative characteristics
(e.g., beta, correlations, tracking error), and peer group; and (3)
fund ratings. The fund ratings that independent firms may provide are
generally based on methodologies proprietary to each firm.\245\
---------------------------------------------------------------------------
\243\ While various firms provide automated fund rankings for
much of the covered investment fund universe, true ``analyst
coverage'' is considerably more limited. Morningstar provides
``analyst ratings'' for certain open-end funds, closed-end funds,
and ETFs. Based on queries of the Morningstar database, as of
October 2018, only 1,562 open-end funds, no closed-end funds, and
200 ETFs had a Morningstar analyst rating. We calculated that in
total, as of December 2017, there were 9,564 mutual funds, 596
closed-end funds, and 1,629 ETFs and ETPs. See supra note 216.
\244\ See infra section III.C.5.
\245\ See, e.g., Zacks Investment Research, ETF Rank Guide (Mar.
12, 2013), available at https://www.zacks.com/stock/news/94561/zacks-etf-rank-guide; Morningstar, Morningstar's Two Rating for
Assessing a Fund (2014), available at http://corporate1.morningstar.com/Documents/UK/Landing/Morningstars-Two-Ratings-For-Assessing-A-Fund.
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2. Regulatory Structure
The objective of this analysis is to consider the effects of
regulations being adopted pursuant to the FAIR Act's statutory mandate.
Thus, for the purposes of the baseline, we take into account the
regulatory structure in place immediately prior to the enactment of the
FAIR Act. We also note that on July 3, 2018, the interim effectiveness
provision of the FAIR Act came into effect.\246\ This provision allows
broker-dealers to rely on the rule 139 safe harbor when publishing or
distributing covered investment fund research reports. In addition,
under this provision, covered investment funds are deemed to be
securities that are listed on a national securities exchange and are
not subject to section 24(b) of the Investment Company Act. While the
effectiveness of this provision is now part of the regulatory
framework, in light of its recent effectiveness and the
[[Page 64203]]
limited time duration until it will be replaced by rule 139b, as a
practical matter, it is unclear to what extent broker-dealers will rely
on the interim provision to publish or distribute research reports
about covered investment funds.
---------------------------------------------------------------------------
\246\ See section 2(d) of the FAIR Act.
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a. Legal and Regulatory Framework Applicable to Statements Included in
Covered Investment Fund Research Reports
A broker-dealer's publication or distribution of a covered
investment fund research report could be deemed to constitute an offer
that otherwise could be a non-conforming prospectus whose use in the
offering may violate section 5 of the Securities Act.\247\ We
understand that some broker-dealers currently publish and distribute
communications styled as ``research reports'' regarding covered
investment funds in compliance with rule 482 under the Securities
Act.\248\ Unlike research reports covered under the rule 139 safe
harbor, broker-dealers' publication or distribution of rule 482
advertisements could subject the broker-dealer to liability under
section 12(a)(2) of the Securities Act.\249\ In addition, rule 482
advertisements regarding open-end investment companies, trust accounts,
and money markets funds are subject to requirements on the standardized
presentation of performance information.\250\
---------------------------------------------------------------------------
\247\ See supra note 5 and accompanying text.
\248\ Research reports regarding covered investment funds could
also be distributed today as ``supplemental sales literature'' under
rule 34b-1 under the Investment Company Act. However, research
reports distributed under rule 34b-1 would need to be preceded or
accompanied by a statutory prospectus. See supra note 167 and
accompanying text.
\249\ Section 12(a)(2) provides express remedies to the person
purchasing the security (i.e., a private right of action) for
material misstatements and omissions made by any seller of the
security. It also provides a different standard for claims for
damages than under Exchange Act rule 10b-5, which requires proof of
scienter in the representations made. See 15 U.S.C. 77l(a)(2); see
also rule 10b-5 [17 CFR 240.10b-5].
\250\ Research reports that are published or distributed as rule
34b-1 supplemental sales literature also would be subject to
requirements relating to the standardized presentation of
performance information, because rule 34b-1 incorporates many of the
rule 482 requirements relating to performance disclosure. See supra
notes 166, 248.
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Additionally, certain SRO rules governing content standards may
apply to advertisements styled as ``research reports'' under rule 482
or to communications that would be covered investment fund research
reports under rule. These include FINRA rule 2210, which contains
general content standards that apply broadly to member
communications.\251\ In addition, covered investment fund research
reports pertaining to funds other than open-end registered investment
companies that are not listed or traded on an exchange (i.e., ETFs,
ETPs, closed-end funds, and BDCs) may be subject to FINRA rules 2241
and 2242 governing content standards of ``research reports'' as defined
by FINRA.\252\
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\251\ See FINRA rule 2210(d)(1).
\252\ See supra note 183 (discussing the scope of these rules in
more detail, including noting that the scope of FINRA rules
2241(c)(1) and 2242(c)(2) generally apply only to a subset of
communications that would be considered covered investment fund
research reports under rule 139b).
---------------------------------------------------------------------------
Exposure to liability under section 12(a)(2) of the Securities Act,
rule 482 requirements on the standardized presentation of performance
information, and the various aforementioned FINRA rules impose costs on
broker-dealers. These include conduct costs resulting from additional
liability (e.g., foregoing publication of certain reports), and
compliance costs associated with the relevant content standards. We are
not able to quantify these costs.\253\
---------------------------------------------------------------------------
\253\ In the Proposing Release, we asked commenters to supply
data that could aid us in quantifying these costs. No such data was
provided in the comment letters received. See Proposing Release,
supra note 2, at 26812.
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b. Filing Requirements
Under the baseline, a research report or other communication about
a covered investment fund that is a registered investment company would
have to comply with the requirements of Securities Act rule 482 \254\
and registered investment company sales material, including rule 482
``omitting prospectus'' advertisements as well as supplemental sales
literature,\255\ are required to be filed with the Commission under
section 24(b) of the Investment Company Act.\256\ Broker-dealers that
are FINRA members are also subject to certain additional filing
requirements under current FINRA rule 2210.\257\
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\254\ See FINRA rule 2210(d)(5) (providing that non-money market
fund open-end management company performance data as permitted by
rule 482 in retail communications and correspondence must disclose
standardized performance information and, to the extent applicable,
certain sales charge and expense ratio information); see also supra
note 161.
\255\ See supra note 248.
\256\ Rule 24b-3 under the Investment Company Act deems these
materials to have been filed with the Commission if filed with
FINRA. See supra notes 144, 189 and accompanying text.
\257\ FINRA rule 2210's filing requirements include a number of
exclusions, including an exclusion for certain research reports,
except that broker-dealers are required to file research reports
with FINRA if they are also required to be filed with the Commission
pursuant to section 24(b) of the Investment Company Act. See supra
notes 176-178, and accompanying text.
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C. Costs and Benefits
In this section, we first consider the overarching costs and
benefits associated with the FAIR Act's statutory mandates. Second, we
evaluate the costs and benefits of the specific provisions of the rules
we are adopting and their relation to the overarching considerations
resulting from the statutory mandate. Next, we discuss the effects on
efficiency, competition, and capital formation of the new rules. We
conclude with a discussion of alternatives considered.
1. FAIR Act Statutory Mandate
a. Benefits
We believe that the expansion of the rule 139 safe harbor (as
mandated by the FAIR Act) will generally reduce broker-dealers' costs
of publishing and distributing research reports about covered
investment funds. These cost reductions are expected because under the
new rules a broker-dealer could publish or distribute covered
investment fund research reports without reliance on rule 482 or rule
34b-1 and without being required to file these reports under section
24(b) of the Investment Company Act and the rules and regulations
thereunder.\258\ Broker-dealers publishing or distributing covered
investment fund research reports in reliance on the expanded safe
harbor will not be subject to the liability provisions of section
12(a)(2) of the Securities Act,\259\ rule 34b-1, or the filing
requirements of section 24(b) of the Investment Company Act.\260\ Thus,
they will be expected to incur lower costs associated with liability
under section 12(a)(2), lower conduct costs, and lower compliance costs
(including fewer content and filing requirements).\261\ Because of
these cost reductions, we expect publication and distribution of such
reports to increase. First, we expect that certain broker-dealers that
had previously published and distributed communications under rule 482
that could be styled as ``research reports'' will aim to meet the
conditions of the expanded safe harbor and increase their supply of
covered investment fund research as a result. Second, we expect some
broker-dealers that have previously not published or distributed such
reports (due to the
[[Page 64204]]
activity being deemed too costly or subject to too many restrictions),
to begin doing so. We believe that the aforementioned effects will
generally benefit broker-dealers and advisers to covered investment
funds if, as we expect, they increase broker-dealers' sales of covered
investment funds.
---------------------------------------------------------------------------
\258\ See supra section II.D.1.
\259\ See supra note 249.
\260\ See supra section II.D.1.
\261\ However, we would not expect any lower costs of compliance
for any research reports that currently are structured as rule 34b-1
supplemental sales literature (and are not rule 482 advertising
prospectuses), because supplemental sales literature is not an
``offer'' to which prospectus liability under section 12(a)(2) of
the Securities Act would attach.
---------------------------------------------------------------------------
Because there is limited historical experience dealing specifically
with broker-dealers' research reports on covered investment funds,
there is little in the way of direct empirical evidence on the value of
such reports to investors. Prior research on the informativeness of
broker-dealers' research on operating companies suggests that broker-
dealers can produce research that positively contributes to the
information content of market prices,\262\ and--perhaps more
importantly--that broker-dealers may enjoy a comparative advantage in
its production.\263\ However, other studies have questioned the
investment value of such research to investors \264\ or its continued
relevance.\265\
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\262\ See, e.g., Brad M. Barber, Reuven Lehavy, & Brett Trueman,
Ratings changes, ratings levels, and the predictive value of
analysts' recommendations, 39 Financial Management 2, 533-553 (2010)
(broker-dealers' research analysts' upgrades (downgrades) elicit
positive (negative) price reactions, respectively). See also Scott
E. Stickel, The Anatomy of the Performance of Buy and Sell
Recommendations, 51 Financial Analysts Journal 5, 25-39 (Sept. 1,
1995) (broker-dealers' research provides new information,
particularly for smaller firms, where information is less generally
available). See also Kent L. Womack, Do Brokerage Analysts'
Recommendations Have Investment Value?, 51 The Journal of Finance 1,
137-167 (1996) (price reactions are permanent and exhibit post-
announcement drift).
\263\ See, Boris Groysberg, Paul Healy & Craig Chapman, Buy-Side
vs. Sell-Side Analysts' Earnings Forecasts, 64 Financial Analysts
Journal 4, 25-39 (July 1, 2008) (informativeness of broker-dealers'
sell-side research is superior to that of buy-side firms).
\264\ See Brad Barber, Reuven Lehavy, Maureen McNichols & Brett
Trueman, Can Investors Profit from the Prophets? Security Analyst
Recommendations and Stock Returns, 56 The Journal of Finance 2, 531-
563 (Apr. 1, 2001) (investors hoping to exploit research analysts'
recommendations must trade frequently and these transaction costs
often exceed the gains from trading); see also Xi Li, The
persistence of relative performance in stock recommendations of
sell-side financial analysts, 40.1 Journal of Accounting and
Economics 3, 129-152 (2005). See also Narasimhan Jegadeesh,
Joonghyuk Kim, Susan D. Krische & Charles M. C. Lee, Analyzing the
Analysts: When Do Recommendations Add Value?, 59 The Journal of
Finance 3, 1083-1124 (2004) (significant portion of investment value
may be attributable to previously documented trading signals, with
little incremental value attributable to the broker-dealer
research). See also Yongtae Kim & Minsup Song, Management Earnings
Forecasts and Value of Analyst Forecast Revisions, 61 Management
Science 7, 1663-1683 (2015) (past estimates of the informativeness
of analyst recommendations may be confounded by the impact of
forecasts issued by management).
\265\ See Oya Alt[inodot]nk[inodot]l[inodot][ccedil], Robert S.
Hansen & Liyu Ye, Can analysts pick stocks for the long-run?, 119
Journal of Financial Economics 2, 371-398 (Feb. 2016) (reductions in
transactions costs and increases in computational speed reduced the
amount of new information available for analysts to discover).
---------------------------------------------------------------------------
We are cautious in drawing implications from these findings to
broker-dealers' research on covered investment funds. While analysts
researching operating companies generally endeavor to identify
mispricing--to forecast the idiosyncratic component of firms' future
returns--covered investment funds represent portfolios of securities,
and many covered investment funds are priced at net asset value
(``NAV'').\266\ Although individual securities within a covered
investment fund's portfolio may be viewed as ``mispriced'' by a
research analyst, diversification effects will tend to drown out such
effects at the fund level and minimize idiosyncratic variation in
investors' return on their investment in the fund. Therefore, any
``investment value'' \267\ of research on covered investment funds
would likely be rooted in analysts' ability to predict broader market
movements. Such ability is generally believed to be rather rare.\268\
We therefore believe that the value to investors of information in
broker-dealers' research reports will largely be limited to the
synthesis or discovery of factual information about fund
characteristics, fees, or other transactions costs. For example,
investors may find analysts' views of a fund's management, objectives,
risk exposures, tracking error, volatility, tax efficiency, fees, or
other fund characteristics to be valuable. Such analysis could be a
valuable source of information for investors evaluating relative fund
performance.\269\
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\266\ Closed-end funds, for example, are not priced on a NAV
basis and their (mis-) pricing has long served as a puzzle in the
finance literature. See, e.g., Charles M.C. Lee, Andrei Schleifer, &
Richard H. Thaler, Investor Sentiment and the Closed-End Fund
Puzzle, 46 The Journal of Finance 1 (Mar. 1991). Similar pricing
issues may arise in BDCs.
\267\ We mean this in the sense of providing a signal about
future investment performance.
\268\ See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman, &
Russ Wermers, Measuring Mutual Fund Performance with Characteristic-
Based Benchmarks, 52 The Journal of Finance 3, 1035-1058 (July
1997).
\269\ See, e.g., W. J. Armstrong, Egemen Genc & Marno Verbeek,
Going for Gold: An Analysis of Morningstar Analyst Ratings,
Management Science (Aug. 2017).
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We believe that the quantity of information available to potential
investors of covered investment funds will increase as a result of
broker-dealers' increased publication and distribution of covered
investment fund research reports. The rules we are adopting will also
allow for greater flexibility in the type of information that broker-
dealers may communicate to customers.\270\ To the extent that this new
information is valuable, it will benefit investors by providing them
with additional information to help shape investment decisions.
Finally, we believe that important negative information about a covered
investment fund, such as high fees, high risk exposure, or an
inefficient portfolio strategy will be more likely to be publicized as
a result of increased competition among information providers, with
attendant benefits to investors.\271\
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\270\ Currently such communications would be subject to rule 482
requirements, including standards on the presentation of performance
information. See supra section II.C.
\271\ See Matthew Gentzkow & Jesse M. Shapiro, Media Bias and
Reputation, 114 Journal of Political Economy 2, 280-316 (Apr. 1,
2006).
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b. Costs
Prior experience and academic research suggests that, unchecked,
broker-dealers' conflicts of interest can lead to bias in research
reports,\272\ and that such bias has the potential to adversely affect
investor welfare.\273\
[[Page 64205]]
Broker-dealers' financial incentives to sell covered investment funds
could undermine the objectivity of the information they produce about
such funds, and the existence of the rule 139b safe harbor could
increase opportunities for broker-dealers to promote funds from which
they derive the most financial benefits.\274\ If such conflicts are
unrecognized by or unknown to investors, they could negatively affect
investor welfare. Although market mechanisms \275\ as well as existing
regulation \276\ may limit the extent of such actions, there is the
potential that they could nonetheless impose costs on investors--
particularly retail investors.\277\
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\272\ See Amitabh Dugar & Siva Nathan, The Effect of Investment
Banking Relationships on Financial Analysts' Earnings Forecasts and
Investment Recommendations*, 12 Contemporary Accounting Research 1,
131-160 (Sept. 1, 1995) (``Dugar and Nathan Article'') (affiliated
analysts issue more optimistic earnings forecasts and investment
recommendations about companies with which their firms had an
investment banking relationship). See also Hsiou-wei Lin & Maureen
F. McNichols, Underwriting Relationships, Analysts' Earnings
Forecasts and Investment Recommendations, 25 Journal of Accounting
and Economics 1, 101-127 (Feb. 26, 1998) (``Lin and McNichols
Article'') (affiliated analysts are more optimistic in their long-
term growth forecasts and investment recommendations).
\273\ See Roni Michaely & Kent L. Womack, Conflict of Interest
and the Credibility of Underwriter Analyst Recommendations, 12 The
Review of Financial Studies 4, 653-686 (July 2, 1999) (``Michaely
and Womack Article'') (stock recommendations of affiliated analysts
perform worse prior to, at the time of, and subsequent to the
recommendation); see also Patricia M. Dechow, Amy P. Hutton &
Richard G. Sloan, The Relation between Analysts' Forecasts of Long-
Term Earnings Growth and Stock Price Performance Following Equity
Offerings*, 17 Contemporary Accounting Research 1, 1-32 (Mar. 1,
2000). See also Global Research Analyst Settlement, Litigation
Release No. 18438 (Oct. 31, 2003) (The court issued an Order
approving a $1.4 billion global settlement of the SEC enforcement
actions against several investment firms and certain individuals
alleging undue influence of investment banking interests on
securities research); see also Deutsche Bank Securities Inc. and
Thomas Weisel Partners LLC Settle Enforcement Actions Involving
Conflicts of Interest Between Research and Investment Banking, SEC
Press Release 2004-120 (Aug. 26, 2004). The settlement was an action
in response to conflicts of interest that certain broker-dealers
were found to have failed to manage in an adequate or appropriate
manner and was modified in 2010 to remove certain requirements where
FINRA and NYSE rules addressed the same concerns. See 2010
Modifications to Global Research Analyst Settlement, Litigation
Release No. 21457 (Mar. 19, 2010).
\274\ Such concerns were also noted by one commenter. See
Morningstar Comment Letter.
\275\ See infra section III.C.1.b(2).
\276\ See infra section III.C.1.b(1).
\277\ See infra section III.C.1.b(2).
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The potential for conflicts of interest to lead to actions that
impose costs on investors depends in large part on the strength of the
underlying incentives. In the context of broker-dealers' research on
covered investment funds, the greatest conflicts of interest are faced
by broker-dealers serving as investment advisers to covered investment
funds, who--due to asset-based management fees--have strong incentives
to increase demand for the funds that they advise. Because the FAIR Act
by its terms,\278\ and also rule 139b,\279\ will not extend the safe
harbor to a broker-dealer that is publishing or distributing a research
report about a covered investment fund for which the broker-dealer
serves as an investment adviser (or where the broker-dealer is an
affiliated person of the investment adviser), we believe that there
will be limited potential for the greatest conflicts of interest to
impose costs on investors.
---------------------------------------------------------------------------
\278\ See section 2(f)(3) of the FAIR Act.
\279\ See rule 139b(a).
---------------------------------------------------------------------------
Other conflicts of interest may nevertheless arise from incentives
in fund distribution arrangements.\280\ Distributing broker-dealers may
receive compensation from sales loads, 12b-1 fees,\281\ shelf space
fees, or other revenue sharing agreements, all of which create
financial incentives for broker-dealers to promote and sell funds and
potentially to promote and sell particular funds or share classes.\282\
Associated persons of broker-dealers (i.e., analysts) may face similar
conflicts of interests arising from incentives in their compensation
agreements.\283\ Finally, broker-dealers may have fewer direct or non-
pecuniary incentives.\284\ However, in all of these cases, the risk
that such conflicts of interest could result in actions that negatively
impact information communicated to investors is mitigated by the fact
that a broker-dealer will bear the costs of such actions, but generally
may be unable to fully appropriate the benefits.\285\
---------------------------------------------------------------------------
\280\ See Susan E. K. Christoffersen, Richard Evans & David K.
Musto, What Do Consumers' Fund Flows Maximize? Evidence from Their
Brokers' Incentives, 68 The Journal of Finance 1, 201-235 (Feb. 1,
2013) (where brokers' compensation arrangements with funds are found
to drive their customers' fund flows).
\281\ See rule 12b-1 under the Investment Company Act [17 CFR
270.12b-1].
\282\ See infra note 298 (noting that the Commission has
historically found broker-dealers to have violated sections 17(a)(2)
and (3) of the Securities Act by making recommendations of more
expensive mutual fund share classes while omitting material facts).
\283\ Such conflicts of interest arising from incentives in
compensation agreements involving research analysts issuing research
reports covered by FINRA Rule 2241 are mitigated by FINRA rules
2241(b)(2)(C), (E), (F), and (K). Additionally, section 501(a)(2) of
Regulation AC (17 CFR 242.501(a)(2)) requires specific disclosure
regarding research analyst compensation in order to mitigate the
conflicts of interest that can arise based on analyst compensation
arrangements.
\284\ For example, although it is prohibited conduct, a broker-
dealer may have a financial incentive to provide coverage for, or to
promote, a fund based on an understanding that the fund will
participate in offerings underwritten by the broker-dealer. See,
e.g., FINRA rule 2241(b)(2) (requiring that a member's written
policies and procedures must be reasonably designed to, among other
things, ``prevent the use of research reports or research analysts
to manipulate or condition the market or favor the interests of the
member''); see also NASD Fines U.S. Bancorp Piper Jaffray and
Managing Director $300,000, FINRA News Release (June 25, 2002)
available at http://www.finra.org/newsroom/2002/nasd-fines-us-bancorp-piper-jaffray-and-managing-director-300000 (announcing
settlement with U.S. Bancorp Piper Jaffray and one of its managing
directors in which the NASD found that the firm violated a NASD (now
FINRA) rule requiring all firms and associated persons to adhere to
high standards of commercial honor and just and equitable principles
of trade when it threatened to discontinue research coverage of a
company if the company did not select it as lead underwriter for an
upcoming offering). But see also note 183.
Rule 12b-1(h)(1) prohibits funds from compensating a broker-
dealer for promoting or selling funds shares by directing brokerage
transactions to that broker. See rule 12b-1(h)(1) under the
Investment Company Act [17 CFR 270.12b-1(h)(1)]; see also
Prohibition on the Use of Brokerage Commissions to Finance
Distribution, Investment Company Act Release No. 26591 (Sept. 2,
2004) [69 FR 54727 (Sept. 9, 2004)].
\285\ For example, if a broker-dealer firm publishes biased
research about a fund, some of the gains (i.e., compensation from
sales of that fund) may accrue to other broker-dealer firms (i.e.,
other broker-dealer firms that distribute the same fund) while the
costs of the action (i.e., reputation costs, litigation risk, and
risk of regulatory action) will be borne entirely by the broker-
dealer firm that published the biased research.
---------------------------------------------------------------------------
It is difficult for us to quantify the aforementioned costs in the
context of this rulemaking. We are not aware of any studies directly
examining the role that conflicts of interest play in broker-dealers'
research reports on covered investment funds in U.S. markets, or of any
data that would support a quantitative analysis of an expanded safe
harbor in this context.\286\ Although one commenter registered similar
concerns,\287\ no commenters provided any data that would facilitate
such a quantitative analysis.\288\ As with the potential benefits
discussed above, we are limited to characterizing the potential costs
qualitatively. While we believe that expanding the rule 139 safe harbor
to broker-dealers' publication or distribution of covered investment
fund research reports has the potential to impose costs on retail
investors, existing regulations, specific provisions of the rules that
we are adopting,\289\ and certain market mechanisms will reduce these
costs.
---------------------------------------------------------------------------
\286\ Authors have examined the impact of conflicts of interest
on mutual fund research in China, providing evidence consistent with
bias arising from conflicts of interest in that market, though
differences between Chinese and U.S. markets and corresponding
regulatory frameworks make it difficult to apply inferences drawn
from experience in Chinese markets to U.S. markets. See Y. Zeng, Q.
Yuan & J. Zhang, Blurred stars: Mutual fund ratings in the shadow of
conflicts of interest, 60 Journal of Banking & Finance 1, 284-295
(2015).
\287\ See Morningstar Comment Letter.
\288\ In the Proposing Release, we requested comment on our
characterization of these costs. See Proposing Release, supra note
2, at 26816.
\289\ See infra section III.C.2.
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(1) Existing Regulation
Rules and regulations have been implemented to address potential
conflicts of interest that may arise with broker-dealers specifically
in the context of research reports.\290\ As discussed in detail
above,\291\ the definition of ``research report'' for purposes of
Regulation AC and FINRA rules 2241 and 2242 is narrower than the
definition of ``research report'' for purposes of the FAIR Act and rule
139b. However, to the extent a research report meets both the
definition of a research report under rule 139b and the definition of
research report as defined in Regulation AC, Regulation AC will be
applicable to that research report (and, if it meets the definition of
``research report'' in FINRA rule 2241, FINRA rule 2241 also will apply
if the research report otherwise were within the scope of rule 2241
\292\). These rules may help promote objective and reliable
research.\293\
---------------------------------------------------------------------------
\290\ See supra note 35; see also Proposing Release, supra note
2, at 26791 n.37.
\291\ See supra note 183.
\292\ See id.
\293\ See section 501 of the Sarbanes-Oxley Act; Regulation
Analyst Certification, Securities Act Release No. 8193 (Feb. 20,
2003) [68 FR 9481 (Feb. 27, 2003)]. Several studies have analyzed
bias in broker-dealers' research following the Global Settlement and
subsequent regulatory changes, in particular at sanctioned banks.
See O. Kadan, L. Madureira, R. Wang, & T. Zach, Conflicts of
interest and stock recommendations: The effects of the global
settlement and related regulations 22 The Review of Financial
Studies 10, 4189-4217 (2009). See also, S. A. Corwin, S. A. Larocque
& M. A. Stegemoller, Investment banking relationships and analyst
affiliation bias: The impact of the global settlement on sanctioned
and non-sanctioned banks, 124 Journal of Financial Economics 3, 614-
631 (2017).
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[[Page 64206]]
Additionally, as described above, FINRA rule 2210 contains general
content standards that apply broadly to member communications,
including broker-dealer research reports. These general content
standards require, among other things, that all member communications
``must be based on principles of fair dealing and good faith, must be
fair and balanced, and must provide a sound basis for evaluating the
facts in regard to any particular security or type of security,
industry or service.'' \294\
---------------------------------------------------------------------------
\294\ See supra section II.D.1.
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If a broker-dealer recommends \295\ a covered investment fund to
its customers, additional obligations under the federal securities laws
and FINRA rules will apply. As a general matter, broker-dealers must
deal with their customers fairly \296\--and, as part of that
obligation, have a reasonable basis for any recommendation.\297\
Furthermore, when making recommendations, broker-dealers may be
generally liable under the antifraud provisions if they do not give
``honest and complete information'' or disclose any material adverse
facts or conflicts of interest, including any economic self-
interest.\298\
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\295\ See, e.g., Additional Guidance on FINRA's New Suitability
Rule, FINRA Regulatory Notice 12-25 (May 2012), at Q.2, (regarding
the scope of ``recommendation''), n.25.
\296\ See, e.g., Duker & Duker, Exchange Act Release No. 2350
(Dec. 19, 1939), at 2 (Commission opinion) (``Inherent in the
relationship between a dealer and his customer is the vital
representation that the customer be dealt with fairly, and in
accordance with the standards of the profession.'').
\297\ See Mac Robbins & Co., Exchange Act Release No. 6846 (July
11, 1962), at 3 (``[T]he making of representations to prospective
purchasers without a reasonable basis, couched in terms of either
opinion or fact and designed to induce purchases, is contrary to the
basic obligation of fair dealing borne by those who engage in the
sale of securities to the public.''), aff'd sub nom., Berko v. SEC,
316 F.2d 137 (2d Cir. 1963). A broker-dealer's recommendation must
also be suitable for the customer. See, e.g., J. Stephen Stout,
Exchange Act Release No. 43410 (Oct. 4, 2000), at 11 (Commission
opinion) (``As part of a broker's basic obligation to deal fairly
with customers, a broker's recommendation must be suitable for the
client in light of the client's investment objectives, as determined
by the client's financial situation and needs.''); see also FINRA
Rule 2111.05(b) (``The customer-specific obligation requires that a
member or associated person have a reasonable basis to believe that
the recommendation is suitable for a particular customer based on
that customer's investment profile, as delineated in Rule
2111(a).'').
\298\ See, e.g., De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d
1293, 1302 (2d Cir. 2002); Chasins v. Smith, Barney & Co., 438 F.2d
1167, 1172 (2d Cir. 1970). Generally, under the antifraud
provisions, whether a broker-dealer has a duty to disclose material
information to its customer is based upon the scope of the
relationship with the customer, which is fact intensive. See, e.g.,
Conway v. Icahn & Co., Inc., 16 F.3d 504, 510 (2d Cir. 1994) (``A
broker, as agent, has a duty to use reasonable efforts to give its
principal information relevant to the affairs that have been
entrusted to it.''). For example, where a broker-dealer processes
its customers' orders, but does not recommend securities or solicit
customers, then the material information that the broker-dealer is
required to disclose is generally narrow, encompassing only the
information related to the consummation of the transaction. See,
e.g., Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 536 (2d
Cir. 1999). The Commission has historically charged broker-dealers
with violating sections 17(a)(2) and (3) of the Securities Act for
making recommendations of more expensive mutual fund share classes
while omitting material facts. See, e.g., In re IFG Network Sec.,
Inc., Exchange Act Release No. 54127 (July 11, 2006), at 15
(Commission opinion) (registered representative violated 17(a)(2)
and (3) by omitting to disclose to his customers material
information concerning his compensation and its effect upon returns
that made his recommendation that they purchase Class B shares
misleading; ``The rate of return of an investment is important to a
reasonable investor. In the context of multiple-share-class mutual
funds, in which the only bases for the differences in rate of return
between classes are the cost structures of investments in the two
classes, information about this cost structure would accordingly be
important to a reasonable investor.'').
---------------------------------------------------------------------------
(2) Market Mechanisms
We believe that by facilitating production of information on
covered investment funds, the FAIR Act's mandates will contribute to
competition among information providers,\299\ which we believe can
mitigate the effects of conflicts of interest on research reports.\300\
With respect to broker-dealers' research on operating companies,
analysts' career concerns \301\ have also been found to have similar
effects, and, in principle, broker-dealers' reputations could as
well.\302\ However, we believe it is unlikely that analyst career
concerns or broker-dealer reputation will play as significant a role in
the context of covered investment fund research reports which we expect
to be aimed primarily at retail investors. Research reports about
operating companies have traditionally been provided to institutional
customers as part of a bundle of services provided by full-service
brokerages.\303\ In this setting, broker-dealers benefit from
institutional investors' willingness to pay for broker-dealers'
additional bundled services (e.g., research).\304\ Such institutional
customers are generally capable of producing similar reports, and so
can evaluate the quality of broker-dealers' research.\305\ Thus, they
can provide market discipline: Broker-dealers' provision of low-quality
or misleading information could plausibly be discovered and lead to the
loss of valuable customer relationships. We do not believe that similar
mechanisms would be as effective in the covered investment fund
context. We expect broker-dealers to publish and distribute covered
investment fund research reports on funds that they distribute to their
customers.\306\ With retail investors, information asymmetries are
greater: Retail investors do not generally possess the capabilities to
replicate an analyst report or evaluate its quality.\307\ Moreover, the
problem of evaluating the performance of analysts is harder in the
context of covered
[[Page 64207]]
investment funds.\308\ Because institutional investors are not major
investors in covered investment funds,\309\ we believe they are
unlikely to provide market discipline in this context.\310\
---------------------------------------------------------------------------
\299\ See infra section III.C.5.
\300\ See Harrison Hong & Marcin Kacperczyk, Competition and
Bias, 125 The Quarterly Journal of Economics 4, 1683-1725 (Nov. 1,
2010) (reduction in (analyst) competition resulting from mergers
reduces analyst coverage and increases bias in the remaining
coverage).
\301\ See Harrison Hong & Jeffrey D. Kubik, Analyzing the
Analysts: Career Concerns and Biased Earnings Forecasts, 58 The
Journal of Finance 1, 313-351 (2003) (analysts' reputation plays a
role in the analyst's career outcome); see also Andrew R. Jackson,
Trade Generation, Reputation, and Sell-Side Analysts, 60 The Journal
of Finance 2, 673-717 (Apr. 1, 2005) see also Lily Fang & Ayako
Yasuda, The Effectiveness of Reputation as a Disciplinary Mechanism
in Sell-Side Research, 22 The Review of Financial Studies 9, 3735-
3777 (Sept. 1, 2009) (``Fang and Yasuda Article'')
\302\ For a discussion of the role of reputation in financial
intermediation, see Thomas J. Chemmanur & Paolo Fulghieri,
Investment Bank Reputation, Information Production, and Financial
Intermediation, 49 The Journal of Finance 1, 57-79 (1994)
(``Chemmanur and Fulghieri Article''). See also Fang and Yasuda
Article, supra note 301 (analyst reputation mitigates bias, but
institutional reputation does not).
\303\ See Mehran, Hamid, and Ren[eacute] M. Stulz, The Economics
of Conflicts of Interest in Financial Institutions, 85 Journal of
Financial Economics 2, 267-296 (Aug. 1, 2007) (``Mehran and Stulz
Article''). We note however, that this model has been disrupted by
the European MiFID II regulations that took effect in 2018. See e.g.
CFA Institute, MiFID II: A New Paradigm for Investment Research,
available at https://www.cfainstitute.org/-/media/documents/support/advocacy/mifid_ii_new-paradigm-for-research-report.ashx
\304\ Institutional customers are valuable in that they are
willing to pay for brokers-dealers' additional services (e.g.,
research). Payments for such services need not be direct and may be
reflected in (relatively) higher brokerage commissions. See Michael
A. Goldstein, Paul Irvine, Eugene Kandel & Zvi Wiener, Brokerage
Commissions and Institutional Trading Patterns, 22 The Review of
Financial Studies 12, 5175-5212 (Dec. 1, 2009).
\305\ See id. See also Ulrike Malmendier & Devin Shanthikumar,
Are Small Investors Naive about Incentives?, 85 Journal of Financial
Economics 2, 457-489 (Aug. 1, 2007) (``Malmendier and Shanthikumar
Article'') (institutions account for bias in analysts'
recommendations while retail investors do not).
\306\ See supra section III.B.1.c.
\307\ See Mehran and Stulz Article, supra note 303.
\308\ Traditional analyst research reports on operating
companies largely focus on firm-specific factors, and thus are more
akin to ``stock picking'' than ``market timing'': They attempt to
forecast the idiosyncratic component of firms' future returns.
Covered investment funds represent portfolios of securities and
diversification effects reduce the amount of idiosyncratic variation
in their returns. Thus, abstracting from fees, ``fund picking'' is
more akin to ``market timing'' than ``stock picking.'' Market timing
is a skill that is relatively rare and econometrically difficult to
detect. See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman &
Russ Wermers, Measuring Mutual Fund Performance with Characteristic-
Based Benchmarks, 52 The Journal of Finance 3, 1035-1058 (July
1997).
\309\ See supra section III.B.1.a.
\310\ See Alexander Ljungqvist, Felicia Marston, et al.,
Conflicts of Interest in Sell-Side Research and the Moderating Role
of Institutional Investors, 85 Journal of Financial Economics 2,
420-456 (Aug. 1, 2007) (securities of interest to institutional
investor receive coverage that is less biased).
---------------------------------------------------------------------------
We also acknowledge that biases resulting from conflicts of
interest need not adversely impact investors if investors
disregard,\311\ discount,\312\ or de-bias \313\ the recommendations of
conflicted analysts.\314\ We believe however, that retail investors who
are primary clientele for covered investment funds are less likely to
be aware of potential bias in analysts' recommendations,\315\ may fail
to de-bias or otherwise condition their trades based on the credibility
of the recommendation,\316\ and could thus be led to invest in
underperforming securities.\317\
---------------------------------------------------------------------------
\311\ See Dugar and Nathan Article, supra note 272.
\312\ See Michaely and Womack Article, supra note 273.
\313\ See Lin and McNichols Article, supra note 272.
\314\ Institutional market participants generally attribute bias
in sell-side analysts' research reports to conflicts of interest.
See Michaely and Womack Article, supra note 273.
\315\ See Michael B. Mikhail, Beverly R. Walther & Richard H.
Willis, When Security Analysts Talk, Who Listens?, 82 The Accounting
Review 5, 1227-1253 (2007) (``Mikhail Walther and Willis Article'').
See also Diane Del Guercio & Paula A. Tkac, Star Power: The Effect
of Morningstar Ratings on Mutual Fund Flow, 43 Journal of Financial
and Quantitative Analysis 4, 907-936 (Dec. 2008) (retail investors
in mutual funds are very sensitive to fund rankings). See
Christopher R. Blake & Matthew R. Morey, Morningstar Ratings and
Mutual Fund Performance, 35 The Journal of Financial and
Quantitative Analysis 3, 451-483 (2000) (mutual fund ranking have
little predictive power for future performance).
\316\ See id.; Malmendier and Shanthikumar Article, supra note
305.
\317\ See Mikhail Walther and Willis Article, supra note 315.
See also Malmendier and Shanthikumar Article, supra note 305. See
also Amanda Cowen, Boris Groysberg & Paul Healy, Which Types of
Analyst Firms Are More Optimistic?, 41 Journal of Accounting and
Economics 1, 119-146 (Apr. 1, 2006) (finding that analysts at retail
brokerage firms are more optimistic than those serving only
institutional investors). See Xuanjuan Chen, Tong Yao & Tong Yu,
Prudent Man or Agency Problem? On the Performance of Insurance
Mutual Funds, 16 Journal of Financial Intermediation 2, 175-203
(Apr. 1, 2007) (underperformance of mutual funds sponsored by
insurance companies is attributed to inadequate monitoring by less
sophisticated retail customers who are subject to cross-selling
efforts by their insurer). See also Daniel Bergstresser, John M. R.
Chalmers, and Peter Tufano, Assessing the Costs and Benefits of
Brokers in the Mutual Fund Industry, 22 Review of Financial Studies
10, 4129-4156 (Oct. 2009) (broker-sold mutual funds deliver lower
risk-adjusted returns (even before subtracting distribution fees)
than direct-sold funds). See also Diane Del Guercio & Jonathan
Reuter, Mutual Fund Performance and the Incentive to Generate Alpha,
69 The Journal of Finance 4, 1673-1704 (Aug. 1, 2014)
(underperformance of actively managed mutual funds is attributed to
the underperformance of funds sold by brokers; the authors find
little evidence for underperformance in the subset of funds that are
sold directly to investors).
---------------------------------------------------------------------------
2. Rule 139b
As discussed above, rule 139b conditions eligibility for the safe
harbor on satisfaction of several conditions.\318\ These conditions are
generally modeled on and resemble similar provisions in rule 139 (with
differences from rule 139 that the FAIR Act specifically directs, or
that tailor the provisions of rule 139 more directly or specifically to
the context of covered investment fund research reports).\319\ We
believe that modeling rule 139b on rule 139 will benefit market
participants through regulatory consistency. We address these
conditions in turn in the sections that follow.
---------------------------------------------------------------------------
\318\ See supra section II.B.
\319\ See supra paragraph accompanying notes 12-15.
---------------------------------------------------------------------------
a. Affiliate Exclusion
Under the affiliate exclusion of rule 139b,\320\ a broker-dealer
who is an affiliate of a covered investment fund (or is an investment
adviser or an affiliated person of the investment adviser to a covered
investment fund), would not be eligible for the safe harbor of rule
139b when publishing or distributing a research report about that
covered investment fund. The economic benefit of the affiliate
exclusion is that it reduces the potential for retail investors to
receive research reports containing information that was published,
distributed, authorized, or approved by persons whose financial
incentives create the greatest conflicts of interest.\321\ The primary
cost of the affiliate exclusion will be borne by broker-dealers that
both distribute covered investment funds and act as investment advisers
to such funds (or do so through affiliated persons). These broker-
dealers will be unable to provide research reports to their customers
on funds that they (or their affiliated persons) advise.\322\ In
addition, we believe that smaller broker-dealers, and broker-dealers
without significant research departments and who would want to rely on
pre-publication materials distributed by a covered investment fund, its
adviser, or affiliated persons, would also be significantly affected by
the new rules.
---------------------------------------------------------------------------
\320\ See section 2(f)(3) of the FAIR Act. See supra section
II.A.1.
\321\ See supra section III.C.1.b.
\322\ See supra notes 18-21 and accompanying text.
---------------------------------------------------------------------------
We expect covered investment funds and their investment advisers to
engage in a broad range of marketing activities to support the
distribution of fund shares (particularly in the case of redeemable
securities such as those issued by mutual funds), and that funds and
their advisers prepare and distribute materials to distributing broker-
dealers intended to increase sales. The affiliate exclusion and
associated guidance \323\ will reduce the potential for retail
investors to receive research reports containing materials from persons
whose financial incentives create the greatest conflicts of
interest.\324\
---------------------------------------------------------------------------
\323\ See supra section II.A.1.
\324\ Persons covered by the affiliate exclusion may have strong
financial interests to increase sales of associated covered
investment funds. See supra paragraph accompanying note 278.
---------------------------------------------------------------------------
The affiliate exclusion is also likely to limit the benefits of the
rule for certain broker-dealers. Many broker-dealers distributing
covered investment fund securities do not have sizeable research
departments, and we understand that very few broker-dealers operate at
a scale that would allow for comprehensive coverage of the covered
investment funds that they distribute. We believe that under the
affiliate exclusion, it would be inappropriate for such broker-dealers
to publish or distribute research report provided by a covered
investment fund or the fund's affiliates.\325\ Thus, the affiliate
exclusion could have the effect of limiting broker-dealers' ability and
willingness to publish and distribute research reports about the funds
they distribute: In order to rely on the rule to publish or distribute
a covered investment fund research report, these broker-dealers would
need to conduct their own research in-house or to rely on independent
third-party service providers for their information.
---------------------------------------------------------------------------
\325\ Among other things, we believe it would be inappropriate
for any person covered by the affiliate exclusion, or for any person
acting on its behalf, to publish or distribute a research report
indirectly that the person could not publish or distribute directly
under the rule. See supra paragraph accompanying note 30.
---------------------------------------------------------------------------
[[Page 64208]]
b. Regular-Course-of-Business Requirement
Under rule 139b, research reports (both issuer-specific research
reports and industry research reports) need to be published or
distributed by the broker-dealer in the ``regular course of its
business'' in order to rely on the safe harbor.\326\ For issuers that
do not have a class of securities in ``substantially continuous
distribution,'' issuer-specific research reports that represent the
initiation of publication of research reports about the issuer or its
securities or reinitiation following discontinuation of publication of
such research reports would be deemed to not satisfy the regular-
course-of-business requirement.\327\ The regular-course-of-business
requirement of rule 139b is similar to that of rule 139, except that,
as directed by the FAIR Act, rule 139b specifies that the ``initiation
or reinitiation requirement'' only applies to research reports
regarding a covered investment fund that does not have a class of
securities in substantially continuous distribution.\328\
---------------------------------------------------------------------------
\326\ See supra sections II.B.1.c and II.B.2.b.
\327\ See supra notes 112-114 and accompanying text.
\328\ See section 2(b)(1) of the FAIR Act; see also supra note
101 and accompanying text.
---------------------------------------------------------------------------
Given the breadth of the definition of ``research report'' under
the FAIR Act (and the definition of ``research report'' that we are
adopting under rule 139b), certain communications that are currently
treated as covered investment fund advertisements under Securities Act
rule 482 could fall under the rule 139b definition of ``research
report.'' \329\ Investors, particularly retail investors, may be
unaware of the differences in regulatory status and purpose among the
various types of communications regarding registered investment
companies and BDCs. This may result in investors not being able to
readily discern what constitutes a research report and what constitutes
an advertisement about these issuers. We continue to believe that
broker-dealers that publish or distribute research reports in the
regular course of business are more likely to publish analysis that
investors recognize as research.\330\ Therefore, in principle we expect
this requirement to benefit investors by reducing opportunities for
communications published or distributed under the safe harbor to cause
confusion about their intended purpose. However we also believe that
establishing whether a research report is published in the ``regular
course of business'' could, in practice, prove uniquely challenging in
the covered investment funds context.\331\
---------------------------------------------------------------------------
\329\ See supra note 162 and accompanying text.
\330\ See Proposing Release, supra note 2, at 26797.
\331\ See Proposing Release, supra note 2, at 26797-98
(requesting comment on the application of the regular-course-of-
business requirement in the context of broker-dealers' publication
or distribution of covered investment fund research reports and
unique concerns relevant to this context (e.g., whether the
requirement should be modified to address broker-dealers that have
not previously published or distributed covered investment fund
research reports)).
---------------------------------------------------------------------------
First, in the context of covered investment funds, the distinction
between communications intended as sales materials and those intended
as research could be difficult to discern. Research reports about debt
and equity securities have traditionally been provided to institutional
customers as part of the broker-dealer's collection of services.\332\
Institutional customers are generally capable of producing similar
reports, and so can more readily evaluate the quality of broker-
dealers' research.\333\ In these circumstances, broker-dealers have a
compelling business rationale for producing high-quality research as
distinct from sales materials.
---------------------------------------------------------------------------
\332\ See Mehran and Stulz Article, supra note 303.
\333\ See id; see also Malmendier and Shanthikumar Article,
supra note 305.
---------------------------------------------------------------------------
In contrast, we expect covered investment fund research reports to
be produced by broker-dealers that distribute covered investment funds
to retail investors.\334\ Thus, we believe that cultivating a
reputation for high-quality research is less likely to serve as the
primary business rationale for broker-dealers' publication and
distribution of research reports on covered investment funds. Rather,
we expect that facilitating the marketing of covered investment funds
to customers (so as to increase revenues derived from distribution
arrangements) will motivate these activities. In this setting, the
distinction between different types of communications will not be as
clear.
---------------------------------------------------------------------------
\334\ See supra section III.B.1.c.
---------------------------------------------------------------------------
Second, the information environment surrounding covered investment
funds further complicates establishing whether publishing research
reports about covered investment funds is undertaken in the regular
course of business. In the context of research reports about operating
companies, a research analyst ``following'' an operating company
continually monitors that company so as to provide timely forecasts and
recommendations. Because of differences in the nature of covered
investment funds and operating companies, we believe that the same is
less likely to hold for a research analyst ``following'' a covered
investment fund.\335\ We believe that the opportunities for acquiring
idiosyncratic information relevant to future returns of covered
investment funds are generally more limited: Covered investment funds
represent portfolios of securities and diversification effects reduce
the value of idiosyncratic (i.e., firm-specific) information.\336\
Consequently, we expect research analysts ``following'' covered
investment funds to focus instead on information related to fund
characteristics (e.g., fees, portfolio composition, or index tracking
strategy) and on developments at the sector- or macro-level. Because we
do not expect the arrival of such information to be as frequent, we
expect that the inclusion of new analysis in research reports about
covered investment funds could be more rare than in the context of
operating company research reports. Consequently, the publication or
distribution of covered investment fund research reports could occur
relatively infrequently, or could be driven largely by market-wide
factors. This could make it more difficult to establish whether a
covered investment fund research report is published in the regular
course of business.
---------------------------------------------------------------------------
\335\ The regular-course-of-business requirement generically
requires ``research reports'' to be published or distributed in the
regular course of a broker-dealer's business and is not limited to
covered investment fund research reports. See Proposing Release,
supra note 2, at 26797.
\336\ See supra notes 267-268 and accompanying text.
---------------------------------------------------------------------------
We noted in the Proposing Release that due to the aforementioned
distinctions in the information environment and business rationale, we
believed that the regular-course-of-business requirement in the context
of rule 139b may be more challenging to apply in practice than the
regular-course-of-business requirement in the context of rule 139 and
that the potential benefits of this requirement in rule 139b may be
more limited. We also noted that the effects of the regular-course-of-
business requirement would be clearer in cases where, in the case of
issuer-specific research reports, the bright-line ``initiation or
reinitiation'' requirement applies (i.e., where the covered investment
fund does not have a class of securities in substantially continuous
distribution). For such cases, the regular-course-of-business
requirement would condition the availability of the safe harbor on the
research report not representing the initiation or reinitiation of
coverage by the broker-dealer publishing or distributing said research
report. However, because the universe of covered investment funds is
dominated
[[Page 64209]]
by funds with a class of securities that could be considered to be in
substantially continuous distribution,\337\ the bright-line test of the
regular-course-of-business requirement would impact only a small subset
of funds.
---------------------------------------------------------------------------
\337\ See supra section III.B.1.a.
---------------------------------------------------------------------------
Related concerns were voiced by several commenters who questioned
the feasibility of satisfying the regular-course-of-business
requirement under the proposed rules.\338\ As discussed above, we have
included additional guidance to mitigate concerns about the
interpretation of the regular-course-of-business requirement.\339\
While we believe that this guidance should address commenters' concerns
about the feasibility of satisfying the regular-course-of-business
requirement, we acknowledge that--due to the reasons discussed above--
broker-dealers evaluating whether their research activities satisfy the
regular-course-of-business requirement are likely to face more
uncertainty when those activities relate to covered investment funds
than when those activities relate to operating companies. However, we
believe that broker-dealers would only issue covered investment fund
research reports if the benefits are likely to outweigh the costs,
including uncertainty.
---------------------------------------------------------------------------
\338\ See supra sections II.B.1.c, II.B.2.b.
\339\ See supra paragraph accompanying note 118.
---------------------------------------------------------------------------
c. Reporting History and Minimum Market Value Requirements for Issuers
Appearing in Issuer-Specific Research Reports
Under rule 139b, a broker-dealer's publication or distribution of
issuer-specific research reports does not qualify for the safe harbor
unless the covered investment fund included in the report satisfies a
minimum public market value threshold of $75 million.\340\ Issuers are
also required to have been subject to the reporting requirements of the
Investment Company Act (for covered investment funds that are
registered investment companies) or the reporting requirements under
section 13 or section 15(d) of the Exchange Act (for covered investment
funds that are not registered investment companies) for a period of at
least 12 calendar months prior to reliance on the rule as well as to
have timely filed all required reports during the preceding 12 calendar
months.\341\
---------------------------------------------------------------------------
\340\ See rule 139b(a)(1)(i)(B).
\341\ Including Forms N-CSR, N-Q, N-PORT, N-MFP, and N-CEN as
applicable for registered investment companies, and Forms 10-K, 10-
Q, and 20-F as applicable for covered investment funds that are not
registered investment companies. See rule 139b(a)(1)(i)(A).
---------------------------------------------------------------------------
The covered investment funds market is dynamic.\342\ In 2017, more
than six hundred covered investment funds entered the market, while
more than eight hundred exited. The entry and exit of covered
investment funds creates a situation in which a younger covered
investment fund may not be widely followed by market participants.\343\
Thus, for covered investment funds, the universe of young--and
potentially less-followed--issuers is large.\344\ Moreover, securities
issued by covered investment funds may not be subject to significant
levels of market scrutiny. Unlike securities issued by operating
companies (that generally have diverse groups of investors, including
institutional investors, money managers, arbitrageurs, activist
investors, and short sellers), covered investment funds are primarily
held by retail investors.\345\ As covered investment fund shares are
not a major component of institutional investors' portfolios, we
believe that they are less likely to garner wide-spread attention from
the types of sophisticated institutional investors most capable of
subjecting them to scrutiny.\346\
---------------------------------------------------------------------------
\342\ See supra section III.B.1.a.
\343\ In contrast, there were fewer than one hundred U.S. IPOs
for operating companies in 2016. See Jay Ritter, Initial Public
Offerings: Updated Statistics (Aug. 8, 2017), available at https://site.warrington.ufl.edu/ritter/files/2017/08/IPOs2016Statistics.pdf.
\344\ For example, Morningstar notes that funds with short track
records are unlikely to be provided coverage. See Morningstar,
Morningstar Manager Research Coverage Decision-Making (June 2018),
available at https://morningstardirect.morningstar.com/clientcomm/Morningstar_Manager_Research_Coverage_Decision_Making.pdf.
\345\ See supra section III.B.1.a.
\346\ See supra note 310 and accompanying text.
---------------------------------------------------------------------------
We believe that in the context of covered investment funds, where
we expect limited market discipline from institutional investors and
where large numbers of new funds are created each year, the information
available to investors could be sparse. In such an environment, a
single research report about a covered investment fund could have a
disproportionate effect on retail investors' beliefs about the fund
and--in the case of a biased research report--have a negative effect on
investor welfare. We believe that conditioning the availability of the
safe harbor on the aforementioned reporting history and market
valuation requirements would help restrict the availability of the safe
harbor in situations where we expect the information environment to be
most limited: For new funds and for funds with limited trading or
interest.\347\
---------------------------------------------------------------------------
\347\ For example, while Morningstar provides analyst ratings
for 200 ETFs and 1,562 open-end funds, among ETFs and open-end funds
falling below the $75 million minimum public market value threshold,
only 27 received an analyst rating. See supra notes 243 and 344.
---------------------------------------------------------------------------
As noted by several commenters, because young and small covered
investment funds are relatively common, the costs associated with these
conditions on the availability of a safe harbor could be
significant.\348\ In particular, as shown in Table 1, the $75 million
minimum public market valuation condition will limit the availability
of the safe harbor with respect to broker-dealers' publication or
distribution of research reports for approximately one-third of all
covered investment funds.\349\ Research reports about nearly half of
extant ETFs, ETPs will not qualify for the safe harbor.\350\
Availability of the safe harbor would be least impacted for research
reports about BDCs and closed-end funds.\351\
---------------------------------------------------------------------------
\348\ See SIFMA Comment Letter I; ICI Comment Letter; Fidelity
Comment Letter; see also BlackRock Comment Letter.
\349\ 30% of all covered investment funds have public market
valuations less than $75 million. See Table 1.
\350\ 41% of ETF and ETPs have public market valuations less
than $75 million. See Table 1.
\351\ 12% of closed-end funds and 7% of BDCs have public market
valuations less than $75 million. See Table 1.
---------------------------------------------------------------------------
Although small funds represent a very small fraction of covered
investment fund assets, they are relatively large in number.\352\
Because nearly one-third of covered investment funds will not satisfy
the eligibility criteria for the safe harbor, we believe that those
funds will be less likely to receive coverage by broker-dealers insofar
as the inability to rely on the safe harbor reduces broker-dealers'
willingness to publish and distribute research reports.
---------------------------------------------------------------------------
\352\ See Table 1.
[[Page 64210]]
Table 1--Covered Investment Funds With Public Market Value Less Than $75 Million, and the Fraction of Covered
Investment Fund Assets Held by These Funds
[For each covered investment fund type, we report the percentage of funds of that type with a public market
value below $75 million and the percentage of covered investment fund assets held in funds with public market
values below $75 million. Mutual fund, ETF, and ETP statistics are based on data from CRSP mutual fund database
(2017Q3). Close-end fund statistics are based on data from CRSP monthly stock file (Dec. 2017). BDC statistics
are based on Commission's listing of registered BDCs, and regulatory filings (2017) compiled by Compustat and
Audit Analytics]
----------------------------------------------------------------------------------------------------------------
Funds with public market value
<$75 million
Covered investment fund type -----------------------------------
Number of funds
(%) Fund assets (%)
----------------------------------------------------------------------------------------------------------------
Open-end.................................................................... 30 <1
Closed-end.................................................................. 12 <1
ETF/ETP..................................................................... 41 <1
BDC......................................................................... 7 <1
-----------------------------------
Total................................................................... 30 <1
----------------------------------------------------------------------------------------------------------------
Several commenters raised concerns that--in addition to the
aforementioned costs--compliance with the reporting history and minimum
market value requirements as proposed could be operationally
challenging for broker-dealers.\353\ In general, we do not believe that
verifying covered investment funds' reporting history and public market
valuation represents a significant additional burden for broker-dealers
in this position.\354\
---------------------------------------------------------------------------
\353\ See SIFMA Comment Letter I; see also Fidelity Comment
Letter.
\354\ For example, much of this information is currently
accessible through the publicly available EDGAR system and/or third-
party data providers.
---------------------------------------------------------------------------
Another commenter noted that some broker-dealers provide investors
research about large numbers of funds on a largely automated basis, and
that ensuring compliance with the reporting history and minimum public
market value requirements would create ``operational hurdles'' for
these broker-dealers.\355\ We believe that broker-dealers that choose
to automate publication of research reports will make significant
investments in technology to implement this automation, and that
broker-dealers with infrastructure capable of automating publication of
research reports should have little difficulty implementing the
procedures required for similarly automating the verification of these
requirements.\356\ However, in a change from the proposal, final rule
139b will not require the minimum public market valuation condition to
be verified at the time of reliance.\357\ Rather, the final rule
requires that this condition be satisfied at the time of the broker's
or dealer's first publication or distribution of a research report on
the covered investment fund, and at least quarterly thereafter.\358\ We
believe this change should simplify compliance without materially
affecting the provisions' effectiveness.\359\
---------------------------------------------------------------------------
\355\ See Fidelity Comment Letter; see also paragraphs
accompanying supra notes 64, 73.
\356\ We note that a software system capable of automatically
generating non-trivial research reports about a given covered
investment funds would contain data access modules providing
programmatic access to the covered investment fund's historical
filings and pricing data. Conditional on the existence of such
modules, implementation of tests for the reporting history and
minimum market value requirements would represent a de minimis cost.
\357\ See supra section II.B.1.b.
\358\ See rule 139b(a)(1)(i)(B).
\359\ We believe that implementing periodic assessments would be
simpler and less costly than implementing an assessment at the time
of reliance. At the same time, we do not believe that there would be
a material difference in the set of covered investment funds
captured by the minimum public valuation threshold under these two
approaches. See supra paragraph accompanying note 104.
---------------------------------------------------------------------------
Finally, one commenter raised concerns that because of shortcomings
in the data currently available about affiliates' holdings, it may not
be possible for broker-dealers to establish the public market value of
a covered investment fund if affiliate holdings are to be excluded from
the calculation.\360\ Although we believe that that the information
required to make this calculation may be available to broker-dealers,
we understand that it may not currently be generally available in a
structured form amenable to automation. This could present operational
difficulties for broker-dealers developing processes for automated
report publication. In a change from the proposal, final rule 139b
eliminates the requirement that the public market valuation calculation
be calculated net of affiliates' holdings for most covered investment
funds. We believe that this change is unlikely to materially affect the
effectiveness of the minimum public market value requirement \361\
while eliminating a plausible obstacle to its automated verification in
the vast majority of cases. We acknowledge, however, that retaining the
requirement to adjust for affiliate holdings in the public market
valuation calculation for commodity- and currency-based trusts could
reduce the amount of automated coverage provided to such trusts by
broker-dealers.\362\
---------------------------------------------------------------------------
\360\ See SIFMA Comment Letter II.
\361\ Covered investment funds are subject to unique legal
provisions that generally restrict affiliate ownership and provide
additional legal protections when affiliate ownership is permitted.
See, e.g., Investment Company Act sections 12, 17, and 57 and rules
thereunder. In addition, unlike rule 139, rule 139b does not permit
affiliates of covered investment funds to rely on the safe harbor,
mitigating the risk that a fund with significant affiliate holdings
would be the subject of market moving research by those same
affiliates.
\362\ See supra note 99.
---------------------------------------------------------------------------
d. Reporting Requirement for Issuers Appearing in Industry Reports
Under rule 139b an industry research report could only include
covered investment funds that are required to file reports pursuant to
section 30 of the Investment Company Act (or, for covered investment
funds that are not registered investment companies under the Investment
Company Act, required to file reports pursuant to section 13 or section
15(d) of the Exchange Act).\363\ As discussed above, these conditions
generally track parallel conditions under rule 139, but have been
modified so that they would be applicable with respect to covered
investment fund issuers. We do not expect these conditions to have
economic effects
[[Page 64211]]
beyond marginally improving economic efficiency by more closely
aligning regulations with their intended context.
---------------------------------------------------------------------------
\363\ See rule 139b(a)(2)(i). As discussed previously, each
issuer included in an issuer-specific research report also would be
required to be subject to these reporting requirements, as well as
the requirement to have filed in a timely manner all of the periodic
reports required to be filed during the preceding 12 calendar
months. See supra section II.B.1.a.
---------------------------------------------------------------------------
e. Content and Presentation Requirements for Industry Research Reports
Under rule 139b, the content and presentation standards for
industry research reports of rule 139 are tailored to the context of
covered investment funds. Under rule 139b (and rule 139), issuers
appearing in industry research reports are subject to fewer conditions
than issuers that are subjects of issuer-specific research
reports.\364\ We believe that in the absence of content and
presentation requirements such as these, an industry research report
could be used to circumvent the conditions associated with the safe
harbor available for issuer-specific research reports. We therefore
believe that the content and presentation standards we are adopting
have benefits similar to those of the parallel content and presentation
requirements in rule 139, and provide meaningful limits for industry
research reports.\365\
---------------------------------------------------------------------------
\364\ See supra sections II.B.1, II.B.2.
\365\ See supra sections II.B.2.c, II.B.2.d.
---------------------------------------------------------------------------
We believe the compliance costs imposed by these requirements on
the production of industry research reports would be low, particularly
as broker-dealers are already familiar with similar conditions in rule
139, making implementation of presentation conditions for industry
research reports on covered investment funds less burdensome.
f. Presentation of Performance Information
Given the definition of ``research report'' under the FAIR Act (and
the definition of ``research report'' being adopted under rule 139b),
certain communications by broker-dealers that historically have been
treated as advertisements for registered investment companies under
rule 482 now could be distributed as covered investment fund research
reports under the rule 139b safe harbor.\366\ In the Proposing Release,
we raised concerns that not including provisions similar to rule 482 in
proposed rule 139b could result in investors receiving communications
about covered investment funds where the character of the communication
(i.e., bona fide research versus advertising) is unclear.\367\
Conflicts of interest resulting from broker-dealers' financial
incentives could affect the manner in which performance data is
presented in research reports, potentially leading to misleading
presentation of performance data. In addition, investors could be
confused if performance is presented differently in an advertisement
and in a research report, particularly if the research report doesn't
adequately disclose the methodologies used to produce the performance
that could explain the differences. Retail investors, in particular,
may be unable to assess the non-standardized performance figures when
considering their investment decisions.
---------------------------------------------------------------------------
\366\ See supra note 162 and accompanying text. Similarly,
``research reports'' regarding covered investment funds that broker-
dealers today might publish or distribute as ``supplemental sales
literature'' under Investment Company Act rule 34b-1 (which must be
preceded or accompanied by a statutory prospectus) could be
distributed as covered investment fund research reports under rule
139b. See supra note 165 and accompanying text.
\367\ See Proposing Release, supra note 2, at 26825.
---------------------------------------------------------------------------
As discussed above, unlike in the Proposing Release, final rule
139b incorporates provisions on the presentation of performance
information in research reports about registered investment companies
that mirror those of rule 482 and--with respect to closed-end funds--
Form N-2.\368\ Incorporating these presentation standards in rule 139b
reduces the potential for confusion between (i) registered open-end
management investment company advertisements and selling materials
covered by rule 482 and registered closed-end investment company
selling materials covered by Form N-2 and (ii) rule 139b research
reports.\369\ Additionally, incorporating some of these provisions into
rule 139b would reduce the potential for investor confusion resulting
from divergent standards in the presentation of performance data.
---------------------------------------------------------------------------
\368\ Rule 482 does not set forth requirements on the
presentation of performance information in research reports about
registered closed-end investment companies. See supra section II.C.
\369\ See supra paragraph accompanying notes 165-167.
---------------------------------------------------------------------------
Because fees can represent a significant drag on investment
returns,\370\ because different performance measures may be more or
less favorable at different times, and because retail investors are
known to be sensitive to past performance data,\371\ we believe that
the manner in which past performance data is presented can be an
important factor driving investors' investment decisions. As discussed
above, even unaffiliated broker-dealers may have incentives, stemming
from funds' distribution arrangements, to promote a covered investment
fund, or to promote certain funds over others.\372\ When broker-dealers
publish or distribute research reports on covered investment funds,
their choices with respect to how fees are disclosed, which performance
measures are quoted, and for what time periods could be affected by
these considerations. This in turn can adversely affect investors,
particularly unsophisticated investors. We believe that these
additional requirements on the presentation of performance information
will limit opportunities for selective performance disclosure and will
curtail opportunities to circumvent the performance reporting
requirements of rule 482 and Form N-2.
---------------------------------------------------------------------------
\370\ See, e.g., Mark M. Carhart, On Persistence in Mutual Fund
Performance, 52 The Journal of Finance 1, 57-82 (Mar. 1997).
\371\ See Erik R. Sirri & Peter Tufano, Costly Search and Mutual
Fund Flows, 53 The Journal of Finance 5, 1589-1622 (Oct. 1, 1998).
\372\ See supra section III.C.1.b.
---------------------------------------------------------------------------
By limiting opportunities for selective performance disclosure, we
believe that final rule 139b will also reduce the potential for
investor confusion. Under the final rule, there will be fewer
opportunities for the performance disclosure in registered investment
company advertisements and research reports to diverge. There also
could be less potential for investor confusion when comparing research
reports about different covered investment funds, or reports issued by
different broker-dealers. These results would benefit investors. As
discussed in the Proposing Release, the extent of the benefits
resulting from requirements on the presentation of performance
information depends on their effectiveness in ensuring consistent
disclosure and/or alerting investors to factors that could influence
their understanding of the disclosure in a research report. The extent
of the benefit also would depend on the audience who will be reading
research reports about registered investment companies. As discussed in
the Proposing Release, we believe that retail investors would generally
be less likely to be able to identify sources of bias (and disregard or
discount bias) in communications about covered investment funds than
institutional investors and therefore could benefit from limitations on
selective performance disclosure. We believe that rule 482 standards on
the presentation of performance information have been effective at
limiting selective disclosure in applicable registered investment
company advertisements, and that they will be similarly effective for
research reports falling under rule 139b. Moreover, as noted above, we
believe that retail investors will be the primary consumers of such
research reports, and that such investors would be most likely
[[Page 64212]]
to benefit from these additional provisions.
As discussed in the Proposing Release, we believe that the most
significant costs associated with additional requirements on the manner
in which performance information may be presented would result from
their potential to limit the manner in which the content of broker-
dealers' research reports is presented. Although we are not preventing
alternative performance measures from being included in research
reports, by limiting the prominence afforded to such performance
measures we could adversely affect broker-dealers' ability to provide
valuable analysis. For example, a broker-dealer who wishes to center
its analysis on a fund's risk-adjusted returns would be limited in how
such information could be presented in the report, even though certain
audiences for research reports could consider this information to be
particularly relevant.
We believe that broker-dealers' direct compliance costs under these
additional provisions would be minimal. Because we believe that broker-
dealers that will publish research reports are likely currently
distributing advertisements under rule 482, these broker-dealers likely
already have processes and systems to produce charts and tables of
performance measures using timely data under the presentation standards
required by the final rules. However, we acknowledge that the final
rules' will impose costs on broker-dealers that did not previously
distribute advertisements under rule 482 and they would need to develop
processes and systems to implement these presentation standards. We
estimate the one-time implementation costs attributable to the new
presentation standards for each broker-dealer publishing research
reports to be approximately 5 hours or $1,310.\373\ Further, we expect
the systems necessary to satisfy the requirement for timely data under
rule 482(g) would generally be available to broker-dealers publishing
research reports.
---------------------------------------------------------------------------
\373\ Calculated as 5 hours x Senior Business Analyst at $262
per hour = $1.310. The hourly wage rate is from SIFMA's Management &
Professional Earnings in the Securities Industry 2013, modified to
account for an 1,800-hour work year; multiplied by 5.35 to account
for bonuses, firm size, employee benefits and overheard; and
adjusted to account for the effects of inflation.
---------------------------------------------------------------------------
3. Rule 24b-4
Rule 24b-4 excludes a covered investment fund research report from
the coverage of section 24(b) of the Investment Company Act and the
rules and regulations thereunder, except to the extent that such report
is not subject to the content provisions of SRO rules related to
research reports, including those contained in the rules governing
communications with the public regarding investment companies or
substantially similar standards. As discussed above, this rule is meant
to implement section 2(b)(4) of the FAIR Act, which we interpret to
exclude covered investment fund research reports from section 24(b) of
the Investment Company Act so long as they continue to be subject to
the general content standards in FINRA rule 2210(d)(1).\374\ For
covered investment fund research reports that are published or
distributed by FINRA member firms, all such research reports would be
subject to the content standards of FINRA rule 2210(d)(1), and thus we
would interpret these research reports to be excluded from the
Commission's filing requirements under the rule.\375\
---------------------------------------------------------------------------
\374\ See supra note 183 and accompanying text.
\375\ See id.
---------------------------------------------------------------------------
As discussed above, where covered investment fund research reports
would no longer be required to be filed with the Commission pursuant to
section 24(b), rule 24b-4 could have the effect of narrowing the types
of communications regarding registered investment companies that would
be filed with FINRA (under current FINRA rule 2210).\376\ However, we
believe that administrative processes related to handling regulatory
reviews of communications subject to filing requirements impose costs
on broker-dealers, which in turn can reduce their willingness to
publish and distribute such communications. Consequently, although we
do not believe that limiting these filing requirements as required by
the FAIR Act represents a first-order economic effect of the new rules,
we believe that doing so will reduce administrative costs for broker-
dealers publishing or distributing covered investment fund research
reports. At the same time, as discussed above, we believe that
eliminating these filing requirements may have the result that some
communications that are were subject to FINRA's filing requirements
would no longer be subject to routine review.\377\ While these
communications may still be reviewed by FINRA--for example, through
examinations, targeted sweeps, or spot-checks--we believe that an
effect of the FAIR Act, as implemented through rule 24b-4, may be to
reduce the monitoring by FINRA and the Commission of broker-dealers'
communications with customers for compliance with the applicable rules
and regulations.\378\
---------------------------------------------------------------------------
\376\ See id.
\377\ See supra section II.D.1.
\378\ But see supra note 195 and accompanying text (noting that
the FAIR Act's rules of construction provide that the Act shall not
be construed as limiting the authority of an SRO to require the
filing of communications with the public if the purpose of such
communications ``is not to provide research and analysis of covered
investment funds''); see also section 2(c)(2) of the FAIR Act.
---------------------------------------------------------------------------
4. Amendments to Rule 101 of Regulation M and Form 12b-25
As discussed above, rule 101 of Regulation M prohibits a person who
participates in a distribution from attempting to induce others to
purchase securities covered by the rule during a specified period.\379\
However, rule 101 provides an exception for research activities that
satisfy the conditions of Securities Act rule 138 or rule 139. The
conforming amendment expands this exception to include research
activities that satisfy the conditions of rule 139b. We believe that
broker-dealers would generally be unable to make use of the rule 139b
safe harbor absent this conforming amendment. Consequently, we do not
consider its effects separately.
---------------------------------------------------------------------------
\379\ See supra section II.E.
---------------------------------------------------------------------------
As discussed above, we are making a technical amendment to Form
12b-25 to replace references to Form N-SAR with references to Form N-
CEN and to remove the checkbox and accompanying text related to
transition reports on Form N-SAR.\380\ The amendments to Form 12b-25
that the Commission is adopting are ministerial actions that correct
outdated references and therefore will have no separate economic
effect, including no effect on competition.
---------------------------------------------------------------------------
\380\ See id.
---------------------------------------------------------------------------
5. Effects on Efficiency, Competition, and Capital Formation
The primary effects on economic efficiency and capital formation
resulting from rules 139b and 24b-4 obtain from the statutory mandates
of the FAIR Act. Because financial intermediaries such as broker-
dealers are generally assumed to possess some comparative advantage in
the production of information about securities, efficiency
considerations would--in the absence of significant market
imperfections--dictate that broker-dealers should be active in the
production of such information. To the extent that the increase in
broker-dealers' production of research reports about covered investment
funds--that we expect to occur as a result of the FAIR Act's statutory
mandates \381\--is valuable to investors, we expect it to increase
allocative efficiency, with
[[Page 64213]]
attendant positive consequences on capital formation. As noted earlier,
the existence of the safe harbor could provide increased opportunities
for broker-dealers to publish and distribute research on funds from
which they derive financial benefits.\382\ To the extent that this
could limit the value investors derive from research reports that
broker-dealers publish and distribute, any potential gains to
efficiency and improvements to capital formation could be reduced (or
eliminated).
---------------------------------------------------------------------------
\381\ See supra section III.C.1.a.
\382\ See supra section III.C.1.b.
---------------------------------------------------------------------------
Beyond the aforementioned broader effects on efficiency and capital
formation resulting from the FAIR Act's statutory mandates, we believe
that the specific conditions \383\ on the availability of the safe
harbor in rule 139b will generally further economic efficiency and
facilitate capital formation by reducing the potential for retail
investors to receive research reports whose publication or distribution
may be motivated by financial incentives that could cause a conflict of
interest. We believe that the affiliate exclusion and related guidance
will have the largest impact because it addresses the greatest
conflicts of interests in this context: Those arising from broker-
dealers in investment advisory relationships.\384\ In addition, we
believe that the Commission's various tailoring of the new rules to the
covered investment fund context will yield marginal efficiency
improvements from reductions in regulatory ambiguity.
---------------------------------------------------------------------------
\383\ See supra section III.C.2.
\384\ See supra section III.C.2.a.
---------------------------------------------------------------------------
With respect to competition, we believe that expansion of the rule
139 safe harbor will increase competition in the market for research
reports on covered investment funds. Under the baseline, the market for
research reports on covered investment funds is dominated by a small
number of independent research firms, with few broker-dealers producing
original research about such funds.\385\ We believe that the
availability of the safe harbor will encourage some broker-dealers to
publish proprietary research on covered investment funds. However, due
to the high costs associated with maintaining research departments
capable of covering the large covered investment fund universe,\386\ we
believe that most broker-dealers will continue to rely on content
licensed from independent firms.\387\ We also believe that there are
competitive implications stemming from the guidance we have given to
address possible circumvention of the affiliate exclusion.\388\ This
guidance may have the effect of placing smaller broker-dealers--who may
not operate at a scale large enough to sustain a research department--
at a competitive disadvantage. These smaller broker-dealers may find
that they are unable to compete with larger broker-dealers in the
provision of ``original'' research about covered investment funds.
---------------------------------------------------------------------------
\385\ See supra section III.B.1.c.
\386\ See supra section III.B.1.a.
\387\ We expect that broker-dealers that choose to publish
research on covered investment funds will generally not license it
to their competitors.
\388\ See supra section III.C.2.a.
---------------------------------------------------------------------------
6. Alternatives Considered
We considered several alternative approaches to implementing the
FAIR Act mandates that could satisfy the requirements of the FAIR Act.
We summarize these here.
a. Conditions on Issuers Appearing in Issuer-Specific Research Reports
As discussed above, we believe that conditioning the availability
of the safe harbor on the $75 million minimum public market value
requirement will promote investor protection by limiting research
reports to issuers that have a demonstrated market following.\389\
However, we acknowledge that it will mean that research reports about
significant numbers of smaller covered investment funds would not
qualify for inclusion in research reports under the safe harbor.\390\
We believe that this will reduce the effect of the new rules on the
availability of research reports about smaller covered investment
funds.\391\
---------------------------------------------------------------------------
\389\ See supra section II.B.1.b.
\390\ See SIFMA Comment Letter I; see also ICI Comment Letter;
BlackRock Comment Letter.
\391\ See supra section III.C.2.c.
---------------------------------------------------------------------------
Depending on the distribution of covered investment funds' public
market values, a somewhat lower threshold could significantly increase
the number of covered investment funds that qualify for inclusion in
research reports without undermining investor protection (because it
would not materially increase the number of qualifying funds without a
demonstrated market following). Conversely, a significantly higher
threshold could further promote investor protection without
significantly decreasing the number of qualifying funds (however, as
discussed below, we did not consider this alternative because the FAIR
Act prevents us from conditioning the availability of the safe harbor
on a minimum public market
[[Page 64214]]
value requirement that is greater than what is required under rule
139).
[GRAPHIC] [TIFF OMITTED] TR13DE18.004
We have considered a range of alternative minimum public market
values thresholds. Figure 5 plots the percentage of covered investment
funds whose public market valuations would fall under each alternative
threshold. Figure 5 shows that although the safe harbor would not be
available to significant numbers of covered investment funds under the
$75 million threshold, material increasing its availability would only
be achievable through large reductions to the threshold. This is due to
large numbers of funds being very small: As shown in Figure 6, over 600
covered investment funds have a public market valuation of $5 million
or less. We do not believe that a significantly lower threshold would
be effective at promoting investor protection because, as discussed
above in section III.C.2.c, we expect the information environment to be
more limited for smaller funds than for larger funds.\392\ At the same
time, we believe that imposing the threshold would only restrict the
availability of research for covered investment funds that have small
economic significance. As shown in Figure 7, covered investment funds
falling below the $75 million threshold account for less than 1% of the
dollars invested in each of the four covered investment fund types.
---------------------------------------------------------------------------
\392\ One commenter suggested lowering the threshold to no more
than $20 million; see SIFMA Comment Letter I. Another commenter
noted that 41% of all ETFs and exchange-traded products would be
excluded by the $75 million threshold; see Fidelity Comment Letter.
Although these commenters argued that lowering the threshold could
benefit investors by increasing the number of funds for which
covered investment fund research reports were available, they did
not address the question of the potential cost to investors
resulting from a lower threshold. See supra section III.C.2.c.
---------------------------------------------------------------------------
[[Page 64215]]
[GRAPHIC] [TIFF OMITTED] TR13DE18.005
[GRAPHIC] [TIFF OMITTED] TR13DE18.006
The FAIR Act prevents us from conditioning the availability of the
safe harbor on a minimum public market value requirement that is
greater than what is required under rule 139.\393\ This effectively
prevents us from conditioning the availability of the safe harbor for
research reports on the subject covered investment fund having a public
float of more than $75 million. Consequently, we do not consider
[[Page 64216]]
higher minimum public market value thresholds.
---------------------------------------------------------------------------
\393\ See supra note 83 and accompanying text.
---------------------------------------------------------------------------
b. Conditions on Issuers Appearing in Industry Research Reports
(1) Applying Uniform Conditions on Issuers Appearing in Issuer-Specific
and Industry Research Reports
With respect to conditions affecting the availability of the safe
harbor for industry research reports, we considered applying to
industry research reports the same requirements as would apply to
issuer-specific research reports. As with the restrictions on issuer-
specific research reports, similarly restricting industry research
reports could help ensure that funds included in research reports are
well-followed, and could restrict the availability of the safe harbor
in situations where we expect the information environment to be most
limited: For new funds and for funds with niche markets.
In the context of research reports about covered investment funds,
cost-benefit considerations for including additional conditions on
industry reports differ slightly from those that apply in the context
of traditional research reports about equity and debt securities. In
the context of research reports about equity and debt securities,
analysis of an industry, in the case of operating companies, may
require the discussion of specific firms within that industry. For
example, a discussion about a mature industry (e.g., automobiles) may
require discussion of a disruptive new entrant (e.g., autonomous
vehicle start-up). In the context of the rule 139 safe harbor, the new
entrant may not satisfy the reporting history and minimum float
requirements. This would reasonably prevent an issuer-specific research
report about the new entrant from qualifying for the safe harbor.
However, it would not further the goal of facilitating coverage of the
industry to limit the safe harbor for industry reports to reports that
do not discuss the new entrant: Analysis of the industry may require
discussion of specific issuers that would not qualify for inclusion in
issuer-specific research reports.
In the context of covered investment funds, a similar rationale
would not apply as broadly. Rule 139b content requirements for industry
research reports would reference covered investment fund issuers of the
same ``type or investment focus,'' rather than the issuers' ``industry
or sub-industry'' (i.e., a broad category of similar businesses).\394\
Although it is clear that an industry research report about some
covered investment fund types (e.g., emerging growth bonds) may have
reasons to include a discussion of issuers that may not be eligible for
inclusion in issuer-specific research reports (e.g., best-performing
new fund), it is not clear that such reasons would rise to the level of
requiring the discussion of such issuers. Unlike the effects of an
operating company issuer on its ``industry,'' the effects of a covered
investment fund issuer on its fund ``type'' is very limited.
---------------------------------------------------------------------------
\394\ See supra section II.B.2.c.
---------------------------------------------------------------------------
(2) Allowing Affiliates To Appear in Comprehensive List of Recommended
Issuers
We considered providing that a comprehensive list of recommended
issuers may include issuers that are affiliates of the broker-dealer
that is publishing or distributing the research report under certain
circumstances, including: If affiliates were identified; if disclosure
about the affiliated issuers were limited; or if any performance
information included in a list that includes affiliated issuers were
presented in accordance with rule 482.\395\ Generally, we believe that
including such provisions would benefit broker-dealers that play a
significant role both as investment advisers to, and as distributors
of, covered investment funds. However, as discussed above, we believe
that broker-dealers publishing or distributing research reports about
affiliated funds would have the potential for the most significant
conflicts of interest.\396\ Moreover, permitting affiliated funds to be
included in such comprehensive lists could result in confusion: Broker-
dealers would be able to offer recommendations for affiliated funds in
industry research reports, but there would be no safe harbor enabling
them to publish or distribute issuer-specific research reports (which
could provide the basis for such recommendations) as a result of the
affiliate exclusion.
---------------------------------------------------------------------------
\395\ See id.
\396\ See supra section III.C.1.b.
---------------------------------------------------------------------------
c. Approach to Regular-Course-of-Business Requirement
As discussed in section III.C.2.b, in principle we expect a
regular-course-of-business requirement to reduce opportunities for the
safe harbor to be used in ways that lead to investor confusion.
However, we also believe that in the context of covered investment
funds, establishing whether a report is published in the ``regular
course of business'' could present more challenges than in the rule 139
context of research reports about the securities of operating
companies.\397\ Thus, we requested comment on and have considered
various alternative approaches to the regular-course-of-business
requirements.\398\ Specifically, we have considered that this
requirement be defined more specifically to address, for example,
circumstances in which a broker-dealer has not previously published or
distributed research reports.\399\ For example, we considered whether
rule 139b should provide a ``start-up'' period to allow broker-dealers
to establish a regular course of business of publishing research
reports.\400\ We have also considered requiring that the regular-
course-of-business requirement incorporate more specific requirements
regarding the persons preparing such reports (e.g., that they must be
employed by a broker-dealer to prepare such research in the regular
course of his or her duties).\401\
---------------------------------------------------------------------------
\397\ See supra section II.B.2.b.
\398\ See Proposing Release, supra note 2, at 26797-98. We did
not receive comments specifically addressing the economic effects of
alternative approaches to the regular-course-of-business
requirement.
\399\ See id.
\400\ See id.
\401\ See id.
---------------------------------------------------------------------------
Conditioning availability of the safe harbor on a broker-dealer's
having published research reports for a given period of time, or on the
broker-dealer's having operated for some amount of time, could lead to
the publication of reports that are more likely to be recognized as
research.\402\ Moreover, we believe that broker-dealers with a longer
operating history and those who have published research reports--
relying on the existing rule 139 safe harbor or otherwise without
relying on the safe harbor--will have made greater investments in their
reputations. Such investments increase the reputational costs
associated with the publication of research reflecting conflicts of
interest, which as discussed above could mitigate the effects of
conflicts of interest on research reports.\403\
---------------------------------------------------------------------------
\402\ See id.
\403\ See Chemmanur and Fulghieri Article, supra note 302; see
also supra section III.C.1.b. However, we note that the efficacy of
an institutional reputation mechanism has not found empirical
support in related settings. See Fang and Yasuda Article, supra note
301 (where sell-side research analysts' reputation mitigates
manifestation of conflicts of interest from underwriting
relationships, while institutional reputation does not).
---------------------------------------------------------------------------
In rule 139b, we have chosen not to incorporate these more specific
alternative approaches to the regular-
[[Page 64217]]
course-of-business requirement. While we note the potential benefits of
such approaches in enhancing the value that covered investment fund
research reports may provide investors, we also understand that these
more specific alternatives may restrict the flow of relevant
information to investors.
d. Presentation of Performance Information
As discussed above, we have chosen to incorporate rule 482 and Form
N-2 requirements on the presentation of performance information in
final rule 139b.\404\ We also considered the alternatives of including
rule 156 guidance factors (or a subset thereof), requirements relating
to disclosure of nonrecurring fees, and requirements on the timeliness
of performance data.\405\ We also considered a requirement in rule 139b
to incorporate general narrative disclosure into a research report
about a registered investment company, aimed at reducing potential
investor confusion.\406\ For example, we could have required such
research reports to incorporate a legend stating that the document is a
research report and is not subject to the Commission's regulations
applicable to sales and advertising. We also could have required such a
research report to incorporate similar disclosure without requiring
that it be structured as a legend (which would require the disclosure
of similar concepts but would not require any particular wording).\407\
---------------------------------------------------------------------------
\404\ See supra sections II.C and III.C.2.f.
\405\ See Proposing Release, supra note 2, at 26825-26.
\406\ See id.
\407\ See id.
---------------------------------------------------------------------------
In general, imposing additional requirements on the presentation of
performance information would further reduce opportunities for research
reports to present fund performance information in a manner
inconsistent with similar information presented in advertisements and
supplemental sales literature. We believe that these additional
requirements would therefore reduce investor confusion and
opportunities for the safe harbor to be used to present misleading
information to investors.\408\ However, imposing these additional
requirements would increase compliance costs for broker-dealers. In
particular, imposing rule 156 (or similar) guidance factors would make
determinations of compliance with the provisions of rule 139b less
certain. This could make broker-dealers reluctant to rely on the rule
139b safe harbor and impede the publication and distribution of broker-
dealer research on covered investment funds.
---------------------------------------------------------------------------
\408\ See id.
---------------------------------------------------------------------------
The alternatives of including various forms of disclosures to the
effect that a ``research report'' is not subject to the Commission's
regulations applicable to sales and advertising would impose the lowest
costs on broker-dealers. However, we believe that requiring disclosure
to this effect is unlikely to have significant beneficial effects in
the retail context.
IV. Paperwork Reduction Act
New rule 139b contains ``collection of information'' requirements
within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\409\ Specifically, rule 139b(a)(3) requires that broker-
dealers that provide performance information in their covered
investment fund research reports about (i) open-end funds must be in
accordance with specified rule 482 presentation requirements or (ii)
closed-end funds must be in accordance with a specified instruction set
forth in Form N-2. The title for this collection of information is:
``Rule 139b Disclosure of Standardized Performance,'' a new collection
of information. We are requesting comment on this collection of
information requirement in this Release, and intend to submit these
requirements to the Office of Management and Budget (``OMB'') for
review under the PRA.\410\ If approved, responses to the new collection
of information requirement would not be mandatory for broker-dealers
seeking to rely upon rule 139b but would be necessary for those broker-
dealers that would like to provide performance information in their
covered investment fund research reports. Responses to the information
collections will not be kept confidential. An agency may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid OMB control number.
---------------------------------------------------------------------------
\409\ 44 U.S.C. 3501-3521.
\410\ In the Proposing Release, we did not submit a PRA analysis
because--although there was a set of requests for comment on the
subject--the proposal did not include a standardized performance
disclosure requirement, and we believed our proposal did not contain
a ``collection of information'' requirement within the meaning of
the PRA. See Proposing Release, supra note 2, at 26826.
As discussed in the Proposing Release, supra note 2, at 26826,
and above, certain communications that previously would have been
treated as rule 482 advertising prospectuses or rule 34b-1
supplemental sales literature could be considered covered investment
fund research reports subject to the rule 139b safe harbor. This
could result in a reduction in the information collection burdens
for rules 482 and 34b-1 if fewer materials are filed. In connection
with the extension of a currently approved collection for rules 482
and 34b-1, the Commission will adjust the burdens associated with
these collections of information to reflect these changes, as
appropriate. At this time, we do not have any comments regarding
overall burden estimates for the final rule. This Release is
requesting such comments.
---------------------------------------------------------------------------
In the Proposing Release, we solicited comment on whether rule 139b
should include a standardized performance disclosure requirement.\411\
In response to comments received, we have decided to adopt such a
requirement.\412\ We believe that standardized performance presentation
is an appropriate requirement because investors tend to consider fund
performance a significant factor in evaluating or comparing investment
companies, and the requirement addresses potential investor confusion
if a communication were not easily recognizable as research as opposed
to an advertising prospectus or supplemental sales literature. Rule
139b requires that research reports about open-end funds that include
performance information must present it in accordance with paragraphs
(d), (e), and (g) of rule 482. Rule 139b also requires that research
reports about closed-end funds that include performance information
must present it in accordance with instructions to item 4.1(g) of Form
N-2.
---------------------------------------------------------------------------
\411\ See Proposing Release, supra note 2, at 26803-04.
\412\ See supra section II.C.
---------------------------------------------------------------------------
It is difficult to provide estimates of the burdens and costs for
those broker-dealers that will include performance information in a
rule 139b research report. As discussed above, this is difficult to
estimate because current data collected does not reflect the affiliate
exclusion, does not include the entire universe of covered investment
funds, and it is uncertain what percentage of communications currently
filed as rule 482 advertising prospectuses (or rule 34b-1 supplemental
sales materials) will instead be published in reliance on rule 139b, as
covered investment fund research reports.\413\ For purposes of the PRA,
we estimate that 10% of the rule 482 and rule 34b-1 communications
currently filed by broker-dealers with FINRA (approximately 65,000)
could be considered as rule 139b covered investment fund research
reports. We estimate that broker-dealers will publish annually 6,500
(10% of 65,000) covered investment fund research reports. Moreover, we
assume for purposes of the PRA that all estimated rule 139b research
reports will include fund performance information. We further
[[Page 64218]]
estimate that 1,417 broker-dealers would likely be respondents to the
collection of information with a frequency of 4.6 responses per
year.\414\ We further estimate that 50% of these broker-dealers will
have experience in complying with standardized performance requirements
under rule 482. For the 50% of this subset of broker-dealers that do
not have experience with complying with rule 482, we estimate that
there will be a one-time implementation cost for each broker-dealer of
5 internal burden hours. Additionally, we estimate that each research
report will require 3 hours of ongoing internal burden hours by a
broker-dealers' personnel to comply with the rule 139b collection of
information requirements, which for each broker-dealer is estimated to
be 13.8 internal burden hours.\415\ Accordingly, we estimate that the
standardized performance presentation requirements will result in an
average annual hour burden of about 16.3 hours per broker-dealer \416\
in the first year of compliance and about 13.8 hours per broker-dealer
for each of the next two years. Amortized over three years, the average
annual hour burden will be about 14.63 hours per broker-dealer.\417\
---------------------------------------------------------------------------
\413\ See supra note 239 and accompanying paragraph.
\414\ See supra note 230 and accompanying text. 6,500 covered
investment fund research reports/1,417 broker-dealers = 4.6 annual
responses per broker-dealer.
\415\ 4.6 annual responses per broker-dealer x 3 internal burden
hours = 13.8 annual internal burden hours per broker-dealer.
\416\ (50% of * 13.8 hours ongoing compliance) + (50% * (13.8
hours ongoing compliance + 5 hours of initial compliance hours)).
\417\ ((16.3 internal burden hours in year 1) + (13.8 internal
burden hours in year 2) + (13.8 internal burden hours in year 3))/3.
---------------------------------------------------------------------------
In sum, we estimate that rule 139b's requirements will impose a
total annual internal hour burden of 20,731 hours on broker-
dealers.\418\ We do not think there is an external cost burden
associated with this collection of information.
---------------------------------------------------------------------------
\418\ 14.63 annualized burden hours * 1,417 broker-dealers.
---------------------------------------------------------------------------
Request for Comment
We request comment on our approach and the accuracy of the current
estimates. Pursuant to 44 U.S.C. 3506(c)(2)(A), the Commission solicits
comments to: (1) Evaluate whether the collections of information are
necessary for the proper performance of the functions of the agency,
including whether the information will have practical utility; (2)
evaluate the accuracy of the Commission's estimate of the burden of the
collections of information; (3) determine whether there are ways to
enhance the quality, utility, and clarity of the information to be
collected; and (4) evaluate whether there are ways to minimize the
burden of the collections of information on those who are required to
respond, including through the use of automated collection techniques
or other forms of information technology.
The agency has submitted the proposed collections of information to
OMB for approval. Persons wishing to submit comments on the collection
of information requirements of the proposed amendments should direct
them to the Office of Management and Budget, Attention Desk Officer for
the Securities and Exchange Commission, Office of Information and
Regulatory Affairs, Washington, DC 20503, and should send a copy to
Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549, with reference to File No. S7-11-18.
As OMB is required to make a decision concerning the collections of
information between 30 and 60 days after publication of the proposal, a
comment to OMB is best assured of having its full effect if OMB
receives it within 30 days of publication. Requests for materials
submitted to OMB by the Commission with regard to these collections of
information should be in writing, refer to File No. S7-11-18, and be
submitted to the Securities and Exchange Commission, Office of FOIA
Services, 100 F Street NE, Washington, DC 20549.
V. Final Regulatory Flexibility Act Analysis
This Final Regulatory Flexibility Act Analysis has been prepared in
accordance with section 4(a) of the Regulatory Flexibility Act
(``RFA'').\419\ It relates to new rule 139b, new rule 24b-4, and
revisions to the rules under the Securities Act and the Exchange Act to
implement the FAIR Act. An Initial Regulatory Flexibility Analysis
(``IRFA'') was prepared in accordance with the RFA and included in the
Proposing Release.\420\ The Proposing Release included, and solicited
comment on, the IRFA.
---------------------------------------------------------------------------
\419\ See 5 U.S.C. 604(a).
\420\ See Proposing Release, supra note 2, at 26826-29.
---------------------------------------------------------------------------
A. Need for, and Objectives of, the Rules and Rule Amendments
Rule 139b provides that, if certain conditions are satisfied, a
broker-dealer's publication or distribution of a covered investment
fund research report is deemed for purposes of sections 2(a)(10) and
5(c) of the Securities Act not to constitute an offer for sale or offer
to sell a security that is the subject of an offering of the covered
investment fund, even if the broker-dealer is participating or may
participate in a registered offering of the covered investment fund's
securities. Rule 24b-4 provides that a covered investment fund research
report about a registered investment company will not be subject to
section 24(b) of the Investment Company Act (or the rules and
regulations thereunder), except to the extent the research report is
otherwise not subject to the content standards in SRO rules related to
research reports, including those contained in the rules governing
communications with the public regarding investment companies or
substantially similar standards. The revision to paragraph (a) of rule
139 would clarify that rule 139 does not affect the availability of any
other exemption or exclusion from sections 2(a)(10) or 5(c) of the
Securities Act that may be available to a broker-dealer (as provided,
for example, by the provisions of rule 139a or new rule 139b). The
revision to rule 101 under Regulation M is a conforming amendment
intended to harmonize treatment of research under the Securities Act
and Exchange Act rules by permitting distribution participants under
Regulation M, such as brokers-dealers, to publish or disseminate any
information, opinion, or recommendation relating to a covered security
if the conditions of rule 138, rule 139, or rule 139b under the
Securities Act are met. The new rules and rule revisions implement the
directives under the FAIR Act to extend the current safe harbor
available under rule 139 to broker-dealers' publication or distribution
of covered investment fund research reports. The reasons for, and
objectives of, the new rules and rule revisions are discussed in more
detail in section II above.
B. Significant Issues Raised by Public Comments
In the Proposing Release, we requested comment on each aspect of
the IRFA, including the number of small entities that would be affected
by the proposed rules and amendments, the existence or nature of the
potential impact of the proposals on small entities discussed in the
analysis and how to quantify the impact of the proposed rules. We did
not receive comments specifically addressing the impact of the rules
and amendments on small entities subject to the rule.
C. Small Entities Subject to the Rules
The new rules affect broker-dealers that publish or distribute
covered investment fund research reports. As such, broker-dealers that
are small
[[Page 64219]]
entities are affected by the adopted rules. A broker-dealer is a small
entity if it has total capital (net worth plus subordinated
liabilities) of less than $500,000 on the date in the prior fiscal year
as of which its audited financial statements were prepared pursuant to
Sec. 240.17a-5(d),\421\ and it is not affiliated with any person
(other than a natural person) that is not a small business or small
organization.\422\ As of December 31, 2017, the Commission estimates
that there were approximately 1,043 broker-dealers that would be
considered small entities as defined above.\423\ To the extent a small
broker-dealer publishes or distributes covered investment fund research
reports and seeks to rely on the rule 139b safe harbor--and is without
a significant research department or wants to rely on pre-publication
materials distributed by a covered investment fund, its adviser, or
affiliated persons--it may be significantly affected by the final
rules. Generally, we believe larger broker-dealers engage in these
activities, and we did not receive comments on whether and how the
rules we are adopting today affect small broker-dealers. We also did
not receive comment on the number of small entities that would be
affected by our adoption, including any available empirical data.
---------------------------------------------------------------------------
\421\ See rule 0-10(c)(1) under the Exchange Act [17 CFR 240.0-
10(c)(1)]. Alternatively, if a broker-dealer is ``not required to
file such statements, a broker or dealer that had total capital (net
worth plus subordinated liabilities) of less than $500,000 on the
last business day of the preceding fiscal year (or in the time that
it has been in business, if shorter).'' See id.
\422\ See rule 0-10(c)(2) under the Exchange Act [17 CFR 240.0-
10(c)(2)].
\423\ This estimate is derived from an analysis of data for the
period ending Dec. 31, 2017 obtained from FOCUS Reports (``Financial
and Operational Combined Uniform Single'' Reports) that broker-
dealers generally are required to file with the Commission and/or
SROs pursuant to rule 17a-5 under the Exchange Act [17 CFR 240.17a-
5].
---------------------------------------------------------------------------
D. Reporting, Recordkeeping, and Other Compliance Requirements
We believe that there are no reporting, recordkeeping, and other
compliance requirements with respect to rule 139b and the revision to
Regulation M. As such, we believe that there are no attendant costs and
administrative burdens for small entities associated with these
activities, as they relate to rule 139b and the revision to Regulation
M.
Rule 139b extends the safe harbor under rule 139 to broker-dealers'
publication or distribution of covered investment fund research
reports. As a result of the FAIR Act communications that historically
have been treated as covered investment fund advertisements under rule
482 now could fall under the new rule 139b definition of ``research
report.''
As discussed above, section 24(b) of the Investment Company Act
requires registered open-end investment companies to file sales
literature addressed to or intended for distribution to prospective
investors with the Commission.\424\ Section 2(b)(4) of the FAIR Act
directs the Commission to provide that a covered investment fund
research report shall not be subject to section 24(b) of the Investment
Company Act or the rules and regulations thereunder, except that such
report may still be subject to 24(b) and the rules and regulations
thereunder if it is otherwise not subject to the content standards in
the rules of any SRO related to research reports, including those
contained in the rules governing communications with the public
regarding investment companies or substantially similar standards.\425\
Registered investment company sales literature, including rule 482
advertisements, are required to be filed with the Commission under
section 24(b) of the Investment Company Act.\426\ These filings are
typically done by broker-dealers' compliance staff. The Commission
implemented section 2(b)(4) of the FAIR Act via new rule 24b-4, which
provides that a covered investment fund research report about a
registered investment company shall not be subject to section 24(b) of
the Investment Company Act (or the rules and regulations thereunder),
unless the research report is not otherwise subject to the content
standards in SRO rules related to research reports, including those
contained in the rules governing communications with the public
regarding investment companies or substantially similar standards.\427\
We interpret section 2(b)(4) of the FAIR Act as excluding covered
investment fund research reports from section 24(b) of the Investment
Company Act so long as they continue to be subject to the general
content standards in FINRA rule 2210(d)(1), described above (or
substantially similar SRO rules).\428\ Thus, covered investment fund
research reports, by operation of rule 24b-4, would no longer be
subject to filing requirements under section 24(b) because they would
be subject to the general content standards of FINRA rule
2210(d)(1).\429\ Rule 24b-4 would affect broker-dealers that, in lieu
of a safe harbor such as that provided by rule 139b, would have
published or distributed communications styled as ``research reports''
in compliance with rule 482, which communications would be required to
be filed with the Commission subject to section 24(b) of the Investment
Company Act. The Commission estimates that there were approximately
1,043 broker-dealers, as of December 31, 2017, that would be considered
small entities as defined above.\430\ As such, we believe that the
administrative costs of broker-dealers that previously filed these
communications pursuant to section 24(b) of the Investment Company Act
will be reduced. However, large and small broker-dealers will not be
affected differently by rule 24b-4.
---------------------------------------------------------------------------
\424\ See 15 U.S.C. 80a-24(b); 17 CFR 270.24b-3; supra section
II.D.1.
\425\ See supra section II.D.1.
\426\ See supra notes 187-189 and accompanying text. Rule 24b-3
under the Investment Company Act deems these materials to have been
filed with the Commission if filed with FINRA. See id.
\427\ See rule 24b-4; see also discussion accompanying supra
notes 179-183.
\428\ See supra paragraph accompanying notes 183-185.
\429\ See supra section II.D.1.
\430\ See supra note 423.
---------------------------------------------------------------------------
The amendments are discussed in detail in Section II above. We
discuss the economic impact, including the estimated compliance costs
and burdens, of the amendments in Section III above.
E. Agency Action To Minimize Effect on Small Entities
The RFA directs us to consider significant alternatives that would
accomplish the Commission's stated objectives, while minimizing any
significant adverse impact on small entities. In connection with the
proposals, we considered the following alternatives: (i) Establishing
different compliance or reporting requirements that take into account
the resources available to small entities; (ii) exempting broker-
dealers that are small entities from certain proposed conditions that
must be satisfied in order for the rule 139b safe harbor to be
available (e.g., the extent to which the proposed regular-course-of-
business requirements would apply to small broker-dealers); (iii)
clarifying, consolidating, or simplifying the conditions that must be
satisfied for the rule 139b safe harbor to be available for broker-
dealers that are small entities; and (iv) using performance rather than
design standards.
We do not believe that establishing different compliance and
reporting requirements or timetables for broker-dealers that are small
entities, or exempting broker-dealers that are small entities from
certain conditions, would
[[Page 64220]]
permit us to achieve our stated objectives. We have considered a
variety of approaches to achieve our regulatory objectives and the
directives of the FAIR Act. We do not believe that the new rules impose
any significant new compliance obligations, because the new rules
generally reduce the restrictions regarding communications that would
be considered covered investment fund research reports.
As discussed above, the FAIR Act directs us to extend the current
safe harbor available under rule 139 to broker-dealers' publication or
distribution of covered investment fund research reports, and thus rule
139b's framework, including its scope and conditions, is modeled after
and generally tracks rule 139.\431\ Rule 139 does not incorporate
conditions that affect the availability of the rule's safe harbor
differently for broker-dealers that are small (versus large) entities.
We likewise do not believe it is necessary or appropriate that rule
139b incorporate conditions that would affect the availability of the
new rule's safe harbor differently based on whether a broker-dealer is
a small entity. We have considered whether a different regular-course-
of-business requirement would help mitigate investor confusion in the
case of covered investment fund research reports about registered
investment companies, as discussed in more detail above.\432\ This
could have had the effect of limiting the availability of the rule 139b
safe harbor to certain broker-dealers, which in turn could have direct
or indirect effects on the availability of the safe harbor to smaller
broker-dealers. However, for the reasons discussed above,\433\ we are
not adopting a regular-course-of-business requirement, in either the
new rule 139b provisions on issuer-specific research reports or the
provisions on industry reports, other than a requirement that tracks
the provisions of rule 139 (modified as directed by the FAIR Act).
---------------------------------------------------------------------------
\431\ See supra paragraph accompanying notes 12-15.
\432\ See supra section III.C.6.c.
\433\ See id.
---------------------------------------------------------------------------
Nor do we believe that clarifying, consolidating, or simplifying
the amendments for small entities would satisfy those objectives.
Because rule 139b's framework (including its scope and conditions) is
modeled after and generally tracks rule 139, rule 139b, like rule 139,
does not treat small broker-dealers differently than large broker-
dealers, including by clarifying, consolidating, or simplifying any
conditions.
Further, with respect to using performance rather than design
standards, the rule generally uses performance standards for all
broker-dealers relying on the rule, regardless of size. We believe that
providing broker-dealers with the flexibility with respect to the
design of covered investment fund research reports that they may
publish or distribute in reliance on the safe harbor is appropriate in
light of the diversity of entities included in the universe of covered
investment funds. We also believe that this approach is appropriate in
light of the diverse methodologies that might be taken with respect to
research about these entities (particularly because the term ``research
report'' in the FAIR Act and the rule is defined broadly, as discussed
above \434\). However, we note that the rule also uses design standards
with respect to certain of its conditions (e.g., the conditions
relating to reporting history and minimum public market value that
apply to issuers that could appear in an issuer-specific research
report). These are substantially similar to design standards used in
rule 139, and they would apply with respect to the research reports
published or distributed by all broker-dealers relying on the new rule,
regardless of their size.\435\ For the reasons discussed above, we
believe that this use of design standards is appropriate for the
furtherance of investor protection, and to help ensure that the rule is
not used to circumvent the prospectus requirements of the Securities
Act.\436\
---------------------------------------------------------------------------
\434\ See supra section II.A.2.
\435\ See, e.g., supra sections II.B.1.a (Reporting History and
Timeliness Requirements) and II.B.1.b (Market Following
Requirement).
\436\ See supra notes 49-50 and accompanying text.
---------------------------------------------------------------------------
VI. Statutory Authority
We are adopting the rules contained in this document under the
authority set forth in the Securities Act, particularly sections 6, 7,
8, 10, 17(a), 19(a), and 28 thereof [15 U.S.C. 77a et seq.]; the
Exchange Act, particularly, sections 2, 3, 9(a), 10, 11A(c), 12, 13,
14, 15, 17(a), 23(a), 30, and 36 thereof [15 U.S.C. 78a et seq.]; the
Investment Company Act, particularly, sections 6, 23, 24, 30, and 38
thereof [15 U.S.C. 80a et seq.]; and the FAIR Act, particularly,
section 2 thereof.
List of Subjects
17 CFR Part 230
Advertising, Confidential business information, Investment
companies, Reporting and recordkeeping requirements, Securities.
17 CFR Part 242
Brokers, Fraud, Reporting and recordkeeping requirements,
Securities.
17 CFR Part 249
Reporting and recordkeeping requirements, Securities.
17 CFR Part 270
Confidential business information, Fraud, Investment companies,
Life insurance, Reporting and recordkeeping requirements, Securities.
Text of Rules and Amendments
For the reasons set out in the preamble, title 17, chapter II of
the Code of the Federal Regulations is amended as follows.
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
0
1. The authority citation for part 230 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h,
77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o-
7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-
30, and 80a-37, and Pub. L. 112-106, sec. 201(a), sec. 401, 126
Stat. 313 (2012), unless otherwise noted.
* * * * *
0
2. Amend Sec. 230.139 by revising the introductory text of paragraph
(a) to read as follows:
Sec. 230.139 Publications or distributions of research reports by
brokers or dealers distributing securities.
(a) Registered offerings. Under the conditions of paragraph (a)(1)
or (2) of this section, a broker's or dealer's publication or
distribution of a research report about an issuer or any of its
securities shall be deemed for purposes of sections 2(a)(10) and 5(c)
of the Act not to constitute an offer for sale or offer to sell a
security that is the subject of an offering pursuant to a registration
statement that the issuer proposes to file, or has filed, or that is
effective, even if the broker or dealer is participating or will
participate in the registered offering of the issuer's securities. For
purposes of the Fair Access to Investment Research Act of 2017 [Pub. L.
115-66, 131 Stat. 1196 (2017)], a safe harbor has been established for
covered investment fund research reports, and the specific terms of
that safe harbor are set forth in Sec. 230.139b.
* * * * *
0
3. Add Sec. 230.139b to read as follows:
[[Page 64221]]
Sec. 230.139b Publications or distributions of covered investment
fund research reports by brokers or dealers distributing securities.
(a) Registered offerings. Under the conditions of paragraph (a)(1)
or (2) of this section, the publication or distribution of a covered
investment fund research report by a broker or dealer that is not an
investment adviser to the covered investment fund and is not an
affiliated person of the investment adviser to the covered investment
fund shall be deemed for purposes of sections 2(a)(10) and 5(c) of the
Act not to constitute an offer for sale or offer to sell a security
that is the subject of an offering pursuant to a registration statement
of the covered investment fund that is effective, even if the broker or
dealer is participating or may participate in the registered offering
of the covered investment fund's securities. This section does not
affect the availability of any other exemption or exclusion from
sections 2(a)(10) or 5(c) of the Act available to the broker or dealer.
(1) Issuer-specific research reports. (i) At the date of reliance
on this section:
(A) The covered investment fund:
(1) Has been subject to the reporting requirements of section 30 of
the Investment Company Act of 1940 (the ``Investment Company Act'') (15
U.S.C. 80a-29) for a period of at least 12 calendar months and has
filed in a timely manner all of the reports required, as applicable, to
be filed for the immediately preceding 12 calendar months on Forms N-
CSR (Sec. Sec. 249.331 and 274.128 of this chapter), N-Q (Sec. Sec.
249.332 and 274.130 of this chapter), N-PORT (Sec. 274.150 of this
chapter), N-MFP (Sec. 274.201 of this chapter), and N-CEN (Sec. Sec.
249.330 and 274.101 of this chapter) pursuant to section 30 of the
Investment Company Act; or
(2) If the covered investment fund is not a registered investment
company under the Investment Company Act, has been subject to the
reporting requirements of section 13 or section 15(d) of the Securities
Exchange Act of 1934 (the ``Exchange Act'') (15 U.S.C. 78m or 78o(d))
for a period of at least 12 calendar months and has filed in a timely
manner all of the reports required to be filed for the immediately
preceding 12 calendar months on Forms 10-K (Sec. 249.310 of this
chapter) and 10-Q (Sec. 249.308a of this chapter), or 20-F (Sec.
249.220f of this chapter) pursuant to section 13 or section 15(d) of
the Exchange Act; and
(B) At the time of the broker's or dealer's initial publication or
distribution of a research report on the covered investment fund (or
reinitation thereof), and at least quarterly thereafter;
(1) If the covered investment fund is of the type defined in
paragraph (c)(2)(i) of this section, the aggregate market value of
voting and non-voting common equity held by affiliates and non-
affiliates equals or exceeds the aggregate market value specified in
General Instruction I.B.1 of Form S-3 (Sec. 239.13 of this chapter);
(2) If the covered investment fund is of the type defined in
paragraph (c)(2)(ii) of this section, the aggregate market value of
voting and non-voting common equity held by non-affiliates equals or
exceeds the aggregate market value specified in General Instruction
I.B.1 of Form S-3 (Sec. 239.13 of this chapter); or
(3) If the covered investment fund is a registered open-end
investment company (other than an exchange-traded fund) its net asset
value (inclusive of shares held by affiliates and non-affiliates)
equals or exceeds the aggregate market value specified in General
Instruction I.B.1 of Form S-3 (Sec. 239.13 of this chapter); and
(ii) The broker or dealer publishes or distributes research reports
in the regular course of its business and, in the case of a research
report regarding a covered investment fund that does not have a class
of securities in substantially continuous distribution, such
publication or distribution does not represent the initiation of
publication of research reports about such covered investment fund or
its securities or reinitiation of such publication following
discontinuation of publication of such research reports.
(2) Industry reports. (i) The covered investment fund is subject to
the reporting requirements of section 30 of the Investment Company Act
or, if the covered investment fund is not a registered investment
company under the Investment Company Act, is subject to the reporting
requirements of section 13 or section 15(d) of the Exchange Act;
(ii) The covered investment fund research report:
(A) Includes similar information with respect to a substantial
number of covered investment fund issuers of the issuer's type (e.g.,
money market fund, bond fund, balanced fund, etc.), or investment focus
(e.g., primarily invested in the same industry or sub-industry, or the
same country or geographic region); or
(B) Contains a comprehensive list of covered investment fund
securities currently recommended by the broker or dealer (other than
securities of a covered investment fund that is an affiliate of the
broker or dealer, or for which the broker or dealer serves as
investment adviser (or for which the broker or dealer is an affiliated
person of the investment adviser));
(iii) The analysis regarding the covered investment fund issuer or
its securities is given no materially greater space or prominence in
the publication than that given to other covered investment fund
issuers or securities; and
(iv) The broker or dealer publishes or distributes research reports
in the regular course of its business and, at the time of the
publication or distribution of the research report (in the case of a
research report regarding a covered investment fund that does not have
a class of securities in substantially continuous distribution), is
including similar information about the issuer or its securities in
similar reports.
(3) Disclosure of standardized performance. In the case of a
research report about a covered investment fund that is a registered
open-end management investment company or a trust account (or series or
class thereof), any quotation of the issuer's performance must be
presented in accordance with the conditions of paragraphs (d), (e), and
(g) of Sec. 230.482. In the case of a research report about a covered
investment fund that is a registered closed-end investment company, any
quotation of the issuer's performance must be presented in a manner
that is in accordance with instructions to item 4.1(g) of Form N-2
(Sec. Sec. 239.14 and 274.11a-1 of this chapter), provided, however,
that other historical measures of performance may also be included if
any other measurement is set out with no greater prominence than the
measurement that is in accordance with the instructions to item 4.1(g)
of Form N-2.
(b) Self-regulatory organization rules. A self-regulatory
organization shall not maintain or enforce any rule that would prohibit
the ability of a member to publish or distribute a covered investment
fund research report solely because the member is also participating in
a registered offering or other distribution of any securities of such
covered investment fund; or to participate in a registered offering or
other distribution of securities of a covered investment fund solely
because the member has published or distributed a covered investment
fund research report about such covered investment fund or its
securities. For purposes of section 19(b) of the Exchange Act (15
U.S.C. 78s(b)), this paragraph (b) shall be deemed a rule under that
Act.
[[Page 64222]]
(c) Definitions. For purposes of this section:
(1) Affiliated person has the meaning given the term in section
2(a) of the Investment Company Act.
(2) Covered investment fund means:
(i) An investment company (or a series or class thereof) registered
under, or that has filed an election to be treated as a business
development company under, the Investment Company Act and that has
filed a registration statement under the Act for the public offering of
a class of its securities, which registration statement has been
declared effective by the Commission; or
(ii) A trust or other person:
(A) Issuing securities in an offering registered under the Act and
which class of securities is listed for trading on a national
securities exchange;
(B) The assets of which consist primarily of commodities,
currencies, or derivative instruments that reference commodities or
currencies, or interests in the foregoing; and
(C) That provides in its registration statement under the Act that
a class of its securities are purchased or redeemed, subject to
conditions or limitations, for a ratable share of its assets.
(3) Covered investment fund research report means a research report
published or distributed by a broker or dealer about a covered
investment fund or any securities issued by the covered investment
fund, but does not include a research report to the extent that the
research report is published or distributed by the covered investment
fund or any affiliate of the covered investment fund, or any research
report published or distributed by any broker or dealer that is an
investment adviser (or any affiliated person of an investment adviser)
for the covered investment fund.
(4) Exchange-traded fund has the meaning given the term in General
Instruction A to Form N-1A (Sec. Sec. 239.15A and 274.11A of this
chapter).
(5) Investment adviser has the meaning given the term in section
2(a) of the Investment Company Act.
(6) Research report means a written communication, as defined in
Sec. 230.405 that includes information, opinions, or recommendations
with respect to securities of an issuer or an analysis of a security or
an issuer, whether or not it provides information reasonably sufficient
upon which to base an investment decision.
0
4. Effective May 1, 2020, amend Sec. 230.139b by removing ``N-Q
(Sec. Sec. 249.332 and 274.130 of this chapter),'' in paragraph
(a)(1)(i)(A)(1).
PART 242--REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER
MARGIN REQUIREMENTS FOR SECURITY FUTURES
0
5. The authority citation for part 242 continues to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.
0
6. Section 242.101 is amended by revising paragraph (b)(1) to read as
follows:
Sec. 242.101 Activities by distribution participants.
* * * * *
(b) * * *
(1) Research. The publication or dissemination of any information,
opinion, or recommendation, if the conditions of Sec. 230.138, Sec.
230.139, or Sec. 230.139b of this chapter are met; or
* * * * *
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
0
7. The authority citation for part 249 continues to read, in part, as
follows:
Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C.
5461 et seq.; and 18 U.S.C. 1350; Sec. 953(b), Pub. L. 111-203, 124
Stat. 1904; Sec. 102(a)(3), Pub. L. 112-106, 126 Stat. 309 (2012);
Sec. 107, Pub. L. 112-106, 126 Stat. 313 (2012), and Sec. 72001,
Pub. L. 114-94, 129 Stat. 1312 (2015), unless otherwise noted.
* * * * *
0
8. Amend Form 12b-25 (referenced in Sec. 249.322) as follows:
0
a. On the cover page accompanying the checkboxes, removing the phrase
``Form N-SAR'' and adding in its place ``Form N-CEN'';
0
b. On the cover page below the checkboxes, removing the checkbox and
accompanying phrase ``Transition Report on Form N-SAR'';
0
c. In Part II, removing the phrase ``Form N-SAR'' and adding in its
place ``Form N-CEN''; and
0
d. In Part III, removing the phrase ``Form N-SAR'' and adding in its
place ``Form N-CEN''.
Note: the text of Form 12b-25 does not, and this amendment will
not, appear in the Code of Federal Regulations.
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
0
9. The authority citation for part 270 continues to read, in part, as
follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39,
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless
otherwise noted.
* * * * *
0
10. Add Sec. 270.24b-4 to read as follows:
Sec. 270.24b-4 Filing copies of covered investment fund research
reports.
A covered investment fund research report, as defined in paragraph
(c)(3) of Sec. 230.139b of this chapter under the Securities Act of
1933 (15 U.S.C. 77a et seq.), of a covered investment fund registered
as an investment company under the Act, shall not be subject to section
24(b) of the Act or the rules and regulations thereunder, except that
such report shall be subject to such section and the rules and
regulations thereunder to the extent that it is otherwise not subject
to the content standards in the rules of any self-regulatory
organization related to research reports, including those contained in
the rules governing communications with the public regarding investment
companies or substantially similar standards.
By the Commission.
Dated: November 30, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018-26613 Filed 12-12-18; 8:45 am]
BILLING CODE 8011-01-P