

[Federal Register: January 17, 2007 (Volume 72, Number 10)]
[Notices]               
[Page 2058-2078]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr17ja07-94]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55072; File Nos. SR-NYSE-2006-78; SR-NASD-2006-113]

 
Self-Regulatory Organizations; New York Stock Exchange LLC and 
the National Association of Securities Dealers, Inc.; Notice of Filing 
of Proposed Rule Changes To Amend NYSE Rules 472 and 344, and NASD 
Rules 1050 and 2711 Relating to Research Analyst Conflicts of Interest

January 9, 2007.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 27, 2006, the New York Stock Exchange LLC (``NYSE'' or the 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change. On December 20, 
2006, NYSE filed Amendment No. 1 to its proposed rule change.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ NYSE Amendment No. 1 makes minor revisions to the original 
filing.
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    On September 27, 2006, the National Association of Securities 
Dealers, Inc. (``NASD'') filed with the Commission the proposed rule 
change. On November 17, 2006, NASD filed Amendment No. 1 to its 
proposed rule change.\4\
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    \4\ NASD Amendment No. 1 makes minor revisions to the original 
filing.
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    The proposed rule changes are described in Items I, II, and III 
below, which Items have substantially been prepared by the NYSE and 
NASD (the ``SROs''). The Commission is publishing this notice to 
solicit comments on the proposed rule changes, as amended, from 
interested persons.

I. Self-Regulatory Organizations' Statements of the Terms of Substance 
of the Proposed Rule Changes

    The Exchange proposes to amend certain provisions of NYSE Rules 472 
and 344. These amendments eliminate the exception for pre-publication 
factual verification review of research reports by non-research 
personnel; change the quiet periods surrounding securities offerings 
and the release of lock-up agreements; allow member organizations to 
develop policies and procedures if they choose to prohibit research 
analysts from holding securities for companies they cover; alter the 
format for certain disclosures in research reports; and extend the 
anti-retaliation prohibitions to all employees of a member 
organization, not just investment banking.

[[Page 2059]]

    NASD is proposing to amend NASD Rules 1050 and 2711 to implement 
certain recommendations contained in the December 2005 Joint Report by 
NASD and the NYSE on the Operation and Effectiveness of the Research 
Analyst Conflict of Interest Rules.\5\ NASD believes that the proposed 
rule changes are intended to improve the effectiveness of the research 
analyst conflict of interest rules and registration requirements by 
making certain changes to the existing provisions regarding, among 
other things: Disclosure of conflicts; quiet periods; restrictions on 
review of research reports by non-research personnel; and restrictions 
on personal trading by research analysts.
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    \5\ http://www.[fxsp0]nasd.[fxsp0]com/web/groups[fxsp0]/rules--

regs/documents/rules--regs/[fxsp0]nasdw--015803.[fxsp0]pdf
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    Below is the text of the proposed rule changes.\6\ Proposed new 
language is italicized; proposed deletions are in [brackets].
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    \6\ The rule text reflects the changes contained in SR-NYSE-
2006-77 and SR-NASD-2006-112, which were filed for immediate 
effectiveness on September 27, 2006.
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A. NYSE's Proposed Rule Text

Rule 472. Communications With the Public Approval of Communications and 
Research Reports
    (a)(1) through (2) No Change.
Investment Banking, Research Department and Subject Company 
Relationships and Communications
    (b)(1) Research analysts may not be subject to the supervision, or 
control, of any employee of the member organization's investment 
banking department and personnel engaged in investment banking 
activities may not have any influence or control over the compensatory 
evaluation of a research analyst.
    (2) Research reports may not be subject to review or approval prior 
to publication by Investment Banking personnel or any other employee of 
the member organization who is not directly responsible for investment 
research (``non-research personnel'') other than Legal or Compliance 
personnel.
    [(3) Non-research personnel may review research reports prior to 
publication only to verify the factual accuracy of information in the 
research report or to identify any potential conflicts of interest that 
may exist, provided that:
    (i) Any written communication concerning the content of research 
reports between non-research personnel and Research personnel must be 
made either through Legal or Compliance personnel or in a transmission 
copied to Legal or Compliance personnel; and
    (ii) any oral communication concerning the content of research 
reports between non-research personnel and Research personnel must be 
documented and made either with Legal or Compliance personnel acting as 
intermediary or in a conversation conducted in the presence of Legal or 
Compliance personnel.]
    (b)(4) through (6) renumbered as (b)(3) through (5).
Written Procedures
    (c) No change.
Retention of Communications
    (d) No change.
Restrictions on Trading Securities by Associated Persons
    (e)(1) No research analyst or household member may purchase or 
receive an issuer's securities prior to its initial public offering 
(e.g., so-called pre-IPO shares), if the issuer is principally engaged 
in the same types of business as companies (or in the same industry 
classification) which the research analyst usually covers in research 
reports.
    (2) No research analyst or household member may trade in any 
subject company's securities or derivatives of such securities that the 
research analyst follows for a period of thirty (30) calendar days 
prior to and five (5) calendar days after the member organization's 
publication of research reports concerning such security or a change in 
rating or price target of a subject company's securities.
    (3) No research analyst or household member may effect trades in a 
manner inconsistent with the research analyst's most current 
recommendations (i.e., sell securities while maintaining a ``buy'' or 
``hold'' recommendation, buy securities while maintaining a ``sell'' 
recommendation, or effecting a ``short sale'' in a security while 
maintaining a ``buy'' or ``hold'' recommendation on such security).
    (4) No change.
    (5) The prohibitions in paragraphs (e)(1) through (e)(3) do not 
apply when the following conditions are satisfied:
    (A) The research analyst is employed by a member organization that 
has adopted an internal policy that prohibits research analysts from 
owning any securities issued by the subject company for which the 
research analyst provides coverage and requires analysts to completely 
divest themselves of their existing holdings in such securities;
    (B) The research analyst abides by a reasonable plan of liquidation 
under which all securities issued by subject companies that the analyst 
follows are to be sold within 120 days of the effective date of the 
member organization's policy;
    (C) The research analyst files such liquidation plan with the 
member organization's legal or compliance department within fifteen 
(15) days of the effective date of the member organization's policy;
    (D) The research analyst receives written approval of the 
liquidation plan from the member organization's legal or compliance 
department prior to the sale of any securities under the plan; and
    (E) The member organization must maintain written records 
sufficient to document compliance with each liquidation plan approved 
by its legal or compliance department for three years following the 
date on which the liquidation plan is approved.
    (e)(5) through (6) renumbered as (e)(6) through (7).
Restrictions on Member Organization's Issuance of Research Reports and 
Participation in Public Appearances
    (f)(1) A member organization may not publish or otherwise 
distribute research reports regarding an issuer and a research analyst 
may not recommend or offer an opinion on an issuer's securities in a 
public appearance, for which the member organization acted as manager 
[or], co-manager, underwriter or dealer [of] for an initial public 
offering within [forty (40)] twenty-five (25) calendar days following 
the offering date.
    [(2) A member organization may not publish or otherwise distribute 
research reports regarding an issuer and a research analyst may not 
recommend or offer an opinion on an issuer's securities in a public 
appearance, for which the member organization acted as manager or co-
manager of a secondary offering within ten (10) calendar days following 
the offering date. This prohibition shall not apply to public 
appearances or research reports published or otherwise distributed 
under Securities Act Rule 139 regarding issuers whose securities are 
actively traded, as defined in Securities Exchange Act Rule 101(c)(1) 
of Regulation M.
    (3) No member organization that has agreed to participate or is 
participating as an underwriter or dealer (other than as manager or co-
manager) of an issuer's initial public offering may publish or 
otherwise distribute a research report regarding that issuer and a 
research analyst may not recommend or offer an opinion on that issuer's 
securities in a public appearance for twenty-five (25) calendar days 
following the offering date.]
    [(4)] (2) No member organization which has acted as a manager or 
co-

[[Page 2060]]

manager of a securities offering may publish or otherwise distribute a 
research report and a research analyst may not recommend or offer an 
opinion on an issuer's securities in a public appearance within 
[fifteen (15)] five (5) days prior to or after the expiration, waiver 
or termination of a lock-up agreement or any other agreement that the 
member organization has entered into with a subject company and its 
shareholders that restricts or prohibits the sale of the subject 
company's or its shareholders' securities after the completion of a 
securities offering. This prohibition shall not apply to public 
appearances or research reports published or otherwise distributed 
under Securities Act Rule 139 regarding issuers whose securities are 
actively traded, as defined in Securities Exchange Act Rule 101(c)(1) 
of Regulation M.
    [(5)] (3) A member organization may permit exceptions to the 
prohibitions in paragraphs (f)(1)[,] and (2)[, and (4)] (consistent 
with other securities laws and rules) for research reports that are 
published or otherwise distributed or recommendations or opinions on an 
issuer's securities made in a public appearance due to significant news 
or events, e.g. an announcement of earnings, provided that such 
research reports are pre-approved in writing by the member 
organization's Legal or Compliance personnel.
    [(6)] (4) If a member organization intends to terminate its 
research coverage of a subject company, notice of this termination must 
be made. The member organization must make available a final research 
report on the subject company using the means of dissemination 
equivalent to those it ordinarily uses to provide the customer with its 
research reports on the subject company. The report must be comparable 
in scope and detail to prior research reports and must include a final 
recommendation or rating, unless it is impracticable for the member 
organization to produce a comparable report (e.g., if the research 
analyst covering the subject company or sector has left the employ of 
the member organization, or where the member organization terminates 
coverage on the industry or sector). In instances where it is 
impracticable for the member organization to provide a final 
recommendation or rating, the member organization must provide the 
rationale for the decision to terminate coverage.
Prohibition of Offering Favorable Research for Business
    (g)(1) No change.
    (2) No member organization and no employee of a member organization 
[who is involved with the member organization's investment banking 
activities] may, directly or indirectly, retaliate against or threaten 
to retaliate against any research analyst employed by the member 
organization or its affiliates as a result of an adverse, negative, or 
otherwise unfavorable research report written or public appearance made 
by the research analyst that may adversely affect the member 
organization's present or prospective investment banking relationship 
with the subject company of a research report. This prohibition shall 
not limit a member organization's authority to discipline or terminate 
a research analyst, in accordance with the member organization's 
policies and procedures, for any cause other than the writing of such 
an unfavorable research report or the making of such unfavorable public 
appearance.
Restrictions on Compensation to Research Analysts
    (h) No change.
General Standards for All Communications
    (i) No change.
Specific Standards for Communications
    (j) No change.
Disclosure
    (k)(1) Disclosures Required in Research Reports.
Disclosure of Member Organization's, and Research Analyst's Ownership 
of Securities, Receipt of Compensation, and Subject Company 
Relationships
    [The front page cover of a research report either must include the 
disclosures required under this Rule or must refer the reader to the 
page(s) on which each such disclosure is found.] Any member 
organization that has a conflict of interest or whose research analyst 
has a conflict of interest concerning the subject company of a research 
report must disclose that conflict of interest either (i) on its Web 
site and prominently state the following on the front page of the 
research report: ``[Name of firm and/or the research analyst preparing 
this report] has a conflict of interest that may affect the ability of 
the firm or the analyst to provide objective analysis about the 
company. For more information about this conflict of interest, please 
see [Reference to the firm's Web site]'' or (ii) the front page cover 
of a research report either must include the disclosures required under 
this Rule or must refer the reader to the page(s) on which each such 
disclosure is found. Disclosures, and references to disclosures, must 
be clear, comprehensive, and prominent. For purposes of paragraph 
(k)(1), ``conflict of interest'' shall include any of the following:
    (i) A member organization must disclose in research reports: a. If 
the member organization or its affiliates:
    1. Has managed or co-managed a public offering of securities for 
the subject company in the past twelve (12) months;
    2. Has received compensation for investment banking services from 
the subject company in the past twelve (12) months; or
    3. Expects to receive or intends to seek compensation for 
investment banking services from the subject company in the next three 
(3) months.
    b. If the member organization is making a market in the subject 
company's securities at the time the research report is issued;
    c. If, as of the last day of the month immediately preceding the 
date the publication (or the end of the second most recent month if the 
publication is less than ten (10) calendar days after the end of the 
most recent month), the member organization or its affiliates 
beneficially own 1% or more of any class of common equity securities of 
the subject company. The member organization must make the required 
beneficial ownership computation no later than ten (10) calendar days 
after the end of the prior month. Computation of beneficial ownership 
of securities must be based upon the same standards used to compute 
ownership for purposes of the reporting requirements under Section 
13(d) of the Securities Exchange Act of 1934;
    d. If, as of the last day of the month immediately preceding the 
date of publication of the research report (or the end of the second 
most recent month if the publication date is less than thirty (30) 
calendar days after the end of the most recent month):
    1. The subject company currently is a client of the member 
organization or was a client of the member organization during the 
twelve (12)-month period preceding the date of distribution of the 
research report (In such instances, the member organization also must 
disclose the types of services provided to the subject company. For 
purposes of this paragraph, the types of services provided to the 
subject company may be described as investment banking services, non-
investment banking-securities related services, and non-securities 
services.);

[[Page 2061]]

    2. The member organization received any compensation for products 
or services other than for investment banking services from the subject 
company in the past twelve (12) months.
    e. If a research report contains a price target, the valuation 
methods used, and any price objectives must have a reasonable basis and 
include a discussion of risks;
    f. If a research report contains a rating, the meanings of all 
ratings used by the organization in its ratings system (For example, a 
member organization might disclose that a ``strong buy'' rating means 
that the rated security's price is expected to appreciate at least 10% 
faster than other securities in its sector over the next twelve (12)-
month period. Definitions of ratings terms also must be consistent with 
their plain meaning. Therefore, for example, a ``hold'' rating should 
not mean or imply that an investor should sell a security.);
    g. If a research report contains a rating, the percentage of all 
securities that the member organization recommends an investor ``buy,'' 
``hold,'' or ``sell.'' Within each of the three (3) categories, a 
member organization must also disclose the percentage of subject 
companies that are investment banking services clients of the member 
organization within the previous twelve (12) months (see Rule 472.70 
for further information);
    h. If a research report contains either a rating or a price target, 
and the member organization has assigned a rating or price target to 
the subject company for at least one (1) year, the research report must 
include a chart that depicts the price of the subject company's stock 
over time and indicates points at which a member organization assigned 
or changed a rating or price target. This provision would apply only to 
securities that have been assigned a rating or price target for at 
least one (1) year, and need not extend more than three (3) years prior 
to the date of the research report. The information in the price chart 
must be current as of the end of the most recent calendar quarter (or 
the second most recent calendar quarter if the publication date is less 
than fifteen (15) calendar days after the most recent calendar 
quarter).
    (ii) A member organization must include the following disclosures 
in research reports:
    a. If a research analyst received any compensation:
    1. From the subject company in the past twelve (12) months;
    2. That is based upon (among other factors) the member 
organization's overall investment banking revenues.
    b. If, to the extent the research analyst or an employee of the 
member organization with the ability to influence the substance of a 
research report, knows:
    1. The subject company currently is a client of the member 
organization or was a client of the member organization during the 
twelve (12)-month period preceding the date of distribution of the 
research report. In such instances, such member organization also must 
disclose the types of services provided to the subject company (For 
purposes of paragraph (k)(1) of this Rule, the types of services 
provided to the subject company may be described as investment banking 
services, non-investment banking-securities related services, and non-
securities services.). (For purpose of paragraph (k)(1) of this Rule, 
an employee of a member organization with the ability to influence the 
substance of the research report is an employee who, in the ordinary 
course of that person's duties, has the authority to review the 
particular research report and to change that research report prior to 
publication.);
    2. That the member organization or any affiliate thereof, received 
any compensation for products or services other than investment banking 
services from the subject company in the past twelve (12) months.
    (iii) A research analyst and a member organization must disclose in 
research reports:
    a. If, to the extent the research analyst or member organization 
has reason to know, an affiliate of the member organization received 
any compensation for products or services other than investment banking 
services from the subject company in the past twelve (12) months;
    1. This requirement will be deemed satisfied if such compensation 
is disclosed in research reports within thirty (30) days after 
completion of the most recent calendar quarter, provided that the 
member organization has taken steps reasonably designed to identify 
such compensation during that calendar quarter.
    2. The member organization and the research analyst will be 
presumed not to have reason to know whether an affiliate received 
compensation for other than investment banking services from the 
subject company in the past twelve (12) months if the member 
organization maintains and enforces policies and procedures reasonably 
designed to prevent all research analysts and employees of the member 
organization with the ability to influence the substance of research 
reports from, directly or indirectly, receiving information from the 
affiliate concerning such compensation.
    3. Paragraph 472(k)(1)(iii)a. shall not apply to any subject 
company as to which the member organization initiated coverage since 
the beginning of the current calendar quarter.
    b. If the research analyst or a household member has a financial 
interest in the securities of the subject company, and the nature of 
the financial interest, including, without limitation, whether it 
consists of any option, right, warrant, futures contract, long or short 
position;
    c. If the research analyst or a household member is an officer, 
director, or advisory board member of the subject company;
    d. Any other actual, material conflict of interest of the research 
analyst, or member organization, of which the research analyst knows, 
or has reason to know, at the time the research report is published or 
otherwise distributed.
    When a member organization publishes or otherwise distributes a 
research report covering six (6) or more subject companies (a 
``compendium report'') for purposes of the disclosures required in 
paragraph (k)(1) of this Rule, the compendium report may direct the 
reader in a clear and prominent manner as to where the reader may 
obtain applicable current disclosures. Electronic compendium reports 
may include a hyperlink to the required disclosures. Paper-based 
compendium reports must provide either a toll-free number to call or a 
postal address to write for the required disclosures and may also 
include a web address of the member organization where the disclosures 
can be found.
(k)(2) Disclosures Required in Public Appearances
Disclosure of Member Organization's, and Research Analyst's Ownership 
of Securities, Receipt of Compensation, and Subject Company 
Relationships
    (i) A research analyst must disclose the following conflicts of 
interest in public appearances:
    a. If, as of the last day of the month before the appearance (or 
the end of the second most recent month if the appearance is less than 
ten (10) calendar days after the end of the most recent month), the 
member organization or its affiliates beneficially own 1% or more of 
any class of common equity securities of the subject company. The 
member organization must make the required beneficial ownership 
computation no later than ten (10) calendar days after the end of the 
prior month.

[[Page 2062]]

Computation of beneficial ownership of securities must be based upon 
the same standards used to compute ownership for purposes of the 
reporting requirements under Section 13(d) of the Securities Exchange 
Act of 1934;
    b. If the research analyst or a household member has a financial 
interest in the securities of the subject company, and the nature of 
the financial interest, including, without limitation, whether it 
consists of any option, right, warrant, futures contract, long or short 
position;
    c. If, to the extent the research analyst knows or has reason to 
know:
    1. The subject company currently is a client of the member 
organization or was a client of the member organization during the 
twelve (12)-month period preceding the date of the public appearance by 
the research analyst. In such instances, the research analyst also must 
disclose the types of services provided to the subject company (For 
purposes of this paragraph, the types of services provided to the 
subject company may be described as investment banking services, non-
investment banking-securities related services, and non-securities 
services.);
    2. The member organization or any affiliate thereof, received any 
compensation from the subject company in the past twelve (12) months.
    d. Any other actual, material conflict of interest of the research 
analyst, or member organization, of which the research analyst knows, 
or has reason to know, at the time the public appearance is made;
    e. If the research analyst or a household member is an officer, 
director, or advisory board member of the subject company;
    f. If the research analyst received any compensation from the 
subject company in the past twelve (12) months.
(k)(3) Exceptions to the Required Disclosures
    (i) A member organization or a research analyst will not be 
required to make a disclosure required by Rule 472(k)(l)(i)a.2. and 3., 
(k)(1)(i)d.1., (k)(1)(ii)b.1., and (k)(2)(i)c. to the extent such 
disclosure would reveal material non-public information regarding 
specific potential future investment banking services transactions of 
the subject company.
(k)(4) Third-Party Research Reports
    (i) Subject to paragraph (k)(4)(ii), if a member organization 
distributes or makes available research reports produced by another 
member organization, a non-member organization affiliate of a member 
organization, such as a foreign or domestic broker-dealer or investment 
adviser, or an independent third party, the member organization must 
accompany the research report with the applicable disclosures, as they 
pertain to the member organization, that are required by paragraphs 
(k)(1)(i)c, (k)(1)(i)a, (k)(1)(i)b and (k)(1)(iii)d of this Rule.
    a. A supervisory analyst qualified under NYSE Rule 344 must 
approve, pursuant to Rule 472(a)(2), by signature or initial any third-
party research distributed by a member organization; and
    b. A supervisory analyst or qualified person designated pursuant to 
Rule 342(b)(1) (e.g., a person who has taken and passed the Series 9/
10, or another examination acceptable to the Exchange which 
demonstrates competency relevant to assigned responsibilities, 
including the Series 24 if taken and passed after July 1, 2001) must 
review third-party research distributed by a member organization to 
determine that the disclosures required by Rule 472(k)(1)(i)c, 
(k)(1)(i)a, (k)(1)(i)b and (k)(1)(iii)d are complete and accurate, and 
that the content of the research report is consistent with all 
applicable standards regarding communications with the public.
    (ii) The requirements in paragraph (k)(4)(i) shall not apply to 
research reports prepared by an independent third party that the member 
organization makes available to its customers either upon request or 
through a member organization-maintained Web site.
Other Communications Activities
    (l) No change.
Small Firm Exception
    (m) The provisions of Rule 472(b)(1)[,] and (2) [and (3)] do not 
apply to member organizations that over the three previous years, on 
average per year, have participated in ten (10) or fewer investment 
banking services transactions as manager or co-manager and generated $5 
million or less in gross investment banking services revenues from 
those transactions. For purposes of this paragraph, the term 
``investment banking services transactions'' shall include both debt 
and equity underwritings but not municipal securities underwritings. 
Member organizations that qualify for this exemption must maintain 
records for three (3) years of any communications that, but for this 
exemption, would be subject to paragraphs (b)(1)[,] and (2)[, and (3)] 
of this Rule.

* * * Supplementary Material:

.10 Definitions
    (1) No change.
    (2) Research Report--``Research report'' is generally defined as a 
written or electronic communication which 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 or a public direct participant program), and provides 
information reasonably sufficient upon which to base an investment 
decision. This term does not include:
    (a) The following communications, provided that they do not include 
an analysis, narrative discussion, recommendation or rating of 
individual securities or issuers:
    (1) Reports discussing broad-based indices, e.g. the Russell 2000 
or S&P 500 index;
    (2) Reports commenting on economic, political or market conditions;
    (3) Technical analysis concerning the demand and supply for a 
sector, index or industry based on trading volume and price;
    (4) Statistical summaries of multiple companies' financial data 
(including listings of current ratings);
    (5) Reports that recommend increasing or decreasing holdings in 
particular industries or sectors; or
    (6) Notices of ratings or price target changes, provided that the 
member organization simultaneously directs the readers of the notice as 
to where to obtain the most recent research report on the subject 
company that includes the current applicable disclosures required by 
this rule and that such research report does not contain materially 
misleading disclosures, including disclosures that are outdated or no 
longer applicable;
    (b) The following communications, even if they include information 
reasonably sufficient upon which to base an investment decision or a 
recommendation or rating of individual securities or companies:
    (1) Any communication distributed to fewer than 15 persons;
    (2) Periodic reports, solicitations or other communications 
prepared for investment company shareholders or discretionary 
investment account clients that discuss individual securities in the 
context of a fund's or account's past performance or the basis for 
previously made discretionary investment decisions; or
    (3) Internal communications that are not given to customers; and

[[Page 2063]]

    (c) Communications that constitute statutory prospectuses that are 
filed as part of the registration statement.
    For purposes of approval by a supervisory analyst pursuant to Rule 
472(a)(2), the term research report includes, but is not limited to, a 
report which recommends equity securities, derivatives of such 
securities, including options, debt and other types of fixed income 
securities, single stock futures products, and other investment 
vehicles subject to market risk.
    .10 (3) through (5) No change.
    .20 through .30 No change.
    .40 For purposes of this Rule, the term ``research analyst'' 
includes an allied member, associated person or employee of a member 
organization primarily responsible for, and any person who reports 
directly or indirectly to such research analyst in connection with, the 
preparation of the substance of a research report whether or not any 
such person has the job title of ``research analyst''.
    For purposes of this Rule, the term ``household member'' means any 
individual whose principal residence is the same as the research 
analyst's principal residence. This term does not include an unrelated 
person who shares the same residence as a research analyst, provided 
that the research analyst and unrelated person are financially 
independent of one another. Paragraphs (e)(1), (2), (3), (4)(i), (ii), 
(iii), (iv) and (v), (k)(1)(iii)b., c., and (k)(2)(i)b. and e. apply to 
any account in which a research analyst has a financial interest, or 
over which the research analyst exercises discretion or control[, other 
than an investment company registered under the Investment Company Act 
of 1940]. The trading restrictions applicable to research analysts and 
household members (i.e., paragraphs (e)(1), (2), (3), (4)(i), (ii), 
(iii), (iv) and (v))[;] shall not include an investment company 
registered under the Investment Company Act of 1940 over which the 
research analyst or a household member has discretion or control, 
provided that the research analyst or household member has no financial 
interest in such investment company, other than a performance or 
management fee, and do not apply to a ``blind trust'' account that is 
controlled by a person other than the research analyst or research 
analyst's household member where neither the research analyst nor 
household member knows of the account's investments or investment 
transactions.
    .50 through .140 No change.
Rule 344. Research Analysts and Supervisory Analysts
    Research analysts and supervisory analysts must be registered with, 
qualified by, and approved by the Exchange.

* * * Supplementary Material:

    .10 [For purposes of this Rule, the term ``research analyst'' 
includes a member, allied member, associated person or employee who is 
primarily responsible for the preparation of the substance of a 
research report and/or whose name appears on such report. Such research 
analysts must pass a qualification examination acceptable to the 
Exchange.] For the purposes of this Rule, ``research analyst'' shall 
mean an associated person whose primary job function is to provide 
investment research and who is primarily responsible for the 
preparation of the substance of a research report or whose name appears 
on the report.
    .11 For purposes of this Rule, the term ``supervisory analyst'' 
includes [a member,] an allied member or employee who is responsible 
for preparing or approving research reports under Rule 472(a)(2). In 
order to show evidence of acceptability to the Exchange as a 
supervisory analyst, [a member,] an allied member, or employee may do 
one of the following:
    (1) Present evidence of appropriate experience and pass an Exchange 
Supervisory Analyst Examination (Series 16).
    (2) Present evidence of appropriate experience and successful 
completion of a specified level of the Chartered Financial Analysts 
Examination prescribed by the Exchange and pass only that portion of 
the Exchange Supervisory Analyst Examination (Series 16) dealing with 
Exchange rules on research standards and related matters.
    The Exchange publishes a Study Outline for the Research Analyst 
Examination and the Supervisory Analyst Examination (Series 16).
    .12 No change.

B. NASD's Proposed Rule Text

1050. Registration of Research Analysts
    (a) No change.
    (b) For the purposes of this Rule 1050, ``research analyst'' shall 
mean an associated person whose primary job function is to provide 
investment research and who is primarily responsible for the 
preparation of the substance of a research report or whose name appears 
on a research report.
    (c) through (f) No change.
* * * * *
2711. Research Analysts and Research Reports
(a) Definitions
    For purposes of this rule, the following terms shall be defined as 
provided.
    (1) through (6) No Change.
    (7) ``Research analyst account'' means any account in which a 
research analyst or member of the research analyst's household has a 
financial interest[,] or over which such analyst has discretion or 
control[, other than an investment company registered under the 
Investment Company Act of 1940]. The term ``research analyst account'' 
shall not include an investment company registered under the Investment 
Company Act of 1940 over which the research analyst or a member of the 
research analyst's household has discretion or control, provided that 
the research analyst or household member has no financial interest in 
such investment company, other than a performance or management fee. 
This term also shall [does] not include a ``blind trust'' account that 
is controlled by a person other than the research analyst or member of 
the research analyst's household where neither the research analyst nor 
a member of the research analyst's household knows of the account's 
investments or investment transactions.
    (8) No Change.
    (9) ``Research Report'' means 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 or a public direct participation program) and that provides 
information reasonably sufficient upon which to base an investment 
decision. This term does not include:
    (A) through (C) No Change.
    (10) No Change.
(b) Restrictions on Relationship With Research Department
    (1) No Change.
    (2) [Except as provided in paragraph (b)(3), n]No employee of the 
investment banking department or any other employee of the member who 
is not directly responsible for investment research (``non-research 
personnel''), other than legal or compliance personnel, may review or 
approve a research report of the member before its publication.
    [(3) Non-research personnel may review a research report before its 
publication as necessary only to verify

[[Page 2064]]

the factual accuracy of information in the research report or identify 
any potential conflict of interest, provided that:]
    [(A) Any written communication between non-research personnel and 
research department personnel concerning the content of a research 
report must be made either through authorized legal or compliance 
personnel of the member or in a transmission copied to such personnel; 
and]
    [(B) Any oral communication between non-research personnel and 
research department personnel concerning the content of a research 
report must be documented and made either through authorized legal or 
compliance personnel acting as intermediary or in a conversation 
conducted in the presence of such personnel.]
(c) Restrictions on Communications With the Subject Company
    (1) through (4) No Change.
    (5) A research analyst is prohibited from directly or indirectly:
    (A) No Change.
    (B) Engaging in any communication with a current or prospective 
customer or internal sales personnel in the presence of investment 
banking department personnel or company management about an investment 
banking services transaction.
    (6) through (7) No Change.
    (d) through (e) No Change.
(f) Restrictions on Publishing Research Reports and Public Appearances; 
Termination of Coverage
    [(1) No member may publish or otherwise distribute a research 
report and no research analyst may make a public appearance regarding a 
subject company for which the member acted as manager or co-manager 
of:]
    [(A) An initial public offering, for 40 calendar days following the 
date of the offering; or]
    [(B) A secondary offering, for 10 calendar days following the date 
of the offering; provided that:]
    [(i) Paragraphs (f)(1)(A) and (f)(1)(B) will not prevent a member 
from publishing or otherwise distributing a research report, or prevent 
a research analyst from making a public appearance, concerning the 
effects of significant news or a significant event on the subject 
company within such 40- and 10-day periods, and provided further that 
legal or compliance personnel authorize publication of that research 
report before it is issued or authorize the public appearance before it 
is made; and]
    [(ii) paragraph (f)(1)(B) will not prevent a member from publishing 
or otherwise distributing a research report pursuant to SEC Rule 139 
regarding a subject company with ``actively-traded securities,'' as 
defined in Regulation M, 17 CFR 242.101(c)(1), and will not prevent a 
research analyst from making a public appearance concerning such a 
company.]
    ([2]1) No member that has agreed to participate or is participating 
as an underwriter or dealer [(other than as manager or co-manager)] of 
an issuer's initial public offering may publish or otherwise distribute 
a research report or make a public appearance regarding that issuer for 
25 calendar days after the date of the offering. This paragraph will 
not prevent a member from publishing or otherwise distributing a 
research report, or prevent a research analyst from making a public 
appearance, concerning the effects of significant news or a significant 
event on the subject company within such 25-day period, provided 
further that legal or compliance personnel authorize publication of 
that research report before it is issued or authorize the public 
appearance before it is made.
    ([3]2) For purpose[s] of paragraph (f)(1)[and (f)(2)], the term 
``date of the offering'' refers to the later of the effective date of 
the registration statement or the first date on which the security was 
bona fide offered to the public.
    [(4) No member that has acted as a manager or co-manager of a 
securities offering may publish or otherwise distribute a research 
report or make a public appearance concerning a subject company 15 days 
prior to and after the expiration, waiver or termination of a lock-up 
agreement or any other agreement that the member has entered into with 
a subject company or its shareholders that restricts or prohibits the 
sale of securities held by the subject company or its shareholders 
after the completion of a securities offering. This paragraph will not 
prevent a member from publishing or otherwise distributing a research 
report concerning the effects of significant news or a significant 
event on the subject company within such period, provided legal or 
compliance personnel authorize publication of that research report 
before it is issued. In addition, this paragraph shall not apply to the 
publication or distribution of a research report pursuant to SEC Rule 
139 regarding a subject company with ``actively traded securities,'' as 
defined in Regulation M, 17 CFR 242.101(c)(1), or to a public 
appearance concerning such a subject company.]
    (3) Any member that has acted as a manager or co-manager of a 
securities offering and publishes or otherwise distributes a research 
report concerning a subject company during a period 15 days prior to 
and after the expiration, waiver or termination of a lock-up agreement 
or any other agreement that the member has entered into with a subject 
company or its shareholders that restricts or prohibits the sale of 
securities held by the subject company or its shareholders after the 
completion of a securities offering shall provide with the research 
report a certification, in such form as prescribed by NASD, stating 
that the member has a bona fide reason for issuing the research report.
    ([5]4) If a member intends to terminate its research coverage of a 
subject company, notice of this termination must be made. The member 
must make available a final research report on the subject company 
using the means of dissemination equivalent to those it ordinarily uses 
to provide the customer with its research reports on the subject 
company. The report must be comparable in scope and detail to prior 
research reports and must include a final recommendation or rating, 
unless it is impracticable for the member to produce a comparable 
report (e.g., if the research analyst covering the subject company or 
sector has left the member or if the member terminates coverage of the 
industry or sector). If it is impracticable to produce a final 
recommendation or rating, the final research report must disclose the 
member's rationale for the decision to terminate coverage.
(g) Restrictions on Personal Trading by Research Analysts
    (1) through (4) No Change.
    (5) The prohibitions in paragraphs (g)(1) through (g)(3) do not 
apply to a purchase or sale of the securities of[:]
    [(A) Any registered diversified investment company as defined under 
Section (5)(b)(1) of the Investment Company Act of 1940; or ]
    [(B)] Any [other] investment fund over which neither the research 
analyst nor a member of the research analyst's household has any 
investment discretion or control, provided that the research analyst 
and household member are not made aware of the fund's holdings or 
transactions other than through periodic shareholder reports and sales 
material based on such reports[:] and
    [(i)] The research analyst accounts collectively own interests 
representing no more than 1% of the assets of the fund[;].
    [(ii) The fund invests no more than 20% of its assets in securities 
of issuers principally engaged in the same types of

[[Page 2065]]

business as companies that the research analyst follows; and]
    [(iii) If the investment fund distributes securities in kind to the 
research analyst or household member before the issuer's initial public 
offering, the research analyst or household member must either divest 
those securities immediately or the research analyst must refrain from 
participating in the preparation of research reports concerning that 
issuer.]
    (6) The prohibitions in paragraphs (g)(1) through (g)(3) do not 
apply when the following conditions are satisfied:
    (A) The research analyst is employed by a member that has adopted 
an internal policy that prohibits research analysts from owning any 
securities issued by subject companies for which the research analyst 
provides coverage and requires those analysts to completely divest 
themselves of their existing holdings in such securities;
    (B) The research analyst abides by a reasonable plan of liquidation 
under which all securities issued by companies that the analyst follows 
are to be sold within 120 days of the effective date of the member's 
policy;
    (C) The research analyst files such liquidation plan with the 
member's legal or compliance department within 15 days of the effective 
date of the member's policy;
    (D) The research analyst receives written approval of the 
liquidation plan from the member's legal or compliance department prior 
to the sale of any securities under the plan; and
    (E) The member must maintain written records sufficient to document 
compliance with each liquidation plan approved by its legal or 
compliance department for three years following the date on which the 
liquidation plan is approved.
    ([6]7) Legal or compliance personnel of the member shall pre-
approve all transactions of persons who oversee research analysts to 
the extent such transactions involve equity securities of subject 
companies covered by the research analysts that they oversee. This pre-
approval requirement shall apply to all persons, such as the director 
of research, supervisory analyst, or member of a committee, who have 
direct influence or control with respect to the preparation of the 
substance of research reports or establishing or changing a rating or 
price target of a subject company's equity securities.
(h) Disclosure Requirements
    (1) [Ownership and Material]Definition of ``Conflict of Interest''
    [A member must disclose in research reports and a research analyst 
must disclose in public appearances]For the purposes of paragraph 
(h)(2), ``conflict of interest'' shall include any of the following:
    (A) If the research analyst or a member of the research analyst's 
household has a financial interest in the securities of the subject 
company, and the nature of the financial interest (including, without 
limitation, whether it consists of any option, right, warrant, future, 
long or short position);
    (B) If, as of the end of the month immediately preceding the date 
of publication of the research report or the public appearance (or the 
end of the second most recent month if the publication date is less 
than 10 calendar days after the end of the most recent month), the 
member or its affiliates beneficially own 1% or more of any class of 
common equity securities of the subject company. Computation of 
beneficial ownership of securities must be based upon the same 
standards used to compute ownership for purposes of the reporting 
requirements under Section 13(d) of the Securities Exchange Act of 
1934;
    [(C) Any other actual, material conflict of interest of the 
research analyst or member of which the research analyst knows or has 
reason to know at the time of publication of the research report or at 
the time of the public appearance.]
[(2) Receipt of Compensation]
    [(A) A member must disclose in research reports:]
    ([i]C) If the research analyst received compensation:
    [a.](i) Based upon (among other factors) the member's investment 
banking revenues; or
    [b.](ii) From the subject company in the past 12 months.
    ([ii]D) If the member or any affiliate of the member:
    [a.](i) Managed or co-managed a public offering of securities for 
the subject company in the past 12 months;
    [b.](ii) Received compensation for investment banking services from 
the subject company in the past 12 months; or
    [c.](iii) Expects to receive or intends to seek compensation for 
investment banking services from the subject company in the next 3 
months.
    ([iii]E) If ([1]i) as of the end of the month immediately preceding 
the date of publication of the research report (or the end of the 
second most recent month if the publication date is less than 30 
calendar days after the end of the most recent month) or ([2]ii) to the 
extent the research analyst or an employee of the member with the 
ability to influence the substance of the research knows:
    a. The member received any compensation for products or services 
other than investment banking services from the subject company in the 
past 12 months; or
    b. The subject company currently is, or during the 12-month period 
preceding the date of distribution of the research report was, a client 
of the member. In such cases, the member also must disclose the types 
of services provided to the subject company. For purposes of this Rule 
2711(h)(1), the types of services provided to the subject company shall 
be described as investment banking services, non-investment banking 
securities-related services, and non-securities services.
    ([iv]F) If, to the extent the research analyst or an employee of 
the member with the ability to influence the substance of the research 
report knows an affiliate of the member received any compensation for 
products or services other than investment banking services from the 
subject company in the past 12 months.
    ([v]G) If, to the extent the research analyst or member has reason 
to know, an affiliate of the member received any compensation for 
products or services other than investment banking services from the 
subject company in the past 12 months.
    [a.](i) [This]The requirement to disclose this conflict of interest 
will be deemed satisfied if such compensation is disclosed in research 
reports or on a member's Web site within 30 days after completion of 
the last calendar quarter, provided that the member has taken steps 
reasonably designed to identify any such compensation during that 
calendar quarter. [This]The disclosure requirement shall not apply to 
any subject company as to which the member initiated coverage since the 
beginning of the current calendar quarter.
    [b.](ii) The research analyst and the member will be presumed not 
to have reason to know whether an affiliate received any compensation 
for products or services other than investment banking services from 
the subject company in the past 12 months if the member maintains and 
enforces policies and procedures reasonably designed to prevent the 
research analysts and employees of the member with the ability to 
influence the substance of research reports from, directly or 
indirectly, receiving information from the affiliate concerning whether 
the affiliate received such compensation.

[[Page 2066]]

    (H) If the research analyst or member of a research analyst's 
household serves as an officer, director or advisory board member of 
the subject company.
    (I) If the member was making a market in the subject company's 
securities at the time that the research report was published; and
    (J) Any other actual, material conflict of interest of the research 
analyst or member of which the research analyst knows or has reason to 
know at the time of publication of the research report or at the time 
of the public appearance.
    ([vi]K) For the purposes of this Rule 2711(h)([2]1), an employee of 
the member with the ability to influence the substance of the research 
report is an employee who, in the ordinary course of that person's 
duties, has the authority to review the particular research report and 
to change that research report prior to publication.

(2) Disclosure of Conflicts of Interest

    (A) Any member that has a conflict of interest or whose research 
analyst has a conflict of interest concerning the subject company of a 
research report must disclose that conflict of interest either:
    (i) On its Web site and prominently state the following on the 
front page of the research report:
    ``[Name of firm and/or the research analyst preparing this report] 
has a conflict of interest that may affect the ability of the firm or 
the analyst to provide objective analysis about the company. For more 
information about this conflict of interest, please see [Reference to 
the firm's Web site]'' or
    (ii) In the research report in accordance with paragraph (h)(8).
    (B) A research analyst must disclose in public appearances:
    (i) The conflicts of interest described in paragraphs (h)(1)(A), 
(B) and (J);
    (ii) If, to the extent the research analyst knows or has reason to 
know, the member or any affiliate received any compensation from the 
subject company in the past 12 months;
    (iii) If the research analyst received any compensation from the 
subject company in the past 12 months; or
    ([iii]iv) If, to the extent the research analyst knows or has 
reason to know, the subject company currently is, or during the 12-
month period preceding the date of distribution of the research report, 
was, a client of the member. In such cases, the research analyst also 
must disclose the types of services provided to the subject company, if 
known by the research analyst;[.]or
    (v) If the research analyst or a member of the research analyst's 
household serves as an officer, director or advisory board member of 
the subject company.
    (C) A member or research analyst will not be required to make a 
disclosure required by paragraphs (h)(1)(D)(ii) and 
(iii)[(h)(2)(A)(ii)(b) and (c)], (h)(1)(E)(b)[(2)(A)(iii)(b),] or 
(h)(2)(B)(ii) and (iv[iii]) to the extent such disclosure would reveal 
material non-public information regarding specific potential future 
investment banking transactions of the subject company.
[(3) Position as Officer or Director]
    [A member must disclose in research reports and a research analyst 
must disclose in public appearances if the research analyst or a member 
of the research analyst's household serves as an officer, director or 
advisory board member of the subject company.]
([4]3) Meaning of Ratings
    If a research report contains a rating, the member must define in 
the research report the meaning of each rating used by the member in 
its rating system. The definition of each rating must be consistent 
with its plain meaning.
([5]4) Distribution of Ratings
    (A) Through (B) No Change.
    (C) The information that is disclosed under paragraphs (h)([5]4)(A) 
and (h)([5]4)(B) must be current as of the end of the most recent 
calendar quarter (or the second most recent calendar quarter if the 
publication date is less than 15 calendar days after the most recent 
calendar quarter) and must reflect the distribution of the most recent 
ratings issued by the member for all subject companies, unless the most 
recent rating was issued more than 12 months ago.
    (D) The requirements of paragraph (h)([5]4) shall not apply to any 
research report that does not contain a rating.
([6]5) Price Chart
    If a research report contains either a rating or a price target, 
and the member has assigned a rating or price target to the subject 
company's securities for at least one year, the research report must 
include a line graph of the security's daily closing prices for the 
period that the member has assigned any rating or price target or for a 
three-year period, whichever is shorter.
    The line graph must:
    (A) through (C) No Change.
([7]6) Price Targets
    If a research report contains a price target, the member must 
disclose in the research report the valuation methods used to determine 
the price target. Price targets must have a reasonable basis and must 
be accompanied by a disclosure concerning the risks that may impede 
achievement of the price target.
[(8) Market Making
    A member must disclose in research reports if it was making a 
market in the subject company's securities at the time that the 
research report was published.]
([9]7) Disclosure Required by Other Provisions
    In addition to the disclosure required by this rule, members and 
research analysts must provide disclosure in research reports and 
public appearances that is required by applicable law or regulation, 
including NASD Rule 2210 and the antifraud provisions of the federal 
securities laws.
([10]8) Prominence of Disclosure
    The disclosures required by this paragraph (h), other than those 
made pursuant to paragraph (h)(2)(A)(i), must be presented on the front 
page of research reports or the front page must refer to the page on 
which disclosures are found. Disclosures and references to disclosures 
must be clear, comprehensive and prominent.
([11]9) Disclosures in Research Reports Covering Six or More Companies
    When a member distributes a research report covering six or more 
subject companies (a ``compendium report''), for purposes of the 
disclosures required in paragraph (h), other than those required by 
paragraph (h)(2), the compendium report may direct the reader in a 
clear manner as to where they may obtain applicable current 
disclosures. Electronic compendium reports may include a hyperlink to 
the required disclosures. Paper-based compendium reports must provide 
either a toll-free number to call or a postal address to write for the 
required disclosures and may also include a web address of the member 
where the disclosures can be found.
(1[2]0) Records of Public Appearances
    Members must maintain records of public appearances by research 
analysts sufficient to demonstrate compliance by those research 
analysts with the applicable disclosure requirements under paragraph 
(h) of this Rule. Such records must be maintained for three years from 
the date of the public appearance.
(1[3]1) Third-Party Research Reports
    (A) Subject to paragraph (h)(1[3]1)(B), if a member distributes or 
makes available any research report that is produced by another member, 
a non-

[[Page 2067]]

member affiliate of the member or an independent third party, the 
member must accompany the research report with the current applicable 
disclosures, as they pertain to the member, that are required by 
paragraphs (h)(1)(B), [(h)(1)(C), (h)(2)(A)(ii) and (h)(8)] (h)(1)(D), 
(h)(1)(I) and (h)(1)(J) of this Rule.
    (B) The requirements of paragraph (h)(1[3]1)(A) shall not apply to 
research reports prepared by an independent third party that the member 
makes available to its customers either upon request or through a 
member-maintained Web site.
    (C) No Change.
(i) Supervisory Procedures
    Each member subject to this rule must adopt and implement written 
supervisory procedures reasonably designed to ensure that the member 
and its employees comply with the provisions of this rule (including 
the attestation requirements of Rule 2711(d)(2)), and a senior officer 
of such a member must [attest] annually [to]file with the NASD Member 
Regulation Department by April 1 of each year an attestation that it 
has adopted and implemented those procedures.
(j) Prohibition of Retaliation Against Research Analysts
    No member and no [employee of a member who is involved with the 
member's investment banking activities]non-research personnel as 
defined in paragraph (b)(2) may, directly or indirectly, retaliate 
against or threaten to retaliate against any research analyst employed 
by the member or its affiliates as a result of an adverse, negative, or 
otherwise unfavorable research report or public appearance written or 
made by the research analyst that may adversely affect the member's 
present or prospective investment banking relationship with the subject 
company of a research report. This prohibition shall not limit a 
member's authority to discipline or terminate a research analyst, in 
accordance with the member's policies and procedures, for any cause 
other than the writing of such an unfavorable research report or the 
making of such an unfavorable public appearance.
(k) No Change
* * * * *

II. Self-Regulatory Organizations' Statements of the Purpose of, and 
Statutory Basis for, the Proposed Rule Changes

    In their filings with the Commission, the Exchange and NASD 
included statements concerning the purpose of and basis for the 
proposed rule changes and discussed any comments they received on the 
proposed rule changes. The text of these statements may be examined at 
the places specified in Item IV below. The Exchange and NASD have 
prepared summaries, set forth in sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statements of the Purpose of, and 
Statutory Basis for, the Proposed Rule Changes

1. NYSE's Purpose

Background

    Beginning in 2002, the Exchange and the National Association of 
Securities Dealers, Inc. implemented a series of rule changes (``SRO 
Rules'') to improve objectivity and transparency in equity research and 
provide investors with more reliable and useful information to make 
investment decisions. The NYSE believes that the rules were intended to 
restore public confidence in the validity of research and the veracity 
of research analysts, who are expected to function as unbiased 
intermediaries between issuers and the investors who buy and sell their 
securities. According to the NYSE, the trustworthiness of research had 
eroded due to the pervasive influences of investment banking and other 
conflicts that had manifest themselves during the market boom of the 
late 1990s.
    Generally, the SRO Rules require clear, comprehensive and prominent 
disclosure of conflicts of interest in research reports and public 
appearances by research analysts. The rules further prohibit certain 
conduct--investment banking personnel involvement in the content of 
research and determination of analyst compensation, for example--when 
the conflicts are considered too pronounced to be cured by disclosure.
    The SROs enacted the research analyst conflict rules in two primary 
tranches and, more recently, adopted additional amendments prohibiting 
analysts from participating in road shows. In addition, the SROs 
supplemented their rulemaking with two joint memoranda that provided 
interpretive guidance to their members on a number of issues.\7\ The 
NASD and NYSE rules and interpretations are virtually identical and are 
intended to operate uniformly.
---------------------------------------------------------------------------

    \7\ See NYSE Information Memos 02-26 and 04-10 and NASD Notices 
to Members 02-39 (July 2002) and 04-18 (March 2004).
---------------------------------------------------------------------------

    On May 10, 2002, the SEC approved the first round of proposed SRO 
Rules (``Round 1 Amendments'')--new NASD Rule 2711 (``Research Analysts 
and Research Reports'') and amendments to NYSE Rules 351 (``Reporting 
Requirements'') and 472 (``Communications with the Public'')--which 
implemented basic reforms to separate research from investment banking 
and to provide more extensive disclosure of conflicts of interest in 
research reports and public appearances.\8\
---------------------------------------------------------------------------

    \8\ See Securities Exchange Act Release No. 45908 (May 10, 
2002), 67 FR 34968 (May 16, 2002) (order approving SR-NASD-2002-021 
and SR-NYSE-2002-09).
---------------------------------------------------------------------------

    On July 29, 2003, the SEC approved a second set of amendments to 
the SRO Rules (``Round 2 Amendments'') \9\ that achieved two purposes. 
First, the Round 2 Amendments implemented SRO initiatives to further 
promote analyst objectivity and transparency of conflicts in research 
reports. Second, the Round 2 Amendments implemented changes mandated by 
the Sarbanes-Oxley Act of 2002 (``Sarbanes-Oxley'').\10\ Sarbanes-Oxley 
required adoption by July 30, 2003 of rules ``reasonably designed to 
address conflicts of interest that can arise when securities analysts 
recommend equity securities in research reports and public 
appearances,'' and set forth certain specific rules to be promulgated. 
Many of those rules had already been adopted in the first round of SRO 
rulemaking. The Round 2 Amendments therefore implemented those specific 
Sarbanes-Oxley rules that did not already exist and conformed the 
language of the SRO Rules as necessary.
---------------------------------------------------------------------------

    \9\ See Securities Exchange Act Release No. 48252 (July 29, 
2003), 68 FR 45875 (Aug. 4, 2003) (order approving SR-NASD-2002-154 
and SR-NYSE-2002-49).
    \10\ See Section 15D(a) of the Act, 15 U.S.C. 78o-6.
---------------------------------------------------------------------------

    As part of the Round 2 Amendments, the SEC approved rules requiring 
registration and qualification requirements for research analysts. NYSE 
Rule 344 requires an associated person who functions as a research 
analyst on behalf of a member organization to register as such and pass 
a qualification examination. For the purposes of this requirement, a 
``research analyst'' is defined as an associated person or employee who 
is primarily responsible for the preparation of the substance of a 
research report and/or whose name appears on such ``research report,'' 
as that term is defined in NYSE Rule 472.
    The SROs jointly developed and implemented the Research Analyst 
Qualification Examination (Series 86/87). The examination consists of 
an analysis part (Series 86) and a regulatory

[[Page 2068]]

part (Series 87). Prior to taking either the Series 86 or 87, a 
candidate also must have passed the General Securities Registered 
Representative Examination (Series 7), the Limited Registered 
Representative Examination (Series 17), or the Canada Module of Series 
7 (Series 37 or 38).
    The SRO Rules provide three exemptions from the Series 86 
examination. First, there is an exemption for research analysts who 
have passed Levels I and II of the Chartered Financial Analyst 
(``CFA'') examination and have either (1) completed the CFA Level II 
within 2 years of application or registration, or (2) functioned as a 
research analyst continuously since having passed the CFA Level II.\11\
---------------------------------------------------------------------------

    \11\ See Securities Exchange Act Release No. 49464 (March 24, 
2004), 69 FR 16628 (March 30, 2004) (order approving SR-NASD-2004-
020 and SR-NYSE-2004-03).
---------------------------------------------------------------------------

    A second exemption is available to research analysts who have 
passed Levels I and II of the Chartered Market Technician Examination 
and produce only ``technical research reports,'' as that term is 
defined under the SRO Rules.\12\
---------------------------------------------------------------------------

    \12\ See Securities Exchange Act Release No. 51240 (February 23, 
2005), 70 FR 10451 (March 3, 2005) (notice of immediate 
effectiveness of SR-NASD-2005-022 and SR-NYSE-2005-12).
---------------------------------------------------------------------------

    A third exemption--from both the Series 86 and Series 87--is 
available to persons who may be ``associated persons'' of a member who 
are employed by that member's foreign affiliate but who produce 
research on behalf of the U.S. member. To be eligible for the 
exemption, three primary conditions must be met: (1) A foreign analyst 
must comply with the registration and qualification requirements or 
other standards in an SRO-approved foreign jurisdiction whose 
regulatory scheme reflects a recognition of principles that are 
consonant with the SRO Rules and qualification standards; (2) the U.S. 
member must apply all of the other SROs rules and other member firm 
standards to the research produced by the foreign affiliate and foreign 
research analysts that qualify for, and rely upon, the exemption; and 
(3) the U.S. member must include a specific disclosure that the 
research report has been prepared in whole or part by foreign research 
analysts who may be associated persons of the member who are not 
registered/qualified as a research analyst with the NYSE or NASD, but 
instead have satisfied the registration/qualification requirements or 
other research-related standards of a foreign jurisdiction that has 
been recognized for these purposes by the NYSE and NASD. Currently, the 
following jurisdictions satisfy the applicable SRO standards noted 
above: China, Hong Kong, Japan, Malaysia, Singapore, Thailand and the 
United Kingdom.
    On April 21, 2005, the Commission approved an amendment to the SRO 
Rules that prohibits research analysts from participating in a road 
show related to an investment banking services transaction and from 
communicating with current or prospective customers in the presence of 
investment banking department personnel or company management about 
such an investment banking services transaction.\13\ Additionally, the 
amendment prohibits investment banking personnel from directing a 
research analyst to engage in sales and marketing efforts and other 
communications with a current or prospective customer about an 
investment banking services transaction.
---------------------------------------------------------------------------

    \13\ See Securities Exchange Act Release No. 51593 (April 21, 
2005), 70 FR 22168 (April 28, 2005) (order approving SR-NASD-2004-
141 and SR-NYSE-2005-24). As defined under NASD Rule 2711(a)(3) and 
NYSE Rule 472.20, ``investment banking services'' includes, without 
limitation, acting as an underwriter in an offering for the issuer; 
acting as a financial adviser in a merger or acquisition; providing 
venture capital, equity lines of credit, PIPEs (private investment, 
public equity transactions), or similar investments; serving as 
placement agent for the issuer; or acting as a member of a selling 
group in a securities underwriting.
---------------------------------------------------------------------------

Joint SRO Report

    As part of its May 2002 order approving new NASD Rule 2711 and 
amendments to NYSE Rule 472, the SEC noted that it would require NASD 
and the NYSE to assess the success of the rules after they have been in 
place for a suitable amount of time. In April 2005, the SEC staff 
requested a joint comprehensive report on the operation and 
effectiveness of the rules, together with any recommendations for 
changes or additions to the rules. The SRO staffs submitted that report 
to the SEC on December 22, 2005.
    The SRO staffs concluded in the report that the SRO Rules have been 
effective in helping to restore integrity to research by minimizing the 
influences of investment banking and promoting transparency of other 
potential conflicts of interest. However, the SRO staffs further 
expressed their belief that certain changes to the SRO Rules would 
further improve their effectiveness by striking an even better balance 
between ensuring objective and reliable research on the one hand and 
permitting the flow of information to investors and minimizing costs 
and burdens to members on the other.
    In formulating the recommendations for rule changes in the report, 
the SROs considered extensive data and qualitative feedback regarding 
the range of activities under the SRO Rules, including examinations, 
sweeps, enforcement activities, interpretive issues and registration 
and qualification of research analysts. The SROs also surveyed academic 
studies and media reports about the impact of the rules; compared the 
SRO Rules to the provisions of the so-called ``Global Settlement'' 
among the SROs, the Commission, the North American Securities 
Administrators Association and ten \14\ of the largest investment 
banks; reviewed industry comment letters; and consulted with various 
industry representatives. The proposed rule changes would implement the 
recommendations of the SROs in the SRO report. A discussion of the 
proposed rule changes is set out below.
---------------------------------------------------------------------------

    \14\ In August 2004, two additional firms settled with 
regulators under the same terms as the April 2003 Global Settlement.
---------------------------------------------------------------------------

Exception to Definition of ``Research Report''

    ``Research report'' is defined in NYSE Rule 472.10(2) as a 
``written or electronic communication which includes an analysis of 
equity securities of individual companies or industries, and provides 
information reasonably sufficient upon which to base an investment 
decision.'' The proposed rule change would expressly exclude from the 
definition of ``research report,'' sales material regarding open-end 
registered investment companies that are not listed or traded on an 
exchange and public direct participation programs (``DPPs''). Since 
these investment companies and DPPs are ``equity securities'' as 
defined in Section 3(a)(11) \15\ of the Exchange Act, related sales 
material that contains an analysis of those securities and information 
sufficient upon which to base an investment decision technically is 
covered by the definition. For the following reasons, the Exchange 
believes sales material for both types of products should be excluded 
from the definition of ``research report.''
---------------------------------------------------------------------------

    \15\ 15 U.S.C. 78c(a)(11).
---------------------------------------------------------------------------

    Sales material regarding investment companies is already subject to 
a separate regulatory regime, including NASD Rule 2210 and Securities 
Act Rule 482,\16\ and all advertisements and sales literature regarding 
registered investment companies must be filed with the NASD Advertising 
Regulation Department (the ``Department'') within

[[Page 2069]]

ten (10) business days of first use.\17\ Moreover, the Exchange staff 
does not believe that the conflicts underpinning the SRO Rules are 
manifest to the same extent with respect to research on open-end 
investment companies that are not listed or traded on an exchange.
---------------------------------------------------------------------------

    \16\ 17 CFR 230.482.
    \17\ An advertisement or sales literature concerning a 
registered investment company that includes a performance ranking or 
performance comparison of the investment company with other 
investment companies that is not generally published or are created 
by the fund or its affiliates must be filed with the Department at 
least 10 business days prior to first use or publication. NASD Rule 
2210(c)(4)(A).
---------------------------------------------------------------------------

    Similarly, the NYSE believes that sales material for public DPPs 
also do not present the same conflicts of interest or other regulatory 
concerns as research on exchange-traded securities. Publicly offered 
DPPs typically are limited partnerships or limited liability companies 
whose equity interests do not trade on an exchange and do not have an 
active secondary market. The DPP sponsor generally produces its sales 
material and sells interests in the DPP during an initial public 
offering on a best efforts basis. According to the NYSE, this sales 
material typically consists of ``tombstone'' advertisements whose 
content is strictly limited under Securities Act Rule 134,\18\ or 
supplemental sales literature that must be accompanied or preceded by a 
prospectus for the DPP. Additionally, unlike equity research, NASD Rule 
2210(c)(2)(B) requires members to file advertisements and sales 
literature concerning public DPPs with the Department within ten 
business days of first use. Thus, NASD staff review such sales material 
before or shortly after it is distributed to the public.
---------------------------------------------------------------------------

    \18\ 17 CFR 230.134.
---------------------------------------------------------------------------

    Although exchange-traded funds (``ETFs'') are open-end investment 
companies, they trade on an exchange and therefore those funds would 
not be excepted from the definition of ``research report.'' The 
Exchange requests comment on whether ETFs should also be excluded from 
the definition. In addition, the NYSE believes that NASD Advertising 
Regulation Department review of registered investment company and 
public DPP sales material reduces the likelihood that it will contain 
content that is not fair and balanced.

Exception to Registration and Qualification Requirements for Non-
Research Personnel That Produce ``Research Reports''

    The SRO Rules, in accordance with the mandates of Sarbanes-
Oxley,\19\ are constructed such that the author of a communication that 
meets the definition of a ``research report'' is a ``research 
analyst,'' irrespective of his or her title or primary job. This 
prevents firms from circumventing the rules by redirecting through 
other channels, such as registered representatives or traders, 
potentially biased research that is not subject to the SRO objectivity 
safeguards.
---------------------------------------------------------------------------

    \19\ See Section 15D of the Act.
---------------------------------------------------------------------------

    The Exchange believes it is important to maintain such 
communications as research reports subject to the SRO Rules and those 
principally responsible for their preparation as research analysts. 
However, the proposed rule changes would create a limited exemption 
from the NYSE Rule 344 registration requirements for non-research 
personnel that produce research reports. Thus, for example, the 
registration requirements would not apply to a registered 
representative who occasionally produces communications that 
technically meet the definition of a research report and are 
distributed to fifteen (15) or more clients, or a trader who similarly 
produced market commentary that included an analysis of an individual 
security--also considered a research report under NYSE rules.
    The Exchange believes that the registration and qualification 
requirements were intended for those individuals whose principal job 
function is to produce research, while the balance of the SRO Rules are 
intended to foster objective analysis of equity securities and 
transparency of certain conflicts and to provide beneficial information 
to investors.

Restrictions on Investment Banking Department Relationship With 
Research Department

    Exchange Rule 472(b)(3) permits investment banking and other non-
research employees, other than legal and compliance personnel, to 
review a research report before publication only to verify the factual 
accuracy of information in the report or identify a potential conflict 
of interest. This provision also requires that an authorized legal or 
compliance official act as intermediary for all such permissible 
communications.
    The proposed rule changes eliminate the pre-publication review of 
research by investment banking and other non-research personnel, other 
than by legal and compliance. The NYSE believes that the factual review 
of a research report by investment banking personnel is unnecessary in 
light of the numerous other sources available to verify factual 
information, including the subject company, and only raises concerns 
about the objectivity of the report. According to the NYSE, such review 
may invite pressure on a research analyst from investment banking 
personnel that could be difficult to monitor. Such factual reviews are 
not permitted under the terms of the Global Settlement and the Exchange 
staff is not aware of any evidence that the factual accuracy of 
research produced by firms subject to the Global Settlement has 
suffered. Moreover, the NYSE believes that legal and compliance can 
adequately perform a conflict review without sharing draft research 
reports with investment banking personnel and other non-research 
personnel.

Restrictions on Publishing Research Reports and Public Appearances

    NYSE Rule 472(f) sets forth ``quiet periods'' during which a member 
organization is prohibited from publishing or otherwise distributing a 
research report and a research analyst is prohibited from making a 
public appearance. These quiet periods apply in two circumstances: (1) 
After a public offering of securities and (2) before and after the 
expiration, waiver or termination of a lock-up agreement entered into 
by a member organization with a subject company that restricts the sale 
of securities by that company or its shareholders.
    With respect to the former, NYSE Rule 472 establishes different 
quiet periods depending on whether the offering is an initial public 
offering (``IPO'') or a secondary offering and whether the member 
organization acted as manager or co-manager or as an underwriter or 
dealer. In the current NYSE Rule 472, a member organization that acted 
as a manager or co-manager of an IPO may not publish or otherwise 
distribute research for 40 calendar days following the date of the 
offering; all other member organizations that participated as an 
underwriter or dealer in the offering are subject to a 25-day quiet 
period. For secondary offerings, a ten-day quiet period applies only to 
the manager and co-manager of the offering.
    NYSE Rule 472(f)(5) contains an exception that permits publication 
and distribution of research or a public appearance concerning the 
effects of significant news or a significant event on the subject 
company during the quiet period. Prior guidance by the Exchange has 
interpreted this exception to apply only to news or events that have a 
material impact on, or cause a material change to, a company's 
operation, earnings or financial condition. There is also an exception 
in NYSE Rule 472(f)(2) to the secondary offering quiet period, which 
permits publication or

[[Page 2070]]

distribution of research pursuant to Securities Act Rule 139 \20\ 
regarding a subject company with ``actively-traded securities'' as 
defined in Regulation M of the Act.\21\
---------------------------------------------------------------------------

    \20\ 17 CFR 230.139.
    \21\ 17 CFR 242.101.
---------------------------------------------------------------------------

    The Exchange proposes several changes to the quiet periods 
surrounding public offerings and the releases of lock-up agreements:
(a) Quiet periods following public offerings of securities
    The proposed rule changes to NYSE Rule 472(f) create a uniform IPO 
quiet period for all underwriters and dealers participating in the 
public offering. The amended rule applies a 25-day quiet period to 
managers, co-managers, underwriters and dealers that participate in an 
IPO. The NYSE believes that the objectivity and disclosure safeguards 
of NYSE Rule 472 and other research rule provisions have obviated the 
need for a longer quiet period for managers and co-managers than other 
underwriters and dealers participating in an IPO. The NYSE believes 
that these changes will promote an enhanced flow of valuable 
information to investors and maintain consistency with SEC regulations.
    In addition, the proposed rule changes eliminate quiet periods 
following a secondary offering. According to the NYSE, the success of 
the SRO Rules in mitigating research analyst conflicts of interest 
supports the repeal of the quiet periods following secondary offerings. 
The NYSE believes this will expand the ability of member organizations 
to release more information regarding a subject company's prospects and 
financial condition, without sacrificing the reliability of the 
research.
(b) Quiet periods around releases of lock-up agreements
    The proposed rule changes reduce the quiet period surrounding the 
expiration, termination or waiver of a lock-up agreement from the 
current 15-day period to a five-day period. The Exchange believes that 
some quiet period must be maintained around the release of lock-up 
agreements because an analyst can conceivably write a research report 
after an offering with an honestly held positive opinion, but 
advantageously time the publication of the report for inappropriate 
reasons. Also, the NYSE believes that absent a quiet period around the 
expiration, termination or waiver of a lock-up agreement, member 
organizations may selectively time the issuance of ``booster shot'' 
reports intended to raise the stock price of a company just before 
locked-up shares become freely saleable into the market by a company or 
its major shareholders. NYSE believes a five-day quiet period strikes a 
balance between guarding investors against the selective timing of the 
issuance of research and allowing the prompt dissemination of valuable 
information flow to the marketplace.
    While the Exchange may not have jurisdiction over some of the 
participants to such agreements (e.g., the company and its 
shareholders), it does retain jurisdiction over its member 
organizations that can issue research and, as such, can limit the 
potential for any untoward conduct by maintaining this prohibition.
    Lastly, the Exchange notes the recent strength of the IPO market 
and that such offerings generally contain lock-up agreements. 
Accordingly, the Exchange believes that at this juncture it is 
appropriate to maintain a form of prohibition absent some compelling 
empirical data/evidence to the contrary.
(c) Exceptions to quiet periods
    As noted above, Exchange Rule 472(f)(5) contains an exception that 
permits publication and distribution of research or a public appearance 
concerning the effects of significant news or a significant event on 
the subject company during the quiet period, provided the reports are 
pre-approved in writing by legal or compliance personnel. The Exchange 
has interpreted this exception to apply only to news or events that 
have a material impact on, or cause a material change to, a company's 
operations, earnings or financial condition and that generally would 
trigger the filing requirements of SEC Form 8-K. The Exchange has 
previously not interpreted the exception to include earnings 
announcements absent some other significant news or significant event 
because these announcements generally are not causal events or news 
items that materially affect a company's operations, earnings or 
financial condition.
    The Exchange believes that an amendment to NYSE Rule 472 is 
necessary to include earnings announcements in this exception. 
Accordingly, the proposed rule changes provide that an announcement of 
earnings is included in the exception to the quiet periods for 
significant news or events. The NYSE believes that this amendment will 
promote the flow of potentially important or noteworthy information to 
the market and investors in a timely manner.\22\ According to the NYSE, 
the announcement of a change to earnings estimates or a release of 
earnings that vary from street expectations will, in many instances, be 
accompanied by an announcement of some type of causal events. Further, 
the NYSE believes that earnings announcements and guidance are 
necessary pipelines of information for research analysts to support the 
basis of their investment recommendations.
---------------------------------------------------------------------------

    \22\ See Securities Act Release No. 8400 and Securities Exchange 
Act Release No. 49424 (March 16, 2004), 69 FR 15594 (March 25, 
2004).
---------------------------------------------------------------------------

Restrictions on Personal Trading by Research Analysts

    NYSE Rule 472(e) generally restricts the trading of securities by 
research analyst accounts.\23\ Specifically, the Rule prohibits any 
research analyst account from:
---------------------------------------------------------------------------

    \23\ According to the NYSE, although NYSE Rule 472 does not 
employ the term ``research analyst account,'' the trading 
restrictions of NYSE Rule 472(e) and NASD Rule 2711(g) are 
coterminous. See NYSE Rule 472.40.
---------------------------------------------------------------------------

     Purchasing or receiving any securities before the issuer's 
initial public offering if the issuer is principally engaged in the 
same types of business as companies that the research analyst follows;
     Purchasing or selling any security issued by a company 
that the research analyst follows, or any option or derivative of such 
a security, for a period beginning thirty (30) days before and ending 
five (5) days after the publication of a research report concerning the 
company or a change in a rating or price target of the company's 
securities; and
     Purchasing or selling any security or option or derivative 
of such a security in a manner inconsistent with the analyst's most 
recent recommendation.
    NYSE Rule 472(e)(4) includes exceptions to these trading 
restrictions for certain trades that:
     Are due to unanticipated significant changes in an 
analyst's personal financial circumstances;
     Occur within the 30-day/five-day trading blackout around 
the publication of a report if the report is issued due to a 
significant news event;
     Occur within 30 days after an analyst initiates coverage 
of a company;
     Involve shares of diversified registered investment 
companies; and
     Involve interests in an investment fund over which neither 
the analyst nor a household member has any investment discretion or 
control, the research analyst accounts collectively own no more than 1% 
of the fund's assets, and the fund invests no more

[[Page 2071]]

than 20% of its assets in securities of issuers principally engaged in 
the same types of business as companies that the analyst follows.
    NYSE Rule 472(e)(5) currently requires legal or compliance 
personnel to pre-approve all trades of persons who oversee research 
analysts to the extent such trades involve equity securities of subject 
companies covered by the analysts they oversee.
    The proposed rule changes would revise the exceptions to the 
personal trading restrictions to create an exemption for member 
organizations that voluntarily choose to prohibit their analysts from 
owning shares of the companies they cover. The proposed exemption 
allows such a firm to adopt policies that permit research analysts to 
divest their holdings in an orderly and controlled manner with the 
oversight of the firm's legal and compliance personnel.
    With the proposed changes, NYSE Rule 472 allows member 
organizations that adopt ownership bans to implement the same 
divestiture procedures, regardless of when they adopted such a policy, 
that were permitted when NYSE Rule 472 first became effective, to allow 
analysts to divest their holdings.
    NASD has chosen to amend their Rule 2711(g)(5) by expanding the 
exceptions to the personal trading restrictions for investment funds to 
include investments in any fund (including a registered diversified 
investment company), so long as neither the analyst nor a member of his 
or her household is aware of the fund's holdings or transactions other 
than through periodic shareholder reports and sales material based on 
such reports, and provided that the research analyst account owns no 
more than 1% of the assets of the fund, eliminating the 20% asset 
diversification threshold. NYSE understands that the NASD reasons that 
this change will simplify the ability of analysts to invest in, for 
example, mutual funds and hedge funds that do not disclose their 
holdings other than through periodic reports or sales material based on 
such reports. Also, according to the NYSE, NASD reasons that absent 
discretion or control of an account or the contemporaneous knowledge of 
the account's transactions, a minimal investment by a research analyst 
will not influence the analyst to compromise research objectivity to 
benefit the account.
    The Exchange is not proposing to make this change. The Exchange 
believes that the 20% asset diversification threshold must be retained 
for an account to be eligible for the exception. The Exchange believes 
that maintaining the 20% asset diversification threshold has the 
potential for limiting possible conflicts of interest in the issuance 
research reports by analysts with a vested interest in a fund. The 
Exchange seeks comment on whether to maintain this separate 
requirement.

Disclosure Requirements

    NYSE Rule 472(k) imposes a number of disclosure requirements on 
member organization research reports and research analyst public 
appearances in which the analyst makes a recommendation or offers an 
opinion concerning an equity security. NYSE Rule 472(k) requires 
specific disclosures of conflicts of interest, including whether the 
member organization, the research analyst or a member of the analyst's 
household has a financial interest in the subject company's securities 
or the member organization or its affiliates have received compensation 
from the subject company. NYSE Rule 472(k) also requires a number of 
non-conflicts related disclosures in research reports, including the 
meanings of ratings used in the member organization's rating system if 
the research report contains a rating, the distribution of buy, hold, 
and sell ratings assigned by the member organization if a research 
report contains a rating, and a price chart that plots the assignment 
or changes of the analyst's ratings and price targets for the subject 
company against the movement of the subject company's stock price over 
time if the research report contains a rating or a price target. 
According to the NYSE, the required disclosures must be presented on 
the front page of research reports or the front page must refer to the 
page on which the disclosures are found. Electronic research reports 
may utilize hyperlinks to the disclosures. Disclosures and references 
to disclosures must be clear, comprehensive and prominent.
    The Exchange is concerned that the sheer volume of the disclosures 
required presently may obscure the overall message that the disclosures 
are attempting to convey: That the member organization or research 
analyst faces conflicts of interest with respect to the subject 
company. The NYSE believes that this problem is compounded by the fact 
that many member organizations include additional disclosures required 
by other jurisdictions, as well as sometimes lengthy disclaimers for 
their own purposes. To better realize the goal of the disclosure 
requirements, the Exchange believes that it would be more effective and 
useful to investors to know immediately whether the member organization 
or research analyst producing the research report is conflicted, while 
providing the reader the means to learn more about these conflicts if 
he or she chooses to do so. The NYSE believes that this disclosure 
requirement would ensure that investors obtain prominent disclosure 
that a research-related conflict exists, and would permit investors to 
find additional information about the conflict on the member 
organization's Web site.
    To that end, the proposed rule changes would amend NYSE Rule 
472(k)(1) to permit members, in lieu of publication in the research 
report itself, to disclose their conflicts of interest by including a 
prominent warning on the cover of a research report that such conflicts 
of interest exist, together with information on how the reader may 
obtain more detail about these conflicts on the member's Web site. This 
alternative method of disclosure would then require a member to include 
detailed conflicts information on its Web site. According to the NYSE, 
member organizations could still opt to make all of the disclosures in 
the report itself; however, a Web-based disclosure system can 
effectively alert investors that the firm has a conflict of interest 
that could affect the objectivity of a research report. The NYSE 
believes that it also provides a streamlined disclosure alternative by 
placing disclosures in an accessible and convenient location and 
minimizes costs for many firms.
    Specifically, the proposed rule changes would require any member 
that has a conflict of interest or whose research analyst has a 
conflict of interest to state prominently on the front page of the 
research report the following:
    ``[Name of firm and/or the research analyst preparing this report] 
has a conflict of interest that may affect the ability of the firm or 
the analyst to provide objective analysis about the company. For more 
information about this conflict of interest, please see [Reference to 
the firm's Web site].''
    According to the NYSE, conflicts of interest, as defined by the 
proposed rule, include any of the circumstances that currently require 
disclosure under NYSE Rule 472(k)(1), including if the research analyst 
or household member has a financial interest in the subject company; if 
the member organization owns 1% or more of any class of common equity 
securities of the subject company; receipt by the member organization 
of investment banking and other compensation from the subject company 
or the expectation to seek investment banking compensation; if the 
member makes a market in the

[[Page 2072]]

subject company's securities; if the research analyst or household 
member serves as an officer, director or advisory board member of the 
subject company; and any other actual, material conflict of interest of 
the research analyst or member organization of which the research 
analyst knows or has reason to know at the time of publication of the 
research report.
    The proposed amendment would still require the Web-based 
disclosures concern actual conflicts of interest, rather than the 
possibility of such conflicts. According to the NYSE, a general 
``health warning'' that conflicts of interest ``may or may not'' exist 
are neither useful nor effective.
    The Exchange seeks comment on whether a similar approach could be 
used for disclosure of conflicts in public appearances.
    The proposed rule changes would not permit Web site disclosure for 
certain other disclosures, such as the meanings of the member's ratings 
and the price chart showing the subject company's price movements 
against the analyst's assignments of ratings and price targets, which 
still require disclosure in the research report. The NYSE believes that 
these disclosures provide useful information that should be accessible 
to investors in the report and do not lend themselves easily to the 
terse material conflict warning that would appear on the cover of the 
report. Accordingly, they must be readily available to investors in the 
report itself.

Prohibition on Retaliation Against Research Analysts

    NYSE Rule 472(g)(2) prohibits any member organization and any 
employee of a member organization who is involved with the member 
organization's investment banking activities from directly or 
indirectly retaliating against a research analyst as a result of an 
unfavorable research report or public appearance that may adversely 
affect the member organization's current or prospective investment 
banking relationship with a subject company.
    The Exchange believes that under no circumstances is retaliation 
appropriate against a research analyst who expresses his or her genuine 
beliefs about a subject company. As such, the proposed rule changes 
extend the retaliation prohibition to all employees, not just those 
involved in investment banking activities.

Other Changes

    The proposed rule amendments would also make certain other changes. 
First, the proposal would amend NYSE Rule 472.40 to clarify that the 
trading restrictions applicable to research analysts and household 
members excludes an investment company registered under the Investment 
Company Act of 1940 over which the research analyst or household member 
has discretion or control, provided that the research analyst or 
household member has no financial interest in such investment company, 
other than a performance or management fee.
    Second, the proposed rule changes would amend NYSE Rule 472(b) to 
extend the prohibition on research analysts from engaging in 
communications about an investment banking services transaction with a 
current or prospective customer in the presence of investment banking 
department personnel or company management to communications with 
internal sales personnel. This amendment is intended to further 
mitigate potential conflicts of interest in intra-office 
communications.
    In addition, changes are proposed to delete the term ``member'' as 
used in NYSE Rule 344 to reflect the recent reorganization of the 
Exchange.\24\
---------------------------------------------------------------------------

    \24\ See Securities Exchange Act Release No. 53382 (February 27, 
2006), 71 FR 11251 (March 6, 2006) (order approving SR-NYSE-2005-
77).
---------------------------------------------------------------------------

    The Exchange will announce the effective date of the proposed rule 
change in an Information Memo to be published no later than 60 days 
following Commission approval.
2. NYSE's Statutory Basis
    The statutory basis for the proposed rule changes is Section 
6(b)(5) of the Act \25\ which requires, among other things, that the 
rules of the Exchange are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to perfect the mechanism of a free 
and open market and national market system, and in general to protect 
investors and the public interest. The Exchange believes that the 
proposed rule changes will enhance the clarity and consistency of the 
research analyst rules, thereby facilitating the goals of reducing 
conflicts of interest and fraudulent and manipulative practices, and 
providing investors with more objective, reliable information upon 
which to base investment decisions.
---------------------------------------------------------------------------

    \25\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

3. NASD's Purpose

Background

    Beginning in 2002, NASD and the New York Stock Exchange implemented 
a series of rule changes to improve objectivity and transparency in 
equity research and provide investors with more reliable and useful 
information to make investment decisions. The rules were intended to 
restore public confidence in the validity of research and the veracity 
of research analysts, who are expected to function as unbiased 
intermediaries between issuers and the investors who buy and sell their 
securities. The trustworthiness of research had eroded due to the 
pervasive influences of investment banking and other conflicts that had 
manifest themselves during the market boom of the late 1990s.
    Generally, the SRO Rules require clear, comprehensive and prominent 
disclosure of conflicts of interest in research reports and public 
appearances by research analysts. The rules further prohibit certain 
conduct--investment banking personnel involvement in the content of 
research and determination of analyst compensation, for example--when 
the conflicts are considered too pronounced to be cured by disclosure.
    The SROs enacted the research analyst conflict rules in two primary 
tranches and, more recently, adopted additional amendments prohibiting 
analysts from participating in road shows. In addition, the SROs 
supplemented their rulemaking with two joint memoranda that provided 
interpretive guidance to their members on a number of issues.\26\ The 
NASD and NYSE rules and interpretations are virtually identical and are 
intended to operate uniformly.
---------------------------------------------------------------------------

    \26\ See NASD Notices to Members 02-39 (July 2002) and 04-18 
(March 2004).
---------------------------------------------------------------------------

    On May 10, 2002, the SEC approved the first round of SRO Rules 
(``Round 1 Amendments'')--new NASD Rule 2711(''Research Analysts and 
Research Reports'') and amendments to NYSE Rules 351 (``Reporting 
Requirements'') and 472 (``Communications with the Public'')--which 
implemented basic reforms to separate research from investment banking 
and to provide more extensive disclosure of conflicts of interest in 
research reports and public appearances.\27\ On July 29, 2003, the SEC 
approved a second set of amendments to the SRO Rules (``Round

[[Page 2073]]

2 Amendments'') \28\ that achieved two purposes. First, the Round 2 
Amendments implemented SRO initiatives to further promote analyst 
objectivity and transparency of conflicts in research reports. Second, 
the Round 2 Amendments implemented changes mandated by the Sarbanes-
Oxley.\29\ Sarbanes-Oxley required adoption by July 30, 2003 of rules 
``reasonably designed to address conflicts of interest that can arise 
when securities analysts recommend equity securities in research 
reports and public appearances,'' and set forth certain specific rules 
to be promulgated. Many of those rules had already been adopted in the 
first round of SRO rulemaking. The Round 2 Amendments therefore 
implemented those specific Sarbanes-Oxley rules that did not already 
exist and conformed the language of the SRO Rules as necessary.
---------------------------------------------------------------------------

    \27\ See Securities Exchange Act Release No. 45908 (May 10, 
2002), 67 FR 34968 (May 16, 2002) (order approving SR-NASD-2002-021 
and SR-NYSE-2002-09).
    \28\ See Securities Exchange Act Release No. 48252 (July 29, 
2003), 68 FR 45875 (August 4, 2003) (order approving SR-NASD-2002-
154 and SR-NYSE-2002-49).
    \29\ See Section 15D of the Act, 15 U.S.C. 78o-6.
---------------------------------------------------------------------------

    As part of the Round 2 Amendments, the SEC approved rules requiring 
registration and qualification of research analysts. NASD Rule 1050 
requires an associated person who functions as a research analyst on 
behalf of a member to register as such and pass a qualification 
examination. For the purposes of this requirement, a ``research 
analyst'' is defined as ``an associated person who is primarily 
responsible for the preparation of the substance of a research report 
or whose name appears on a `research report,' '' as that term is 
defined in NASD Rule 2711.
    The SROs jointly developed and implemented the Research Analyst 
Qualification Examination (Series 86/87). The examination consists of 
an analysis part (Series 86) and a regulatory part (Series 87). Prior 
to taking either the Series 86 or 87, a candidate also must have passed 
the General Securities Registered Representative Examination (Series 
7), the Limited Registered Representative Examination (Series 17), or 
the Canada Module of Series 7 (Series 37 or 38).
    The SRO Rules provide three exemptions from the Series 86 
examination. First, there is an exemption for research analysts who 
have passed Levels I and II of the Chartered Financial Analyst 
(``CFA'') examination and have either (1) completed the CFA Level II 
within 2 years of application or registration, or (2) functioned as a 
research analyst continuously since having passed the CFA Level II.\30\ 
A second exemption is available to research analysts who have passed 
Levels I and II of the Chartered Market Technician Examination and 
produce only ``technical research reports'' as that term is defined 
under the SRO Rules.\31\ A third exemption--from both the Series 86 and 
Series 87--is available to persons who may be ``associated persons'' of 
a member who are employed by that member's foreign affiliate but who 
produce research on behalf of the U.S. member. To be eligible for the 
exemption, three primary conditions must be met: (1) A foreign analyst 
must comply with the registration and qualification requirements or 
other standards in an SRO-approved foreign jurisdiction whose 
regulatory scheme reflects a recognition of principles that are 
consonant with the SRO Rules and qualification standards; (2) the U.S. 
member must apply all of the other SROs rules and other member firm 
standards to the research produced by the foreign affiliate and foreign 
research analysts that qualify for, and rely upon, the exemption; and 
(3) the U.S. member must include a specific disclosure that the 
research report has been prepared in whole or part by foreign research 
analysts who may be associated persons of the member who are not 
registered/qualified as a research analyst with the NYSE or NASD, but 
instead have satisfied the registration/qualification requirements or 
other research-related standards of a foreign jurisdiction that have 
been recognized for these purposes by the NYSE and NASD. Currently, the 
following jurisdictions satisfy the applicable SRO standards noted 
above: China, Hong Kong, Japan, Malaysia, Singapore, Thailand and the 
United Kingdom.
---------------------------------------------------------------------------

    \30\ See Securities Exchange Act Release No. 49464 (March 24, 
2004), 69 FR 16628 (March 30, 2004) (order approving SR-NASD-2004-
020 and SR-NYSE-2004-03).
    \31\ See Securities Exchange Act Release No. 51240 (February 23, 
2005), 70 FR 10451 (March 3, 2005) (notice of immediate 
effectiveness of SR-NASD-2005-022 and SR-NYSE-2005-12).
---------------------------------------------------------------------------

    On April 21, 2005, the Commission approved an amendment to the SRO 
Rules that prohibits research analysts from participating in a road 
show related to an investment banking services transaction and from 
communicating with current or prospective customers in the presence of 
investment banking department personnel or company management about 
such an investment banking services transaction.\32\ Additionally, the 
amendment prohibits investment banking personnel from directing a 
research analyst to engage in sales and marketing efforts and other 
communications with a current or prospective customer about an 
investment banking services transaction.
---------------------------------------------------------------------------

    \32\ See Securities Exchange Act Release No. 51593 (April 21, 
2005), 70 FR 22168 (April 28, 2005) (order approving SR-NASD-2004-
141 and SR-NYSE-2005-24). As defined under NASD Rule 2711(a)(3) and 
NYSE Rule 472.20, ``investment banking services'' includes, without 
limitation, acting as an underwriter or participating in a selling 
group in an offering for the issuer; acting as a financial adviser 
in a merger or acquisition; providing venture capital, equity lines 
of credit, private investment, public equity transactions (PIPEs), 
or similar investments; or serving as placement agent for the 
issuer.
---------------------------------------------------------------------------

Joint SRO Report

    As part of its May 2002 order approving new NASD Rule 2711, the SEC 
noted that it would require NASD and the NYSE to assess the success of 
the rules after they have been in place for a suitable amount of time. 
In April 2005, the SEC staff requested a joint comprehensive report on 
the operation and effectiveness of the rules, together with any 
recommendations for changes or additions to the rules. The SRO staffs 
submitted that report to the SEC on December 22, 2005.
    The SRO staffs concluded in the report that the SRO Rules have been 
effective in helping to restore integrity to research by minimizing the 
influences of investment banking and promoting transparency of other 
potential conflicts of interest. However, the SRO staffs further 
expressed their belief that certain changes to the SRO Rules would 
further improve their effectiveness by striking an even better balance 
between ensuring objective and reliable research on the one hand and 
permitting the flow of information to investors and minimizing costs 
and burdens to members on the other.
    In formulating the recommendations for rule changes in the report, 
the SROs considered extensive data and qualitative feedback regarding 
the range of activities under the rule, including examinations, sweeps, 
enforcement activities, interpretive issues and registration and 
qualification of research analysts. The SROs also surveyed academic 
studies and media reports about the impact of the rules; compared the 
SRO Rules to the provisions of the ``Global Settlement'' among the 
SROs, the Commission, the North American Securities Administrators 
Association and ten \33\ of the largest investment banks; reviewed 
industry comment letters; and consulted with various industry 
representatives. If approved, the proposed rule changes would implement 
NASD staff's

[[Page 2074]]

recommendations in the SRO report. A discussion of the proposed rule 
changes is set out below.
---------------------------------------------------------------------------

    \33\ See SEC Litigation Release No. 18438, 2003 SEC LEXIS 2601 
(October 31, 2003). In August 2004, two additional firms settled 
with regulators under the same terms as the April 2003 Global 
Settlement.
---------------------------------------------------------------------------

Exception to Definition of ``Research Report''

    The proposed rule changes would expressly exclude from the 
definition of ``research report'' sales material regarding open-end 
registered investment companies that are not listed or traded on an 
exchange and public direct participation programs (``DPPs''). 
``Research report'' is defined in Rule 2711(a)(9) as a ``written 
(including electronic) communication that includes an analysis of 
equity securities of individual companies or industries, and that 
provides information reasonably sufficient upon which to base an 
investment decision.'' Since these investment companies and DPPs are 
``equity securities'' as defined in Section 3(a)(11) of the Securities 
Exchange Act of 1934, related sales material that contains an analysis 
of those securities and information sufficient upon which to base an 
investment decision technically is covered by the definition. For the 
following reasons, NASD believes sales material for both types of 
products should be excluded from the definition of ``research report.''
    According to NASD, sales material regarding investment companies is 
already subject to a separate regulatory regime, including NASD Rule 
2210 and SEC Rule 482, and all advertisements and sales literature 
regarding registered investment companies must be filed with the NASD 
Advertising Regulation Department within ten business days of first 
use.\34\ Moreover, the NASD staff does not believe that the conflicts 
underpinning the SRO Rules are manifest to the same extent with respect 
to research on open-end investment companies that are not listed or 
traded on an exchange.
---------------------------------------------------------------------------

    \34\ An advertisement or sales literature concerning a 
registered investment company that includes a performance ranking or 
performance comparison of the investment company with other 
investment companies that is not generally published or is created 
by the fund or its affiliates must be filed with the NASD 
Advertising Regulation Department at least ten business days prior 
to first use or publication. NASD Rule 2210(c)(4)(A).
---------------------------------------------------------------------------

    Similarly, NASD believes that sales material for public DPPs also 
do not present the same conflicts of interest or other regulatory 
concerns as research on exchange-traded securities. Publicly offered 
DPPs typically are limited partnerships or limited liability companies 
whose equity interests do not trade on an exchange and do not have an 
active secondary market. The DPP sponsor generally produces its sales 
material and sells interests in the DPP during an initial public 
offering on a best efforts basis. This sales material typically 
consists of ``tombstone'' advertisements whose content is strictly 
limited under SEC Rule 134, or supplemental sales literature that must 
be accompanied or preceded by a prospectus for the DPP. Additionally, 
unlike equity research, NASD Rule 2210(c)(2)(B) requires members to 
file advertisements and sales literature concerning public DPPs with 
the Department within ten business days of first use. Thus, NASD staff 
reviews such sales material before or shortly after it is distributed 
to the public.
    Although ETFs are open-end investment companies, they trade on an 
exchange and therefore those funds would not be excepted from the 
definition of ``research report.'' NASD requests comment on whether 
ETFs should also be excluded from the definition. In addition, NASD 
believes that NASD Advertising Regulation Department review of 
registered investment company and public DPP sales material reduces the 
likelihood that it will contain content that is not fair and balanced.

Exception to Registration and Qualification Requirements for Non-
Research Personnel that Produce ``Research Reports''

    The SRO Rules, in accordance with the mandates of Sarbanes-Oxley, 
are constructed such that the author of a communication that meets the 
definition of a ``research report'' is a ``research analyst,'' 
irrespective of his or her title or primary job. NASD believes that 
this prevents firms from circumventing the rules by redirecting through 
other channels, such as registered representatives or traders, 
potentially biased research that is not subject to the SRO objectivity 
safeguards.
    NASD believes it is important to maintain such communications as 
``research reports'' subject to the rules and those principally 
responsible for their preparation as ``research analysts.'' However, 
the proposed rule changes would create a limited exemption from the 
NASD Rule 1050 registration requirements for non-research personnel 
that produce research reports. Thus, for example, the registration 
requirements would not apply to a registered representative who 
occasionally produces communications that technically meet the 
definition of a research report and are distributed to 15 or more 
clients, or a trader who similarly produced market commentary that 
included an analysis of an individual security--also considered a 
research report under NASD rules. NASD believes that the registration 
and qualification requirements were intended for those individuals 
whose principal job function is to produce research, while the balance 
of the SRO Rules are intended to foster objective analysis of equity 
securities and transparency of certain conflicts and to provide 
beneficial information to investors.

Restrictions on Investment Banking Department Relationship With 
Research Department

    Currently, NASD Rule 2711(b) permits investment banking and other 
non-research employees, other than legal and compliance personnel, to 
review a research report before publication only to verify the factual 
accuracy of information in the report or identify a potential conflict 
of interest. The rule further requires that an authorized legal or 
compliance official act as intermediary for all such permissible 
communications.
    The proposed rule change would eliminate paragraph (b)(3) of NASD 
Rule 2711 that permits pre-publication review of research by investment 
banking and other non-research personnel, other than by legal and 
compliance. NASD believes that review of facts in a report by 
investment banking and other non-research personnel is unnecessary in 
light of the numerous other sources available to verify factual 
information, including the subject company, and only raises concerns 
about the objectivity of the report. According to NASD, such review may 
invite pressure on a research analyst from such personnel that could be 
difficult to monitor. Such factual review is not permitted under the 
terms of the Global Settlement, and NASD staff is not aware of any 
evidence that the factual accuracy of research produced by Global 
Settlement firms has suffered. Moreover, NASD believes that legal and 
compliance can adequately perform a conflict review without sharing 
draft research reports with investment banking or other non-research 
personnel.

Restrictions on Publishing Research Reports and Public Appearances

    NASD Rule 2711(f) sets forth ``quiet periods'' during which a 
member is prohibited from publishing or otherwise distributing a 
research report and a research analyst is prohibited from making a 
public appearance. These quiet periods apply in two circumstances: (1) 
After a public offering of securities and (2) before and

[[Page 2075]]

after the expiration, waiver or termination of a lock-up agreement 
entered into by a member with a subject company that restricts the sale 
of securities by that company or its shareholders.
    With respect to the former, NASD Rule 2711(f) establishes different 
quiet periods depending on whether the offering is an IPO or secondary 
offering and whether the member acted as manager or co-manager. A 
member that acted as a manager or co-manager of an IPO may not publish 
or otherwise distribute research for 40 calendar days following the 
date of the offering; all other members that participated as an 
underwriter or dealer in the offering are subject to a 25-day quiet 
period. A ten-day quiet period applies only to the manager and co-
manager of a secondary offering.
    NASD Rule 2711(f) contains an exception that permits publication 
and distribution of research or a public appearance concerning the 
effects of ``significant news or a significant event on the subject 
company'' during the quiet period. The SRO staffs have interpreted this 
exception to apply only to news or events that have a material impact 
on, or cause a material change to, a company's operation, earnings or 
financial condition. Another exception to the secondary offering quiet 
period permits publication or distribution of research pursuant to SEC 
Rule 139 regarding a subject company with ``actively-traded 
securities'' as defined in SEC Regulation M.
    The proposed rule changes would make several changes to the quiet 
period requirements surrounding public offerings and lock-up 
expirations. First, the proposed rule changes would unify the IPO quiet 
periods for all underwriters and dealers participating in the offering. 
As such, the proposed rule change would amend the rules to apply a 25-
day quiet period to managers, co-managers, underwriters and dealers 
that participate in an IPO. NASD believes that the lengthier quiet 
period for managers and co-managers was intended to allow other voices 
to publicly analyze and value a subject company before managers and co-
managers--those members vested with the greatest interest in seeing the 
stock price of the subject company go up--weighed in with their reports 
and public appearances. According to NASD, at the time this provision 
was enacted, it had been commonplace for managers and co-managers to 
initiate coverage with a positive rating on a company they just brought 
public, irrespective of whether the stock price had already risen well 
beyond the public offering price.
    However, NASD recently has observed more circumstances in which 
managers and co-managers have been neutral or even negative with their 
initial post-quiet period report based on price appreciation or other 
factors. Accordingly, NASD believes that the objectivity safeguards of 
the SRO Rules and the certification requirement of SEC Regulation AC 
have obviated the need for a longer quiet period for managers and co-
managers than other underwriters and dealers participating in an IPO. 
NASD also believes the change would promote more information flow to 
investors and consistency in rule application.
    For some of the same reasons, the proposed rule changes would 
eliminate the quiet periods following a secondary offering. Coupled 
with the protections of SEC Regulation AC and other SRO Rule 
provisions, NASD believes that repeal of this provision would advance 
the SEC's purpose in its Securities Offering Reform rules \35\ to 
increase the flow of information to investors about issuers, without 
sacrificing the reliability of the research. Along those lines, the 
existing SRO Rules already provide exceptions for research reports on 
issuers with ``actively-traded securities'' as defined in SEC 
Regulation M.
---------------------------------------------------------------------------

    \35\ See Securities Act Release No. 8591 (July 19, 2005), 70 FR 
44722 (August 3, 2005).
---------------------------------------------------------------------------

    Second, the proposed rule changes would eliminate the quiet periods 
around the expiration, waiver or termination of a lock-up agreement 
provided, as discussed below, that members provide an additional 
certification, similar to Regulation AC, to having a bona fide reason 
for issuing research during such periods. According to NASD, the quiet 
periods surrounding lock-up releases are intended to prevent abusive 
``booster shot'' reports by members to raise the stock price of a 
company just before previously locked-up shares become freely saleable 
into the market by a company or its major shareholders.
    While NASD remains concerned that these periods pose heightened 
concerns about biased research, the changes to internal structure of 
investment banks and the other safeguards imposed by the current rules 
appear to have addressed these concerns and obviate the need for a 
quiet period that inhibits the flow of information to the marketplace. 
NASD has observed, for example, that negative information about a 
subject company is sometimes released by that company during the quiet 
periods, but the quiet periods prevent some members from providing 
analysis of this negative information to investors in a timely fashion. 
NASD believes that elimination of the quiet periods around lock-ups 
will permit such information to flow to investors without sacrificing 
the overall objectivity of the research.\36\
---------------------------------------------------------------------------

    \36\ NASD believes that practical limitations inhibit effective 
administration of the provision. Most notably, NASD rules do not 
require lock-up agreements, and NASD often has no jurisdiction over 
parties to them, including the subject company and its non-member 
shareholders. NASD therefore cannot always be the arbiter of whether 
certain facts constitute, for example, a waiver or termination of a 
lock-up--a significant impediment to our ability to enforce this 
provision.
---------------------------------------------------------------------------

    NASD Rule 2711(f) would continue to require a reasonable basis for 
any recommendation or price target and the valuation method used to 
determine a price target, while SEC Regulation AC requires 
certification that any such recommendation or price target is genuinely 
held. Accordingly, NASD believes that an effective alternative to the 
quiet periods would be to require that members provide an additional 
certification, similar to Regulation AC, to having a bona fide reason 
for issuing research within 15 days before and after a lock-up 
expiration and was not otherwise issued for any reason pertaining to 
conditioning the market price of the security that was the subject of 
the research report. NASD would set forth the language of the 
certification in a Notice to Members upon approval of the proposed rule 
change.
    In the Joint Report, NYSE recommends an alternative proposal to 
reduce the duration of the quiet periods and expand the exception for 
research concerning the effects of significant news or a significant 
event on the subject company to include earnings related announcements. 
NASD believes its proposal is a more viable means to ensure timely 
information flow to investors than such an alternative approach. As the 
SROs have previously noted in their March 2004 joint interpretive 
memorandum, earnings announcements do not generally fall within the 
exception because ``an earnings announcement itself generally is not a 
causal event or news item that materially affects a company's 
operations, earnings or financial condition.'' NASD believes that a 
carve-out for earnings related announcements could lead to lock-up 
expirations timed to coincide with such announcements--many of which 
are scheduled regularly--thereby essentially negating the quiet period 
altogether. NASD believes that this is problematic because the 
significant news exception applies not only to quiet periods around 
lock-up expirations, but also to the quiet periods after an IPO and the 
blackout

[[Page 2076]]

periods during which analysts are prohibited from trading in securities 
they cover.

Restrictions on Personal Trading by Research Analysts

    NASD Rule 2711(g) generally restricts the trading of securities by 
``research analyst accounts.'' \37\ Specifically, the rule prohibits 
any research analyst account from:
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    \37\ NASD Rule 2711(a)(7) defines the term ``research analyst 
account'' to include any account in which a research analyst or 
member of the analyst's household has a financial interest, or over 
which the analyst has discretion or control, other than an 
investment company registered under the Investment Company Act of 
1940. The proposed rule change would clarify that this definition is 
intended to except from the definition those registered investment 
companies that are managed by a research analyst or member of the 
research analyst's household, provided that the research analyst or 
household member has no financial interest in such investment other 
than a performance or management fee. See infra page 46. The term 
does not include a ``blind trust'' account that is controlled by a 
person other than the research analyst or household member and 
neither the analyst nor any household member knows of the account's 
investments or investment transactions.
---------------------------------------------------------------------------

     Purchasing or receiving any securities before the issuer's 
initial public offering if the issuer is principally engaged in the 
same types of business as companies that the research analyst follows;
     Purchasing or selling any security issued by a company 
that the research analyst follows, or any option or derivative of such 
a security, for a period beginning 30 days before and ending five days 
after the publication of a research report concerning the company or a 
change in a rating or price target of the company's securities; and
     Purchasing or selling any security or option or derivative 
of such a security in a manner inconsistent with the analyst's most 
recent recommendation.
    NASD Rule 2711(g) includes certain limited exceptions to these 
trading restrictions.
    The proposal would make two principal changes to the personal 
trading restrictions. First, the proposed rule changes would revise the 
exceptions to the personal trading restrictions for investment funds in 
paragraph (g)(5). Under the proposed rule changes, the personal trading 
restrictions would not apply to investments in any fund (including a 
registered diversified investment company), so long as neither the 
analyst nor a member of his or her household is aware of the fund's 
holdings or transactions other than through periodic shareholder 
reports and sales material based on such reports, and provided that the 
research analyst account owns no more than 1% of the assets of the 
fund.
    NASD believes that this change would simplify the ability of 
analysts to invest in, for example, mutual funds and hedge funds that 
do not disclose their holdings other than through periodic reports or 
sales material based on such reports. According to NASD, absent 
discretion or control of an account or the contemporaneous knowledge of 
the account's transactions, a minimal investment by a research analyst 
will not influence the analyst to compromise research objectivity to 
benefit the account. NASD understands that NYSE is proposing to retain 
the 20% asset diversification threshold to be eligible for the 
exception. NASD seeks comment on whether to maintain that separate 
requirement.
    Second, the proposed rule changes would create an exemption for 
firms that voluntarily choose to prohibit their analysts from owning 
shares of the companies they cover. The exemption would provide a means 
for analysts at such firms to divest their holdings without violating 
the blackout period and trading against recommendation prohibitions.
    The exemption would allow such a firm to adopt policies that permit 
research analysts to divest their holdings in an orderly and controlled 
way with the oversight of the firm's legal and compliance personnel. 
The SROs permitted firms to allow their analysts to divest their 
holdings in the same manner when the rule first became effective by 
delaying for a certain time period implementation of the personal 
trading restrictions for firms that wished to ban ownership. With the 
recommended change, NASD Rule 2711(g) would allow firms that adopt 
ownership bans to implement the same divestiture procedures regardless 
of when they adopted such a policy.

Disclosure Requirements

    NASD Rule 2711(h) imposes a number of disclosure requirements on 
member research reports and research analyst public appearances in 
which the analyst makes a recommendation or offers an opinion 
concerning an equity security. NASD Rule 2711(h) requires specific 
disclosures of conflicts of interest, including where the member firm, 
the research analyst or a member of the analyst's household has a 
financial interest in the subject company's securities or the member or 
its affiliates have received compensation from the subject company. 
NASD Rule 2711(h) also requires a number of other disclosures in 
research reports that are not directly related to conflicts of interest 
with the subject company, including the meanings of ratings used in the 
member's rating system, the distribution of buy, hold, and sell ratings 
assigned by the member, and a price chart that plots the assignment or 
changes of the analyst's ratings and price targets for the subject 
company against the movement of the subject company's stock price over 
time. The required disclosures must be presented on the front page of 
research reports or the front page must refer to the page on which the 
disclosures are found. Electronic research reports may utilize 
hyperlinks to the disclosures. Disclosures and references to 
disclosures must be clear, comprehensive and prominent.
    According to NASD, these required disclosures promote transparency 
and provide important information to enable investors to assess the 
value of the research in making their investment decision. However, 
NASD believes that it would be equally effective and useful for 
investors to know immediately whether the member firm or research 
analyst producing the research report is conflicted, while providing 
the reader the means to learn more about these conflicts if he or she 
chooses to do so.
    To that end, the proposed rule changes would amend the rules to 
permit members, in lieu of publication in the research report itself, 
to disclose their conflicts of interest by including a prominent 
warning on the cover of a research report that such conflicts of 
interest exist, together with information on how the reader may obtain 
more detail about these conflicts on the member's Web site. This 
alternative method of disclosure would then require a member to include 
detailed conflicts information on its Web site. Members could still opt 
to make all of the disclosures in the report itself; however, NASD 
believes that a Web-based disclosure system would be at least as 
effective and would minimize costs for many firms.
    Specifically, the proposed rule changes would require any member 
that has a conflict of interest or whose research analyst has a 
conflict of interest to state prominently on the front page of the 
research report the following:

    [Name of firm and/or the research analyst preparing this report] 
has a conflict of interest that may affect the ability of the firm 
or the analyst to provide objective analysis about the company. For 
more information about this conflict of interest, please see 
[Reference to the firm's Web site].

    The proposed rule changes would define ``conflict of interest'' to 
include any of the circumstances that currently require disclosure 
under NASD Rule

[[Page 2077]]

2711(h), including if the research analyst or member of the research 
analyst's household has a financial interest in the subject company; if 
the member owns 1% or more of any class of common equity securities of 
the subject company; receipt by the member of investment banking and 
other compensation from the subject company or the intention to seek 
investment banking compensation; if the member makes a market in the 
subject company's securities; if the research analyst or a member of 
the research analyst's household serves as an officer, director or 
advisory board member of the subject company; and any other actual, 
material conflict of interest of the research analyst or member of 
which the research analyst knows or has reason to know at the time of 
publication of the research report.
    The proposed amendment would still require that Web-based 
disclosure concern actual conflicts of interest, rather than the 
possibility of such conflicts. A general ``health warning'' that 
conflicts of interest ``may or may not'' exist are neither useful nor 
effective.
    NASD specifically seeks comment on whether a similar approach could 
be used for disclosure of conflicts in public appearances.
    The proposed rule changes would not permit Web site disclosure for 
certain other disclosures, such as the meanings of the member's ratings 
and the price chart showing the subject company's price movements 
against the analyst's assignments of ratings and price targets. NASD 
believes that those disclosures do not lend themselves easily to the 
terse material conflict warning that would appear on the cover of the 
report. Accordingly, NASD believes that they should be readily 
available to investors in the report itself.

Prohibition on Retaliation Against Research Analysts

    NASD Rule 2711(j) currently prohibits any member and any employee 
of a member who is involved with the member's investment banking 
activities from directly or indirectly retaliating against a research 
analyst as a result of an unfavorable research report or public 
appearance that may adversely affect the member's current or 
prospective investment banking relationship with a subject company.
    Under no circumstances is retaliation appropriate against a 
research analyst who expresses his or her truly held beliefs about a 
subject company. As such, the proposed rule changes would amend this 
provision to extend the retaliation prohibition to all employees, not 
just those involved in investment banking activities.

Other Changes

    The proposed rule changes also would make certain other changes. 
First, the proposed rule change would amend the definition of 
``research analyst account'' in NASD Rule 2711(a)(7) to clarify that it 
excludes an investment company registered under the Investment Company 
Act of 1940 over which the research analyst or household member has 
discretion or control, provided that the research analyst or household 
member has no financial interest in such investment company, other than 
a performance or management fee.
    Second, the proposed rule changes would amend NASD Rule 
2711(c)(5)(B) to extend the prohibition on research analysts from 
engaging in communications about an investment banking services 
transaction with a current or prospective customer in the presence of 
investment banking department personnel or company management to also 
apply to communications with internal sales personnel. NASD believes 
such change would make the provision consistent with respect to a 
research analyst's ability to educate investors and sales personnel 
about an investment banking services transaction.
    Finally, the proposed rule changes would clarify that the annual 
attestation required by NASD Rule 2711(i) must be filed with NASD's 
Member Regulation Department. NASD notes that the Member Regulation 
Department has developed a form, available on the NASD Web site, that 
may be used to make the attestation electronically.
    NASD will announce the effective date of the proposed rule changes 
in a Notice to Members to be published no later than 60 days following 
Commission approval.
4. NASD's Statutory Basis
    NASD believes that the proposed rule changes are consistent with 
the provisions of Section 15A(b)(6) of the Act,\38\ which requires, 
among other things, that NASD rules be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. NASD believes that the proposed rule changes are 
consistent with the provisions of the Act because it promotes both 
objective research and increased information flow to investors and does 
so in an efficient and effective manner.
---------------------------------------------------------------------------

    \38\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organizations' Statements on Burden on Competition

    The NYSE and NASD do not believe that the proposed rule changes 
will result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.

C. Self-Regulatory Organizations' Statements on Comments on the 
Proposed Rule Changes Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Changes and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule changes, or
    (B) Institute proceedings to determine whether the proposed rule 
changes should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
changes are consistent with the Act and whether there are any 
differences between the NYSE and NASD proposals that present compliance 
or interpretive issues.
    We solicit comment as to how the proposals to relocate disclosures 
to a member firm's Web site would affect the utility of this 
information to investors. Please also provide comment on whether 
relocating disclosures to a member firm's Web site would provide a 
substantial cost benefit to firms.
    Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Numbers SR-NYSE-2006-78 and/or SR-NASD-2006-113 on the subject 
line.

[[Page 2078]]

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Numbers SR-NYSE-2006-78 and/or SR-
NASD-2006-113. The file numbers should be included on the subject line 
if e-mail is used. To help the Commission process and review your 
comments more efficiently, please use only one method. The Commission 
will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent 

amendments, all written statements with respect to the proposed rule 
changes that are filed with the Commission, and all written 
communications relating to the proposed rule changes between the 
Commission and any person, other than those that may be withheld from 
the public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Room. Copies of such filings also will be available for 
inspection and copying at the principal office of the NYSE and NASD. 
All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Numbers SR-NYSE-2006-78 
and/or SR-NASD-2006-113 and should be submitted on or before March 5, 
2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\39\
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    \39\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-548 Filed 1-16-07; 8:45 am]

BILLING CODE 8011-01-P
