
[Federal Register Volume 79, Number 226 (Monday, November 24, 2014)]
[Notices]
[Pages 69939-69957]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-27700]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73622; File No. SR-FINRA-2014-047]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt 
FINRA Rule 2241 (Research Analysts and Research Reports) in the 
Consolidated FINRA Rulebook

November 18, 2014.
    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 November 14, 2014, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by FINRA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to adopt NASD Rule 2711 (Research Analysts and 
Research Reports) as a FINRA rule, with several modifications. The 
proposed rule change also would amend NASD Rule 1050 (Registration of 
Research Analysts) and Incorporated NYSE Rule 344 to create an 
exception from the research analyst qualification requirement. The 
proposed rule change would renumber NASD Rule 2711 as FINRA Rule 2241 
in the consolidated FINRA rulebook.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

[[Page 69940]]

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

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

1. Purpose
    As part of the process of developing a new consolidated rulebook 
(``Consolidated FINRA Rulebook''),\3\ FINRA is proposing to adopt in 
the Consolidated FINRA Rulebook NASD Rule 2711 (Research Analysts and 
Research Reports) with several modifications as FINRA Rule 2241. The 
proposed rule change also would amend NASD Rule 1050 (Registration of 
Research Analysts) and Incorporated NYSE Rule 344 (Research Analysts 
and Supervisory Analysts) to create an exception from the research 
analyst qualification requirements.
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    \3\ The current FINRA rulebook includes, in addition to FINRA 
Rules, (1) NASD Rules and (2) rules incorporated from NYSE 
(``Incorporated NYSE Rules'') (together, the NASD Rules and 
Incorporated NYSE Rules are referred to as the ``Transitional 
Rulebook''). While the NASD Rules generally apply to all FINRA 
members, the Incorporated NYSE Rules apply only to those members of 
FINRA that are also members of the NYSE (``Dual Members''). For more 
information about the rulebook consolidation process, see 
Information Notice, March 12, 2008 (Rulebook Consolidation Process).
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Background
    NASD Rule 2711 and Incorporated NYSE Rule 472 (Communications with 
the Public) (``the Rules'') set forth requirements to foster 
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 objectivity 
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 those issuers' securities. The integrity of research 
had eroded due to the pervasive influences of investment banking and 
other conflicts that became apparent during the market boom of the late 
1990s.
    The current NASD and Incorporated NYSE rules have no significant 
differences.\4\ In general, the Rules require disclosure of conflicts 
of interest in research reports and public appearances by research 
analysts. The Rules further prohibit conflicted conduct--investment 
banking personnel involvement in the content of research reports and 
determination of analyst compensation, for example--where the conflicts 
are too pronounced to be cured by disclosure. Several of the Rules' 
provisions implement provisions of the Sarbanes-Oxley Act of 2002 
(``Sarbanes-Oxley''), which mandates separation between research and 
investment banking, proscribes conduct that could compromise a research 
analyst's objectivity and requires specific disclosures in research 
reports and public appearances.\5\
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    \4\ The one substantive difference between the rules involves 
the recordkeeping obligations when a research analyst makes a public 
appearance. Incorporated NYSE Rule 472(k)(2) requires a record of 
the public appearance to be made within 48 hours and include 
specific information about the nature of the appearance and 
applicable disclosures. NASD Rule 2711(h)(12) provides that members 
must maintain records of public appearances sufficient to 
demonstrate compliance with the applicable disclosure requirements.
    \5\ 15 U.S.C. 78o-6.
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    NASD Rule 1050 (Registration of Research Analysts) and Incorporated 
NYSE Rule 344 (Research Analysts and Supervisory Analysts) require any 
person associated with a member and who functions as a research analyst 
to be registered as such and pass the Series 86 and 87 exams, unless an 
exemption applies. NASD Rule 1050 defines ``research analyst'' 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.'' Incorporated NYSE Rule 344 has a substantially similar 
definition.
    In December 2005, in response to a Commission Order, FINRA and the 
NYSE submitted to the Commission a joint report on the operation and 
effectiveness of the research analyst conflict of interest rules 
(``Joint Report'').\6\ Among other things, the Joint Report analyzed 
the impact of the Rules based on academic studies, media reports and 
commentary. The Joint Report concluded that the Rules have been 
effective in helping to restore integrity to research by minimizing the 
influence of investment banking and promoting transparency of other 
potential conflicts of interest. Evidence from academic studies, among 
other sources, further suggested that investors are benefiting from 
more balanced and accurate research to aid their investment decisions. 
A January 2012 GAO report on securities research (``GAO Report'') also 
concluded that empirical results suggest the Rules have resulted in 
increased analyst independence and weakened the influence of conflicts 
of interest on analyst recommendations.\7\
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    \6\ Joint Report by NASD and the NYSE on the Operation and 
Effectiveness of the Research Analyst Conflict of Interest Rules 
(December 2005), available at http://www.finra.org/web/groups/industry/@ip/@issues/@rar/documents/industry/p015803.pdf.
    \7\ United States Government Accountability Office, Securities 
Research, Additional Actions Could Improve Regulatory Oversight of 
Analyst Conflicts of Interest, January 2012.
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    The Joint Report also recommended changes to the Rules to strike 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.\8\ The 
recommendations resulted from a comprehensive review of the Rules. In 
evaluating the Rules, FINRA staff considered several analytical 
touchstones: whether a provision was accomplishing its intended 
purpose; findings from examinations, sweeps and enforcement actions; 
interpretive requests and member questions; a comparison of provisions 
of the ``Global Settlement''; \9\ potential gaps or overbreadth in the 
provisions; and input from members and industry groups. The proposed 
rule change maintains those aforementioned objectives and therefore 
incorporates many of the recommendations in the Joint Report not 
already incorporated into the current rules.\10\
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    \8\ FINRA previously filed two proposed rule changes to 
implement recommendations from the Joint Report. On October 17, 
2006, FINRA filed for immediate effectiveness a proposed rule change 
to codify previously issued interpretive guidance. See Securities 
Exchange Act Release No. 54616 (October 17, 2006), 71 FR 62331 
(October 24, 2006) (Notice of Filing File Nos. SR-NYSE-2006-77; SR-
NASD-2006-112). However, FINRA withdrew the second proposal in 
anticipation of filing this more comprehensive consolidated proposed 
rule change. See Securities Exchange Act Release No. 55072 (January 
9, 2007), 72 FR 2058 (January 17, 2007) (Notice of Filing File Nos. 
SR-NYSE-2006-78; SR-NASD-2006-113) (Withdrawn October 25, 2012).
    \9\ In 2003, federal and state authorities and self-regulatory 
organizations reached a settlement with 10 of the nation's largest 
broker-dealers to resolve allegations of misconduct involving 
conflicts of interest between their research analysts and investment 
bankers. In 2004, two additional firms settled substantively under 
the same terms, which included provisions to effectively separate 
research from investment banking.
    \10\ FINRA has not incorporated all of the Joint Report 
recommendations in the proposed rule change. As discussed infra at 
72, FINRA is not incorporating the recommendation to exclude direct 
participation programs from the definition of ``research report.'' 
FINRA previously addressed a recommendation to provide guidance with 
respect to the road show prohibition. FINRA set forth guidance in 
Regulatory Notice 07-04 that it is permissible for research analysts 
to listen to or view a live webcast of a road show or other widely 
attended presentation to investors or the sales force from a remote 
location. That guidance remains applicable to the proposed rule 
change. As discussed infra at 21, FINRA is not incorporating the 
recommendation to completely eliminate the quiet period after 
secondary offerings. FINRA also is not incorporating the 
recommendation to expand the exceptions to the personal trading 
restrictions because, as discussed infra at 27, FINRA is proposing 
to replace the prescriptive restrictions with a requirement to 
establish, maintain and enforce policies and procedures that obviate 
the need to set out specific exceptions to those provisions. In 
addition, as discussed infra at 34-35, FINRA is not proposing to 
replace the current disclosure requirements with a prominent warning 
on the cover of a research report that conflicts of interest exist, 
together with information on how the reader may obtain more detail 
about the conflicts on the member's Web site.

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[[Page 69941]]

    The proposed rule change would retain the core provisions of the 
current rules, broaden the obligations on members to identify and 
manage research-related conflicts of interest, restructure the rules to 
provide some flexibility in compliance without diminishing investor 
protection, extend protections where gaps have been identified, and 
provide clarity to the applicability of existing rules. Where 
consistent with protection of users of research, the proposed rule 
change reduces burdens: For example, it would modify or eliminate 
requirements (e.g., quiet periods and the annual attestation), expand 
the exemption for firms with limited investment banking activity, and 
create a new limited exemption from the registration requirements for 
``research reports'' produced by persons whose primary job function is 
something other than producing research. Taken together, FINRA believes 
the proposed amendments will result in rules that more effectively and 
efficiently achieve their intended goals of objective, transparent and 
useful research for investors. The proposed rule change reflects input 
from FINRA advisory committees and market participants and includes 
changes made in response to comments received to an earlier 
consolidated rule proposal set forth in Regulatory Notice 08-55. The 
substantive proposed changes to the existing research rules are 
described below.\11\
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    \11\ For economy, the discussion generally refers only to NASD 
Rules; however, those references apply equally to the corresponding 
Incorporated NYSE Rules.
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Definitions
    The proposed rule change mostly maintains the definitions in 
current NASD Rule 2711, with the following modifications:
     Minor changes to the definition of ``investment banking 
services'' to clarify that such services include all acts in 
furtherance of a public or private offering on behalf of an issuer.\12\
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    \12\ See proposed FINRA Rule 2241(a)(5). The current definition 
includes, without limitation, many common types of investment 
banking services. FINRA is proposing to add the language ``or 
otherwise acting in furtherance of'' either a public or private 
offering to further emphasize that the term ``investment banking 
services'' is meant to be construed broadly.
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     clarification in the definition of ``research analyst 
account'' that the definition does not apply to a registered investment 
company over which a research analyst has discretion or control, 
provided that the research analyst or a member of that research 
analyst's household has no financial interest in the investment 
company, other than a performance or management fee.\13\
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    \13\ See proposed FINRA Rule 2241(a)(9).
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     exclusion from the definition of ``research report'' of 
communications concerning open-end registered investment companies that 
are not listed or traded on an exchange (``mutual funds'').\14\
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    \14\ See proposed FINRA Rule 2241(a)(11).
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     move into the definitional section the definitions of 
``third-party research report'' and ``independent third-party research 
report'' that are now in a separate provision of the rules.\15\
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    \15\ See proposed FINRA Rules 2241(a)(3) and (13). FINRA 
believes it creates a more streamlined and user friendly rule to 
combine defined terms in a single definitional section.
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    The current rules define ``research analyst account'' to include 
any account over which a research analyst or member of the research 
analyst's household has a financial interest, or over which such person 
has discretion or control, other than an investment company registered 
under the Investment Company Act of 1940. The purpose of the exception 
is to accommodate circumstances where a research analyst also manages a 
registered investment company; otherwise, every transaction in the 
investment company's fund would be subject to personal trading 
restrictions, including any blackout periods a firm may establish, 
creating substantial logistical difficulties in operating the fund. The 
proposed change is intended to clarify that the exception does not 
apply where the research analyst account has a financial interest in 
the fund, other than a performance or management fee. In those 
circumstances, FINRA believes the conflict is too serious because the 
research analyst account could benefit more directly by taking 
positions in advance of publishing research or making a public 
appearance that could affect the price of the holdings.
    ``Research report'' currently 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 shares of mutual funds are ``equity 
securities'' as defined in Section 3(a)(11) of the Exchange Act, a 
written communication that contains an analysis of mutual fund 
securities and information sufficient upon which to base an investment 
decision technically is covered by the definition.
    However, FINRA believes that communications concerning mutual funds 
should be excluded from the definition of ``research report.'' Sales 
material regarding mutual funds is already subject to a separate 
regulatory regime, including FINRA Rule 2210 and Securities Act of 1933 
(``Securities Act'') Rule 482, and, subject to certain exceptions, 
retail communications regarding registered investment companies must be 
filed with FINRA within 10 business days of first use.\16\ The 
extensive content standards of these rules, combined with the filing 
and review of mutual fund sales material by FINRA staff, substantially 
reduce the likelihood that such material will include materially 
misleading information about the funds. Moreover, FINRA does not 
believe that the conflicts underpinning the research rules are manifest 
to the same extent with respect to reports on mutual funds. For 
example, a mutual fund's share price is determined by the fund's net 
asset value (``NAV''), which is based on the total value of the fund's 
portfolio. Because most mutual funds hold a large

[[Page 69942]]

number of individual securities, it is much less likely that a report 
on a mutual fund would affect the fund's NAV to the same extent that a 
research report on a single stock might impact its share price.
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    \16\ See FINRA Rule 2210(c)(3)(A). A retail communication 
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 FINRA at least 10 business days prior to first use or 
publication. FINRA Rule 2210(c)(7) lists categories of member 
communications that are excluded from the rule's filing 
requirements, including certain retail communications concerning 
investment companies. For example, FINRA Rule 2210(c)(7)(I) excludes 
from the rule's filing requirements certain independently prepared 
reprints or excerpts of articles or reports concerning investment 
companies. However, this filing exclusion only applies to articles 
or reports where the publisher is not an affiliate of the member 
using the reprint or any underwriter or issuer of a security 
mentioned in the reprint, and neither the member using the reprint 
nor any underwriter or issuer of a security mentioned in the reprint 
has commissioned the reprinted article or report.
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Identifying and Managing Conflicts of Interest
    The proposal creates a new section entitled ``Identifying and 
Managing Conflicts of Interest.'' This section contains an overarching 
provision that requires members to establish, maintain and enforce 
written policies and procedures reasonably designed to identify and 
effectively manage conflicts of interest related to the preparation, 
content and distribution of research reports and public appearances by 
research analysts and the interaction between research analysts and 
persons outside of the research department, including investment 
banking and sales and trading personnel, the subject companies and 
customers.\17\ A second provision sets forth more specifically what 
those written policies and procedures must address. They must promote 
objective and reliable research that reflects the truly held opinions 
of research analysts and prevent the use of research or research 
analysts to manipulate or condition the market or favor the interests 
of the member or a current or prospective customer or class of 
customers.\18\ These provisions, therefore, set out the fundamental 
obligation for a member to establish and maintain a system to identify 
and mitigate conflicts to foster integrity and fairness in its research 
products and services. The provisions are also intended to require 
firms to be more proactive in identifying and managing conflicts as new 
research products, affiliations and distribution methods emerge.
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    \17\ See proposed FINRA Rule 2241(b)(1).
    \18\ See proposed FINRA Rule 2241(b)(2).
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    The proposed rule change then sets forth minimum requirements for 
those written policies and procedures. This approach allows for some 
flexibility to manage identified conflicts, with some specified 
prohibitions and restrictions where disclosure does not adequately 
mitigate them. Most of the minimum requirements have been experience 
tested and found effective.
    Sarbanes-Oxley mandates specific rules to prohibit or restrict 
conduct related to the preparation, approval and distribution of 
research reports and the determination of research analyst 
compensation. Thus, the proposal requires members to establish, 
maintain and enforce written policies and procedures reasonably 
designed specifically to achieve compliance with those Sarbanes-Oxley 
requirements. This approach provides firms with more flexibility to 
adopt policies and procedures to effectuate those mandates in a manner 
consistent with the member's size and organizational structure. The 
proposed rule changes also goes beyond Sarbanes-Oxley to require 
additional written policies and procedures that further the separation 
between research and not only investment banking, but also other non-
research personnel, such as sales and trading, that may have interests 
that conflict with independent, unbiased research.
    Thus, the proposed rule change mostly retains or slightly modifies 
the current structural safeguards that the Joint Report found effective 
to promote analyst independence and objective research, but in the form 
of mandated written policies and procedures with some baseline 
proscriptions.\19\ FINRA believes this approach will provide the same 
investor protections as the current rules, but impose less cost than a 
pure prescriptive approach by requiring firms to adopt a compliance 
system that aligns with their particular structure, business model and 
philosophy. FINRA notes that the approach is consistent with FINRA's 
general supervision rule, which similarly provides firms flexibility to 
establish and maintain supervisory programs best suited to their 
business models, reasonably designed to achieve compliance with 
applicable federal securities law and regulations and FINRA rules.\20\
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    \19\ Among the structural safeguards, FINRA believes separation 
between investment banking and research is of particular importance. 
As such, while the proposed rule change does not mandate physical 
separation between the research and investment banking departments 
(or other person who might seek to influence research analysts), 
FINRA would expect such physical separation except in extraordinary 
circumstances where the costs are unreasonable due to a firm's size 
and resource limitations. In those instances, a firm must implement 
written policies and procedures, including information barriers, to 
effectively achieve and monitor separation between research and 
investment banking personnel.
    \20\ See NASD Rule 3010, recently adopted with changes as a 
consolidated FINRA rule by Securities Exchange Act Release No. 71179 
(December 23, 2013), 78 FR 79542 (December 30, 2013) (Order 
Approving File No. SR-FINRA-2013-025). The consolidated rule becomes 
effective December 1, 2014. FINRA further notes that the policies 
and procedures approach is consistent with the effective practices 
highlighted by FINRA in its Report on Conflicts of Interest, among 
them that firms should implement a robust conflicts management 
framework that includes structures, processes and policies to 
identify and manage conflicts of interest. See Report on Conflicts 
of Interest, FINRA (October 2013) at 5, available at http://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p359971.pdf. The proposed changes also help to harmonize 
with approaches in international jurisdictions, such as the rules of 
the Financial Conduct Authority in the United Kingdom. See COBS 
12.2.5 R, The Financial Conduct Authority Handbook, available at 
http://fshandbook.info/FS/html/handbook/COBS/12/2.
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Prepublication Review
    The required policies and procedures must, at a minimum, be 
reasonably designed to prohibit prepublication review, clearance or 
approval of research reports by persons engaged in investment banking 
services activities and restrict or prohibit such review, clearance or 
approval by other persons not directly responsible for the preparation, 
content and distribution of research reports, other than legal and 
compliance personnel.\21\ Thus, this provision maintains the current 
prohibition on prepublication review by investment banking personnel, 
but eliminates the exception in paragraph (b)(3) of Rule 2711 that 
permits pre-publication review of research by investment banking to 
verify the factual accuracy of information in a research report. FINRA 
believes that review of facts in a report by investment banking 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. Such review may invite 
pressure on a research analyst from such personnel that could be 
difficult to monitor. Factual review by investment banking personnel is 
not permitted under the terms of the Global Settlement, and FINRA staff 
is not aware of any evidence that the factual accuracy of research 
produced by Global Settlement firms has suffered. Moreover, legal and 
compliance can adequately perform a conflict review without sharing 
draft research reports with investment banking.
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    \21\ See proposed FINRA Rule 2241(b)(2)(A).
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    The proposal requires policies and procedures reasonably designed 
to at least restrict prepublication review by other non-research 
personnel, other than legal and compliance personnel. Thus, a firm must 
specify in its policies and procedures the circumstances, if any, where 
such review would be permitted as necessary and appropriate; for 
example, where non-research personnel are best situated to verify 
select facts or where administrative personnel review for formatting. 
FINRA notes that members still would be subject to the overarching 
requirement to have policies and procedures reasonably designed to 
effectively manage conflicts of interest between

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research analysts and those outside of the research department.
Coverage Decisions
    The required policies and procedures must be reasonably designed to 
restrict or limit input by investment banking department into research 
coverage decisions to ensure that research management independently 
makes all final decisions regarding the research coverage plan.\22\ 
This provision makes express FINRA's interpretation that the separation 
requirements in current Rule 2711(b)(1) prohibit investment banking 
personnel from making any final coverage decisions. The proposed 
provision does not preclude investment banking personnel from conveying 
customer interests or providing input into coverage considerations, so 
long as final decisions regarding the coverage plan are made by 
research management.
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    \22\ See proposed FINRA Rule 2241(b)(2)(B).
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Supervision and Control of Research Analysts
    The required policies and procedures must be reasonably designed to 
prohibit persons engaged in investment banking activities from 
supervision or control of research analysts, including influence or 
control over research analyst compensation evaluation and 
determination.\23\ The provision is substantively the same as current 
Rule 2711(b)(1), a core structural separation requirement that FINRA 
believes is essential to safeguarding analyst objectivity.
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    \23\ See proposed FINRA Rule 2241(b)(2)(C).
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Research Budget Determinations
    The required policies and procedures must be reasonably designed to 
limit determination of research department budget to senior management, 
excluding senior management engaged in investment banking services 
activities.\24\ This provision makes express FINRA's interpretation 
that the separation requirements of current Rule 2711(b)(1) prohibit 
investment banking personnel from making any determination of research 
budget decisions.
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    \24\ See proposed FINRA Rule 2241(b)(2)(D).
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Compensation
    The required policies and procedures must be reasonably designed to 
prohibit compensation based upon specific investment banking services 
transactions or contributions to a member's investment banking services 
activities.\25\ The policies and procedures further must require a 
committee that reports to the member's board of directors--or if none 
exists, a senior executive officer--to review and approve at least 
annually the compensation of any research analyst who is primarily 
responsible for preparation of the substance of a research report. The 
committee may not have representation from a member's investment 
banking department. The committee must consider, among other things, 
the productivity of the research analyst and the quality of his or her 
research and must document the basis for each research analyst's 
compensation.\26\ These provisions are consistent with the requirements 
in current Rule 2711(d).
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    \25\ See proposed FINRA Rule 2241(b)(2)(E).
    \26\ See proposed FINRA Rule 2241(b)(2)(F).
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Information Barriers
    The required policies and procedures must be reasonably designed to 
establish information barriers or other institutional safeguards to 
ensure that research analysts are insulated from the review, pressure 
or oversight by persons engaged in investment banking services 
activities or other persons, including sales and trading department 
personnel, who might be biased in their judgment or supervision.\27\ 
FINRA believes the other policies and procedures required by the 
proposed rule change to identify and manage research-related conflicts 
of interest should effectively result in compliance with this Sarbanes-
Oxley-based provision. However, FINRA is including the provision to 
emphasize that the conflicts management must extend to persons other 
than investment banking personnel, including sales and trading 
department personnel, who may be placed in a position to supervise or 
influence the content of research reports or public appearances.
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    \27\ See proposed FINRA Rule 2241(b)(2)(G).
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Retaliation
    The required policies and procedures must be reasonably designed to 
prohibit direct or indirect retaliation or threat of retaliation 
against research analysts employed by the member or its affiliates by 
persons engaged in investment banking services activities or other 
employees as the result of an adverse, negative, or otherwise 
unfavorable research report or public appearance written or made by the 
research analyst that may adversely affect the member's present or 
prospective business interests.\28\ This provision is consistent with 
current Rule 2711(j), except that it extends the retaliation 
prohibition to employees other than investment banking personnel. FINRA 
believes it is essential to a research analyst's independence and 
objectivity that no person employed by a member that is in a position 
to retaliate or threaten to retaliate should be permitted to do so 
based on the content of a research report or public appearance.
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    \28\ See proposed FINRA Rule 2241(b)(2)(H). This provision is 
not intended to limit a member's authority to discipline or 
terminate a research analyst, in accordance with the member's 
written policies and procedures, for any cause other than writing an 
adverse, negative, or otherwise unfavorable research report or for 
making similar comments during a public appearance.
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Quiet Periods
    The required policies and procedures must be reasonably designed to 
define quiet periods of a minimum of 10 days after an initial public 
offering, and a minimum of three days after a secondary offering, 
during which the member must not publish or otherwise distribute 
research reports, and research analysts must not make public 
appearances, relating to the issuer if the member has participated as 
an underwriter or dealer in the initial public offering or, with 
respect to the quiet periods after a secondary offering, as a manager 
or co-manager of that offering.\29\ This provision represents a 
significant change from the current rules, which impose a 40-day quiet 
period on a member acting as manager or co-manager of an IPO, a 25-day 
quiet period on a member participating as an underwriter or dealer 
(other than manager or co-manager) in an IPO, and a 10-day quiet period 
on a member acting as manager or co-manager of a secondary offering. As 
mentioned above, the quiet periods do not apply to EGCs.
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    \29\ See proposed FINRA Rule 2241(b)(2)(I). Consistent with the 
Jumpstart Our Business Startups Act (``JOBS Act''), those quiet 
periods do not apply following the IPO or secondary offering of an 
Emerging Growth Company (``EGC''), as that term is defined in 
Section 3(a)(80) of the Exchange Act.
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    With respect to these quiet-period provisions, the proposed rule 
change reduces the current 40-day quiet period for IPOs to a minimum of 
10 days after the completion of the offering for any member that 
participated as an underwriter or dealer, and reduces the 10-day 
secondary offering quiet period to three days after the completion of 
the offering for any member that participated as a manager or co-
manager in the secondary offering.
    The lengthier quiet period for managers and co-managers was 
intended to allow other voices to publicly analyze and value a subject 
company before members most vested in the success of the offering 
expressed a view in their reports and public appearances. However, in 
light of the objectivity safeguards in other

[[Page 69944]]

provisions of the research rules and the certification requirement of 
SEC Regulation AC, FINRA believes it is no longer necessary to impose a 
longer period on managers and co-managers. Both the Joint Report and 
the GAO Report noted that analysts have been issuing less optimistic 
recommendations since the regulatory reforms, particularly at firms 
involved in underwriting subject company securities.\30\ FINRA believes 
that the separation, disclosure and certification requirements in the 
rules and Regulation AC have had greater impact on the objectivity of 
research than maintaining quiet periods during which research may not 
be distributed and research analysts may not make public appearances. 
FINRA has observed--and media reports have documented--instances when a 
manager or co-manager of an IPO has initiated coverage of the subject 
company with a ``hold'' or even ``sell'' rating once the quiet period 
ended.\31\ These examples buttress FINRA's belief that the other 
provisions of the rules and Regulation AC have been effective in 
deterring biased research. FINRA also notes that there is a cost to 
investors when they are deprived of information and analysis during 
quiet periods.
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    \30\ See Joint Report, supra note 6 at 17-20; see GAO Report, 
supra note 7 at 12-15.
    \31\ See Facebook Shares No Lock for Pop After Quiet Period, 
available at http://blogs.wsj.com/marketbeat/2012/06/27/facebook-shares-no-lock-for-pop-after-quiet-period/; see also Warburg Analyst 
Advises Investors to Sell JetBlue, available at http://articles.latimes.com/2002/may/08/business/fi-wrap8.
---------------------------------------------------------------------------

    Accordingly, FINRA is proposing to reduce all of the quiet periods 
after IPOs and secondary offerings. By doing so, FINRA believes the 
proposed rule change would promote more information flow to investors 
without jeopardizing the objectivity of research. As reflected in the 
Joint Report, FINRA was in favor of completely eliminating the quiet 
periods around secondary offerings; however, SEC staff has since 
indicated its view that the Sarbanes-Oxley reference to ``public 
offering of securities'' \32\ encompasses both initial public offerings 
and secondary offerings and therefore mandates a quiet period after 
such public offerings, except for EGCs. FINRA will read with interest 
comments with evidence that suggests that maintaining longer quiet 
periods for manager and co-managers after the IPO of a non-EGC issuer 
would provide a meaningful benefit to investors.
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 78o-6(a)(2).
---------------------------------------------------------------------------

    As recommended in the Joint Report, the proposed rule change also 
eliminates the current quiet periods 15 days before and after the 
expiration, waiver or termination of a lock-up agreement. FINRA 
believes that research issued during such periods potentially offers 
valuable market information, and the other provisions of the research 
rules and SEC Regulation AC provide sufficient protection that such 
research will reflect the analyst's honest beliefs and be free from 
other conflicts that would undermine the value or integrity of research 
issued during these periods. FINRA understands from some underwriters 
that issuers will time release of negative news to occur during these 
quiet periods, thereby depriving investors of timely analysis of the 
impact of the news on their holdings. FINRA also notes that the change 
will bring consistency to the application of the rules, irrespective of 
the subject company, because, as noted above, recent amendments 
implementing the JOBS Act exempt research regarding EGCs from the 
current quiet periods.\33\
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    \33\ FINRA notes that the proposed changes to the quiet periods 
do not affect any quiet periods that may be required under federal 
law.
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Solicitation and Marketing
    In addition, the proposed rule change requires firms to adopt 
written policies and procedures to restrict or limit activities by 
research analysts that can reasonably be expected to compromise their 
objectivity.\34\ This includes the existing prohibitions on 
participation in pitches and other solicitations of investment banking 
services transactions and road shows and other marketing on behalf of 
issuers related to such transactions. FINRA notes that consistent with 
existing guidance analysts may listen to or view a live webcast of a 
transaction-related road show or other widely attended presentation by 
investment banking to investors or the sales force from a remote 
location, or another room if they are in the same location.\35\
---------------------------------------------------------------------------

    \34\ See proposed FINRA Rule 2241(b)(2)(L).
    \35\ See NASD Notice to Members 07-04 (January 2007) and NYSE 
Information Memo 07-11 (January 2007).
---------------------------------------------------------------------------

    Pursuant to the recent amendments implementing the JOBS Act, the 
prohibition on participation in pitch meetings does not apply to a 
research analyst that attends a pitch meeting in connection with an IPO 
of an EGC that is also attended by investment banking personnel. 
However, FINRA notes that research analysts still are prohibited from 
soliciting an investment banking services transaction or promising 
favorable research during permissible attendance at those pitch 
meetings.\36\ The proposed rule change also adds Supplementary Material 
.01, which codifies the existing interpretation that the pitch 
provision prohibits members from including in pitch materials any 
information about a member's research capacity in a manner that 
suggests, directly or indirectly, that the member might provide 
favorable research coverage.\37\ By way of example, the Supplementary 
Material explains that FINRA would consider the publication in a pitch 
book or related materials of an analyst's industry ranking to imply the 
potential outcome of future research because of the manner in which 
such rankings are compiled. The Supplementary Material further notes 
that a member would be permitted to include in the pitch materials the 
fact of coverage and the name of the research analyst, since that 
information alone does not imply favorable coverage.
---------------------------------------------------------------------------

    \36\ See Jumpstart Our Business Startups Act, Frequently Asked 
Questions About Research Analysts and Underwriters, available at 
http://www.sec.gov/divisions/marketreg/tmjobsact-researchanalystsfaq.htm.
    \37\ See proposed FINRA Rule 2241.01 and Notice to Members 07-04 
(January 2007).
---------------------------------------------------------------------------

Joint Due Diligence and Other Interactions With Investment Banking
    The proposed rule establishes a new proscription with respect to 
joint due diligence activities--i.e., due diligence by the research 
analyst in the presence of investment banking department personnel--
during a specified time period. Specifically, proposed Supplementary 
Material .02 states that FINRA interprets the overarching principle 
requiring members to, among other things, establish, maintain and 
enforce written policies and procedures that address the interaction 
between research analysts, banking and subject companies, to prohibit 
the performance of joint due diligence prior to the selection of 
underwriters for the investment banking services transaction. FINRA 
understands that in some instances, due diligence activities take place 
even before an issuer has awarded the mandate to manage or co-manage an 
offering. FINRA believes there is heightened risk in those 
circumstances that investment bankers may pressure analysts to produce 
favorable research that may bolster the firm's bid to become an 
underwriter for the offering. Once the mandate has been awarded, FINRA 
believes joint due diligence may take place in accordance with 
appropriate policies and procedures to guard against interactions to 
further the interests of the investment banking department. At that 
time, FINRA believes that the efficiencies of joint due diligence 
outweigh the risk of pressure

[[Page 69945]]

on research analysts by investment banking. Also, FINRA understands 
that typically an analyst that is participating in due diligence 
activities will not be publishing research at that time due to quiet 
periods under the offering rules of the Securities Act or because the 
analyst has been brought ``over the wall.'' FINRA notes that this 
provision is consistent with restrictions in the Global Settlement.
    The proposed rule continues to prohibit investment banking 
department personnel from directly or indirectly directing a research 
analyst to engage in sales or marketing efforts related to an 
investment banking services transaction, and directing a research 
analyst to engage in any communication with a current or prospective 
customer about an investment banking services transaction.\38\ 
Supplementary Material .03 clarifies that three-way meetings between 
research analysts and a current or prospective customer in the presence 
of investment banking department personnel or company management about 
an investment banking services transaction are prohibited by this 
provision.\39\ FINRA believes that the presence of investment bankers 
or issuer management could compromise a research analyst's candor when 
talking to a current or prospective customer about a deal. 
Supplementary Material .03 also retains the current requirement that 
any written or oral communication by a research analyst with a current 
or prospective customer or internal personnel related to an investment 
banking services transaction must be fair, balanced and not misleading, 
taking into consideration the overall context in which the 
communication is made.
---------------------------------------------------------------------------

    \38\ See proposed FINRA Rule 2241(b)(2)(M). FINRA notes that 
this provision does not prohibit investment banking personnel from 
forwarding to a research analyst the name of a prospective investor 
in an investment banking transaction, provided that the research 
analyst retains discretion whether to contact the investor and for 
the content of any discussion that ensues. See Regulatory Notice 12-
49 (November 2012).
    \39\ See proposed FINRA Rule 2241.03.
---------------------------------------------------------------------------

Promises of Favorable Research and Prepublication Review by Subject 
Company
    The proposal maintains the current prohibition against promises of 
favorable research, a particular research recommendation, rating or 
specific content as inducement for receipt of business or 
compensation.\40\ It further prohibits prepublication review of a 
research report by a subject company for purposes other than 
verification of facts.\41\
---------------------------------------------------------------------------

    \40\ See proposed FINRA Rule 2241(b)(2)(K). FINRA provided 
additional guidance on the current provision, NASD Rule 2711(e), in 
Regulatory Notice 11-41 (September 2011).
    \41\ See proposed FINRA Rule 2241(b)(2)(N).
---------------------------------------------------------------------------

    Supplementary Material .05 maintains the current guidance 
applicable to the prepublication submission of a research report to a 
subject company. Specifically, sections of a draft research report may 
be provided to non-investment banking personnel or the subject company 
for factual review, provided: (1) That the draft section does not 
contain the research summary, research rating or price target; (2) a 
complete draft of the report is provided to legal or compliance 
personnel before sections are submitted to non-investment banking 
personnel or the subject company; and (3) any subsequent proposed 
changes to the rating or price target are accompanied by a written 
justification to legal or compliance and receive written authorization 
for the change. The member also must retain copies of any draft and the 
final version of the report for three years.\42\
---------------------------------------------------------------------------

    \42\ See proposed FINRA Rule 2241.05.
---------------------------------------------------------------------------

Personal Trading Restrictions
    The proposal provides for a more encompassing and flexible 
supervisory approach with respect to research analyst account trading 
in securities of companies the research analyst covers. The current 
rules impose specific blackout periods during which a research analyst 
account may not trade covered securities and require pre-approval by 
legal and compliance of transactions in covered securities by persons 
who oversee research analysts. The current rules also provide several 
exceptions to the blackout periods, including where a report or change 
in rating or price target results from ``significant news or a 
significant event concerning the subject company.'' In addition, the 
blackout periods do not apply to: (1) Transactions in the securities of 
a registered diversified investment company as defined under Section 
(5)(b)(1) of the Investment Company Act of 1940; or (2) purchases or 
sales of securities in other investment funds over which neither the 
research analyst nor a member of a research analyst's household has any 
investment discretion or control, provided that the research analyst 
account collectively owns interests representing no more than 1% of the 
fund's assets and that the fund invests no more than 20% of its assets 
in securities of issuers principally engaged in the same types of 
businesses as companies in the research analyst's coverage universe. 
The rules further prohibit a research analyst account from purchasing 
or selling any security or any option or derivative of such security in 
a manner inconsistent with the research analyst's recommendation as 
reflected in the most recent research report published by the member. 
Legal or compliance may authorize transactions otherwise prohibited by 
the rules based on an unanticipated significant change in the personal 
financial circumstances of the beneficial owner of the research analyst 
account, provided that the authorization is in accordance with policies 
and procedures reasonably designed to avoid a conflict between the 
professional responsibilities of the research analyst and his or her 
personal trading and that the member maintains for three years written 
records documenting the justification for permitting the transaction.
    The proposal instead requires that firms establish written policies 
and procedures that restrict or limit research analyst account trading 
in securities, any derivatives of such securities and funds whose 
performance is materially dependent upon the performance of securities 
covered by the research analyst.\43\ Such policies and procedures must 
ensure that research analyst accounts, supervisors of research analysts 
and associated persons with the ability to influence the content of 
research reports do not benefit in their trading from knowledge of the 
content or timing of a research report before the intended recipients 
of such research have had a reasonable opportunity to act on the 
information in the research report.\44\ The proposal maintains, as 
minimum standards, the current prohibitions on research analysts 
receiving pre-IPO shares in the sector they cover and trading against 
their most recent recommendations. However, members may define 
financial hardship circumstances, if any, in which a research analyst 
would be permitted to trade against his or her most recent 
recommendation.\45\ While the proposed rule change does not include a 
recordkeeping requirement, FINRA expects members to evidence compliance 
with their policies and procedures and retain any related documentation 
in accordance with FINRA Rule 4511. The proposed rule change includes 
Supplementary Material .10, which provides that FINRA would not 
consider a research analyst account to have traded in a manner 
inconsistent with a research

[[Page 69946]]

analyst's recommendation where a member has instituted a policy that 
prohibits any research analyst from holding securities, or options on 
or derivatives of such securities, of the companies in the research 
analyst's coverage universe, provided that the member establishes a 
reasonable plan to liquidate such holdings consistent with the 
principles in paragraph (b)(2)(J)(i) and such plan is approved by the 
member's legal or compliance department.\46\ This provision is intended 
to provide a mechanism by which a firm's analysts can divest their 
holdings to comply with a more restrictive personal trading policy 
without violating the trading against recommendation provision in 
circumstances where an analyst has, for example, a ``buy'' rating on a 
subject company.
---------------------------------------------------------------------------

    \43\ See proposed FINRA Rule 2241(b)(2)(J).
    \44\ See proposed FINRA Rule 2241(b)(2)(J)(i).
    \45\ See proposed FINRA Rule 2241(b)(2)(J)(ii).
    \46\ See proposed FINRA Rule 2241.10.
---------------------------------------------------------------------------

    FINRA believes these provisions will provide enhanced investor 
protection, while allowing firms to tailor management of conflicts 
related to personal trading of subject company securities to their 
particular size and business model. The enhanced protection results 
from expanding the scope of persons covered by the provisions to 
include not only research analyst accounts, but also those of 
supervisors and persons with an ability to influence the content of 
research reports. The proposal also preserves the key protections of 
the current rules by preventing research analysts from trading ahead of 
their customers and by generally requiring consistency between personal 
trading and recommendations to customers.
Content and Disclosure in Research Reports
    With a couple of modifications, the proposed rule change maintains 
the current disclosure requirements. Thus, the proposed rule change 
maintains the mandated Sarbanes-Oxley disclosure requirements,\47\ as 
well as additional disclosure obligations--meanings and distribution of 
ratings and price charts, for example--that are designed to provide 
investors with useful information on which to base their investment 
decisions. The proposed rule change also maintains the requirement that 
disclosures be presented on the front page of the research report or 
the front page must refer to the page on which the disclosures are 
found. Electronic research reports may provide a hyperlink directly to 
the required disclosures. All disclosures and references to required 
disclosures must be clear, comprehensive and prominent.\48\
---------------------------------------------------------------------------

    \47\ See Section 501 Sarbanes-Oxley Act, Public Law 107-204, 116 
Stat. 745 (2002).
    \48\ See proposed FINRA Rule 2241(c)(6).
---------------------------------------------------------------------------

    The proposed rule change adds a requirement that a member must 
establish, maintain and enforce written policies and procedures 
reasonably designed to ensure that purported facts in its research 
reports are based on reliable information.\49\ FINRA has included this 
provision because it believes members should have policies and 
procedures to foster verification of facts and trustworthy research on 
which investors may rely. The policies and procedures also must be 
reasonably designed to ensure that any recommendation or rating has a 
reasonable basis in fact and is accompanied by a clear explanation of 
any valuation method used and a fair presentation of the risks that may 
impede achievement of the recommendation or rating.\50\
---------------------------------------------------------------------------

    \49\ See proposed FINRA Rule 2241(c)(1)(A).
    \50\ See proposed FINRA Rule 2241(c)(1)(B). This is 
substantively the same as NASD Rule 2711(h)(7) but in the form of 
policies and procedures.
---------------------------------------------------------------------------

    In addition, the proposed rule change would require a member to 
disclose in any research report at the time of publication or 
distribution of the report: \51\
---------------------------------------------------------------------------

    \51\ See proposed FINRA Rule 2241(c)(4). In comparing the 
proposed disclosure provisions to those in NASD Rule 2711, FINRA 
notes that in some instances the proposed rule change makes minor 
word or grammatical changes, uses streamlined language or has moved 
some text to Supplementary Material, but does not intend to change 
the substantive disclosure requirements. In those circumstances, 
FINRA considers the proposed disclosure provisions to be 
``substantively the same'' as the current provisions.
---------------------------------------------------------------------------

     If the research analyst or a member of the research 
analyst's household has a financial interest in the debt or equity 
securities of the subject company (including, without limitation, 
whether it consists of any option, right, warrant, future, long or 
short position), and the nature of such interest; \52\
---------------------------------------------------------------------------

    \52\ See proposed FINRA Rule 2241(c)(4)(A). This is 
substantively the same as NASD Rule 2711(h)(1).
---------------------------------------------------------------------------

     if the research analyst has received compensation based 
upon (among other factors) the member's investment banking revenues; 
\53\
---------------------------------------------------------------------------

    \53\ See proposed FINRA Rule 2241(c)(4)(B). This is 
substantively the same as NASD Rule 2711(h)(2)(A)(i)a.
---------------------------------------------------------------------------

     if the member or any of its affiliates: (i) Managed or co-
managed a public offering of securities for the subject company in the 
past 12 months; (ii) received compensation for investment banking 
services from the subject company in the past 12 months; or (iii) 
expects to receive or intends to seek compensation for investment 
banking services from the subject company in the next three months; 
\54\
---------------------------------------------------------------------------

    \54\ See proposed FINRA Rule 2241(c)(4)(C). This is 
substantively the same as NASD Rule 2711(h)(2)(A)(ii).
---------------------------------------------------------------------------

     if, as of the end of the month immediately preceding the 
date of publication or distribution of a research report (or the end of 
the second most recent month if the publication or distribution date is 
less than 30 calendar days after the end of the most recent month), the 
member or its affiliates have received from the subject company any 
compensation for products or services other than investment banking 
services in the previous 12 months; \55\
---------------------------------------------------------------------------

    \55\ See proposed FINRA Rule 2241(c)(4)(D). This provision, 
together with proposed FINRA Rule 2241.04, is substantively the same 
as NASD Rules 2711(h)(2)(A)(iii)a., (iv) and (v).
---------------------------------------------------------------------------

     if the subject company is, or over the 12-month period 
preceding the date of publication or distribution of the research 
report has been, a client of the member, and if so, the types of 
services provided to the issuer. Such services, if applicable, must be 
identified as either investment banking services, non-investment 
banking services, non-investment banking securities-related services or 
non-securities services; \56\
---------------------------------------------------------------------------

    \56\ See proposed FINRA Rule 2241(c)(4)(E). This is 
substantively the same as NASD Rule 2711(h)(2)(A)(iii)b.
---------------------------------------------------------------------------

     if the member was making a market in the securities of the 
subject company at the time of publication or distribution of the 
research report; \57\ and
---------------------------------------------------------------------------

    \57\ See proposed FINRA Rule 2241(c)(4)(G). This is 
substantively the same as NASD Rule 2711(h)(8).
---------------------------------------------------------------------------

     if the research analyst received any compensation from the 
subject company in the previous 12 months.\58\
---------------------------------------------------------------------------

    \58\ See proposed FINRA Rule 2241(c)(4)(H). This is 
substantively the same as NASD Rule 2711(h)(2)(A)(i)b.
---------------------------------------------------------------------------

    The proposal also expands upon the current ``catch all'' 
disclosure, which mandates disclosure of any other material conflict of 
interest of the research analyst or member that the research analyst 
knows or has reason to know of at the time of the publication or 
distribution of a research report or public appearance.\59\ The 
proposed rule change goes beyond the existing provision by requiring 
disclosure of material conflicts known not only by the research 
analyst, but also by any ``associated person of the member with the 
ability to influence the content of a research report.'' \60\ In so 
doing, the proposed rule change would capture

[[Page 69947]]

material conflicts of interest that, for example, only a supervisor or 
the head of research may be aware of. The ``reason to know'' standard 
would not impose a duty of inquiry on the research analyst or others 
who can influence the content of a research report. Rather, it would 
cover disclosure of those conflicts that should reasonably be 
discovered by those persons in the ordinary course of discharging their 
functions.
---------------------------------------------------------------------------

    \59\ For example, FINRA would consider it to be a material 
conflict of interest 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.
    \60\ See proposed FINRA Rule 2241(c)(4)(I).
---------------------------------------------------------------------------

    The proposed rule change also modifies the requirement to disclose 
when a member or its affiliates own securities of the subject company 
to include any ``significant financial interest in the debt or equity 
of the subject company,'' including, at a minimum, beneficial ownership 
of 1% or more of any class of common equity securities of the subject 
company.\61\ Thus, among other things, the proposal delineates the 
obligation to disclose significant debt holdings as a material conflict 
of interest that currently is captured by the ``other material conflict 
of interest'' provision referenced above. FINRA believes that an equity 
research report that analyzes the creditworthiness of the subject 
company could impact the price of the company's debt securities, and 
therefore a material conflict exists where the member or its affiliates 
maintains significant debt holdings in the subject company. The 
determination of beneficial ownership would continue to be based upon 
the standards used to compute ownership for the purposes of the 
reporting requirements under Section 13(d) of the Exchange Act.
---------------------------------------------------------------------------

    \61\ See proposed FINRA Rule 2241(c)(4)(F). The requirement to 
disclose beneficial ownership of 1% or more of any class of common 
equity securities of the subject company is the same as NASD Rule 
2711(h)(1)(B).
---------------------------------------------------------------------------

    The proposal retains the general exception for disclosure that 
would reveal material non-public information regarding specific 
potential future investment banking transactions of the subject 
company.\62\ The proposal also continues to permit a member that 
distributes a research report covering six or more companies 
(compendium report) to direct the reader in a clear manner as to where 
the applicable disclosures can be found. An electronic compendium 
research report may hyperlink to the disclosures. A paper compendium 
report must include a toll-free number or a postal address where the 
reader may request the disclosures. In addition, paper research reports 
may include a web address where the disclosures can be found.\63\
---------------------------------------------------------------------------

    \62\ See proposed FINRA Rule 2241(c)(5).
    \63\ See proposed FINRA Rule 2241(c)(7). This is substantively 
the same as Rule 2711(h)(11).
---------------------------------------------------------------------------

    As detailed in the Joint Report, FINRA believes that a web-based 
disclosure approach would be at least as effective and a more efficient 
means to inform investors of conflicts of interests. To that end, FINRA 
recommended--and eventually proposed in SR-NASD-2006-113--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 conflicts of interest exist, 
together with information on how the reader may obtain more detail 
about these conflicts on the member's Web site. However, FINRA has 
subsequently been informed by SEC staff that it believes such a web-
based disclosure approach would not be consistent with the Sarbanes-
Oxley requirement ``to disclose [conflicts of interest] in each 
report''; \64\ therefore, FINRA has not re-proposed it here.
---------------------------------------------------------------------------

    \64\ 15 U.S.C 78o-6(b).
---------------------------------------------------------------------------

Disclosures in Public Appearances
    The proposal groups in a separate provision the disclosures 
required when a research analyst makes a public appearance.\65\ The 
required disclosures remain substantively the same as under the current 
rules,\66\ with one exception: Consistent with the modification 
referenced above with respect to disclosure in research reports, a 
research analyst is similarly required to disclose in a public 
appearance if a member or its affiliates maintain a ``significant 
financial interest in the debt or equity of the subject company,'' 
including, at a minimum, if the member or its affiliates beneficially 
own 1% or more of any class of common equity securities of the subject 
company, as computed in accordance with Section 13(d) of the Exchange 
Act. Unlike in research reports, the ``catch all'' disclosure 
requirement in public appearances applies only to a conflict of 
interest of the research analyst or member that the research analyst 
knows or has reason to know at the time of the public appearance and 
does not extend to conflicts that an associated person with the ability 
to influence the content of a research report or public appearance 
knows or has reason to know. The proposed rule change defines a person 
with the ``ability to influence the content of a research report'' as 
an associated person who, in the ordinary course of that person's 
duties, has the authority to review the research report and change that 
research report prior to publication or distribution.\67\ FINRA 
understands that supervisors typically do not have the opportunity to 
review and insist on changes to public appearances, many of which are 
extemporaneous in nature. The proposal also retains the current 
requirement in NASD Rule 2711(h)(12) to maintain records of public 
appearances sufficient to demonstrate compliance by research analysts 
with the applicable disclosure requirements.\68\
---------------------------------------------------------------------------

    \65\ See proposed FINRA Rule 2241(d).
    \66\ See NASD Rules 2711(h)(1), (h)(2)(B) and (C), (h)(3) and 
(h)(9).
    \67\ See proposed FINRA Rule 2241.08.
    \68\ See proposed FINRA Rule 2241(d)(3).
---------------------------------------------------------------------------

Disclosure Required by Other Provisions
    With respect to both research reports and public appearances, 
members and research analysts would continue to be required to comply 
with applicable disclosure provisions of FINRA Rule 2210, Incorporated 
NYSE Rule 472 and the federal securities laws.\69\
---------------------------------------------------------------------------

    \69\ See proposed FINRA Rule 2241(e). This is substantively the 
same as NASD Rule 2711(h)(9).
---------------------------------------------------------------------------

Termination of Coverage
    The proposal retains with non-substantive modifications the 
provision in the current rules that requires a member to notify its 
customers if it intends to terminate coverage of a subject company.\70\ 
Such notification must be made promptly \71\ using the member's 
ordinary means to disseminate research reports on the subject company 
to its various customers. Unless impracticable, the notice must be 
accompanied by a final research report, comparable in scope and detail 
to prior research reports, and include a final recommendation or 
rating. If impracticable to provide a final research report, 
recommendation or rating, a firm must disclose to its customers the 
reason for terminating coverage. FINRA expects such circumstances to be 
exceptional, such as where a research analyst covering a subject 
company or sector has left the member or the member has discontinued 
coverage of the industry or sector. FINRA believes this provision, 
which is consistent with the current rules, has been effective in 
achieving its original purpose to prevent firms from dropping coverage 
without notice or explanation instead of issuing a negative report on a 
current or prospective investment banking client.
---------------------------------------------------------------------------

    \70\ See proposed FINRA Rule 2241(f).
    \71\ While current Rule 2711(f)(6) does not contain the word 
``promptly,'' FINRA has interpreted the provision to require prompt 
notification of termination of coverage of a subject company.

---------------------------------------------------------------------------

[[Page 69948]]

Distribution of Member Research Reports
    The proposal codifies an existing interpretation of FINRA Rule 2010 
and provides additional guidance regarding selective--or tiered--
dissemination of a firm's research reports. In that regard, the 
proposal requires firms to establish, maintain and enforce written 
policies and procedures reasonably designed to ensure that a research 
report is not distributed selectively to internal trading personnel or 
a particular customer or class of customers in advance of other 
customers that the firm has previously determined are entitled to 
receive the research report.\72\ The proposal includes further guidance 
to explain that firms may provide different research products and 
services to different classes of customers, provided the products are 
not differentiated based on the timing of receipt of potentially market 
moving information and the firm discloses its research dissemination 
practices to all customers that receive a research product.\73\
---------------------------------------------------------------------------

    \72\ See proposed FINRA Rule 2241(g).
    \73\ See proposed FINRA Rule 2241.07.
---------------------------------------------------------------------------

    A member, for example, may offer one research product for those 
with a long-term investment horizon (``investor research'') and a 
different research product for those customers with a short-term 
investment horizon (``trading research''). These products may lead to 
different recommendations or ratings, provided that each is consistent 
with the meaning of the member's ratings system for each respective 
product. Thus, for example, a firm may define a ``buy'' rating in 
investor research to mean that a stock will outperform the S&P 500 over 
the next 12 months. The same firm may define ``sell'' in trading 
research to mean a stock will underperform its sector index over the 
next month. The firm could maintain a ``buy'' in investor research at 
the same time it had a ``sell'' in trading research on the same stock 
if the firm believed, for example, that the company would report an 
earnings shortfall next week that would lead to a short-term drop in 
price relative to the sector index, but that the stock would recover to 
outperform the S&P 500 over the next 12 months. However, a member may 
not differentiate a research product based on the timing of receipt of 
a recommendation, rating or other potentially market moving 
information, nor may a member label a research product with 
substantially the same content as a different research product as a 
means to allow certain customers to trade in advance of other 
customers.
    In addition, a member that provides different research products and 
services for certain customers must inform its other customers that its 
alternative research products and services may reach different 
conclusions or recommendations that could impact the price of the 
security. Thus, for example, a member that offers trading research must 
inform its investment research customers that its trading research 
product may contain different recommendations or ratings that could 
result in short-term price movements contrary to the recommendation in 
its investment research. FINRA understands, however, that customers may 
actually receive at different times research reports originally made 
available at the same time because of the mode of delivery elected by 
the customer eligible to receive such research services (e.g., in paper 
form versus electronic). However, members may not design or implement a 
distribution system intended to give a timing advantage to some 
customers over others. FINRA will read with interest comments as to 
whether a member should be required to disclose to its other customers 
when an alternative research product or service does, in fact, contain 
a recommendation contrary to the research product or service that those 
customers receive.
Distribution of Third-Party Research Reports
    The proposal expands upon the third-party research report 
distribution requirements in the current rules. The proposal generally 
maintains the existing third-party disclosure requirements,\74\ with 
one modification. Consistent with the proposed disclosure requirement 
discussed above with respect to a member's own research reports, a 
distributing member would be required to disclose if the member or its 
affiliates maintain a significant financial interest in the debt or 
equity securities of the subject company, including, at a minimum, if 
the member or its affiliates beneficially own 1% or more of any class 
of common equity securities of the subject company. The proposed rule 
change also would require members to disclose any other material 
conflict of interest that can reasonably be expected to have influenced 
the member's choice of a third-party research provider or the subject 
company of a third-party research report.\75\ FINRA believes that it is 
important that readers be made aware of any conflicts of interest 
present that may have influenced either the selection or content of 
research disseminated to investors. As is the case in the existing 
Rules, the proposal requires that a member establish, maintain and 
enforce written policies and procedures reasonably designed to ensure 
the completeness and accuracy of all of the applicable disclosures to 
any third-party research it distributes.
---------------------------------------------------------------------------

    \74\ NASD Rule 2711(h)(13)(A) currently requires the 
distributing member firm to disclose the following, if applicable: 
(1) If the member owns 1% or more of any class of equity securities 
of the subject company; (2) if the member or any affiliate has 
managed or co-managed a public offering of securities of the subject 
company or received compensation for investment banking services 
from the subject company in the past 12 months, or expects to 
receive or intends to seek compensation for such services in the 
next three months; (3) if the member makes a market in the subject 
company's securities; and (4) any other actual, material conflict of 
interest of the research analyst or member of which the research 
analyst knows or has reason to know at the time the research report 
is distributed or made available.
    \75\ See proposed FINRA Rule 2241(h)(4).
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    In addition, the proposal continues to address qualitative aspects 
of third-party research reports. For example, the proposal maintains, 
but in the form of policies and procedures, the existing requirement 
that a registered principal or supervisory analyst review and approve 
third-party research reports distributed by a member. To that end, the 
proposed rule change requires a member to establish, maintain and 
enforce written policies and procedures reasonably designed to ensure 
that any third-party research it contains no untrue statement of 
material fact and is otherwise not false or misleading. For the purpose 
of this requirement, a member's obligation to review a third-party 
research report extends to any untrue statement of material fact or any 
false or misleading information that should be known from reading the 
research report or is known based on information otherwise possessed by 
the member.\76\ The proposal further prohibits a member from 
distributing third-party research if it knows or has reason to know 
that such research is not objective or reliable.\77\ FINRA believes 
that, where a member is distributing or ``pushing-out'' third-party 
research, the member must have policies and procedures to vet the 
quality of the research producers. A member would satisfy the standard 
based on its actual knowledge and reasonable diligence; however, there 
would be no duty of inquiry to definitively establish that the third-
party research is, in fact, objective and reliable.
---------------------------------------------------------------------------

    \76\ See proposed FINRA Rules 2241(h)(1) and (h)(3).
    \77\ See proposed FINRA Rule 2241(h)(2).
---------------------------------------------------------------------------

    The proposal maintains the existing exceptions for ``independent 
third-party research reports.'' Specifically, such

[[Page 69949]]

research does not require principal pre-approval or, where the third-
party research is not ``pushed out,'' the third-party disclosures.\78\ 
As to the latter, a member will not be considered to have distributed 
independent third-party research where the research is made available 
by the member: (a) Upon request; (b) through a member-maintained Web 
site; or (c) to a customer in connection with a solicited order in 
which the registered representative has informed the customer, during 
the solicitation, of the availability of independent research on the 
solicited equity security and the customer requests such independent 
research.
---------------------------------------------------------------------------

    \78\ See proposed FINRA Rule 2241(h)(5) and (6).
---------------------------------------------------------------------------

    Finally, under the proposal, members also must ensure that a third-
party research report is clearly labeled as such and that there is no 
confusion on the part of the recipient as to the person or entity that 
prepared the research report.\79\ This requirement codifies guidance 
provided in Notice to Members 04-18.
---------------------------------------------------------------------------

    \79\ See proposed FINRA Rule 2241(h)(7).
---------------------------------------------------------------------------

Exemption for Firms With Limited Investment Banking Activity
    The current rule exempts firms with limited investment banking 
activity--those that over the previous three years, on average per 
year, have managed or co-managed 10 or fewer investment banking 
transactions and generated $5 million or less in gross revenues from 
those transactions--from the provisions that prohibit a research 
analyst from being subject to the supervision or control of an 
investment banking department employee because the potential conflicts 
with investment banking are minimal.\80\ However, those firms remain 
subject to the provision that requires the compensation of a research 
analyst to be reviewed and approved annually by a committee that 
reports to a member's board of directors, or a senior executive officer 
if the member has no board of directors.\81\ That provision further 
prohibits representation on the committee by investment banking 
department personnel and requires the committee to consider the 
following factors when reviewing a research analyst's compensation: (1) 
The research analyst's individual performance, including the research 
analyst's productivity and the quality of research; (2) the correlation 
between the research analyst's recommendations and the performance of 
the recommended securities; and (3) the overall ratings received from 
clients, the sales force and peers independent of investment banking, 
and other independent ratings services.\82\ Thus, the current exemption 
provides limited relief with respect to research analyst compensation 
determination, even where it is permissible for an investment banker to 
supervise and control a research analyst. FINRA believes it follows 
logically to allow those who supervise research analysts under such 
circumstances also to be involved in all aspects of the evaluation and 
determination of those analysts' compensation. Therefore, the proposed 
rule change extends the exemption for firms with limited investment 
banking activity so that such firms would not be subject to the 
compensation committee provision. FINRA notes that the proposal still 
prohibits these firms from compensating a research analyst based upon 
specific investment banking services transactions or contributions to a 
member's investment banking services activities.\83\
---------------------------------------------------------------------------

    \80\ See NASD Rule 2711(k).
    \81\ See NASD Rule 2711(d)(2).
    \82\ See NASD Rule 2711(d) and (k).
    \83\ See proposed FINRA Rules 2241(b)(2)(E) and (i).
---------------------------------------------------------------------------

    The proposed rule change further exempts firms with limited 
investment banking activity from the provisions restricting or limiting 
research coverage decisions and budget determination. While these two 
provisions are not in the current rules, as noted above, FINRA 
interprets NASD Rule 2711(b) to prohibit investment banking from making 
any final coverage decisions or determination of research budget. As 
such, the current exemption in NASD Rule 2711(k) effectively covers 
these two new provisions and so the proposal does not represent a 
substantive change. In addition, the proposal exempts eligible firms 
from the requirement to establish information barriers or other 
institutional safeguards to insulate research analysts from the review 
or oversight by investment banking personnel or other persons, 
including sales and trading personnel, who may be biased in their 
judgment or supervision. However, those firms still are required to 
establish, maintain and enforce written policies and procedures 
reasonably designed to ensure that research analysts are insulated from 
pressure by investment banking and other non-research personnel who 
might be biased in their judgment or supervision. FINRA believes that 
even where research analysts need not be structurally separated from 
investment banking or other non-research personnel, they should not be 
subject to pressures that could compromise their independence and 
objectivity.
    FINRA reviewed and analyzed deal data for calendar years 2009 
through 2011 to determine whether any adjustments should be made to 
these exemption standards. The review targeted firms that either 
managed or co-managed deals and earned underwriting revenues from those 
transactions during the review period. The analysis found that 155 of 
317 such firms--or 49%--would have been eligible for the exemption. The 
data further suggested that incremental upward adjustments to the 
exemption thresholds would not result in a significant number of 
additional firms eligible for the exemption. For example, increasing 
both of the thresholds by 33% (to 40 transactions managed or co-managed 
and $20 million in gross revenues over a three-year period) would 
result in 18 additional exempted firms. As such, FINRA believes the 
current exemption produces a reasonable and appropriate universe of 
exempted firms.
Exemption From Registration Requirements for Certain ``Research 
Analysts''
    As recommended in the Joint Report, the proposed rule change amends 
the definition of ``research analyst'' for the purposes of the 
registration and qualification requirements to limit the scope to 
persons who produce ``research reports'' and whose primary job function 
is to provide investment research (e.g. registered representatives or 
traders generally would not be included).\84\ The revised definition is 
not intended to carve out anyone for whom the preparation of research 
is a significant component of their job; rather, it is intended to 
provide relief for those who produce research reports on an occasional 
basis. The existing research rules, in accordance with the Sarbanes-
Oxley mandates, 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. FINRA 
believes that the registration and qualification requirements, which 
are not mandated by Sarbanes-Oxley, were intended for those individuals 
whose principal job function is to produce research, while the balance 
of the research rules are intended to foster objective analysis, 
transparency of certain conflicts and to provide beneficial information 
to investors. As such, the proposed exemption would extend only to the

[[Page 69950]]

registration requirements, while all other obligations applicable to 
the production and distribution of research reports would remain.
---------------------------------------------------------------------------

    \84\ See proposed NASD Rule 1050(b) and proposed Incorporated 
NYSE Rule 344.10.
---------------------------------------------------------------------------

Attestation Requirement
    The proposal deletes the requirement to attest annually that the 
firm has in place written supervisory policies and procedures 
reasonably designed to achieve compliance with the applicable 
provisions of the rules, including the compensation committee review 
provision. FINRA notes that firms already are obligated pursuant to 
NASD Rule 3010 (Supervision) to have a supervisory system reasonably 
designed to achieve compliance with all applicable securities laws and 
regulations and FINRA rules. Moreover, the research rules also are 
subject to the supervisory control rules (NASD Rule 3012) and the 
annual certification requirement regarding compliance and supervisory 
processes (FINRA Rule 3130).\85\ As such, FINRA believes a separate 
attestation requirement for the research rules is unnecessary.
---------------------------------------------------------------------------

    \85\ NASD Rules 3010 and 3012 have been adopted with changes as 
consolidated FINRA rules. The new rules become effective December 1, 
2014. See supra note 20.
---------------------------------------------------------------------------

Obligations of Persons Associated With a Member
    Supplementary Material .09 clarifies the obligations of each 
associated person under those provisions of the proposed rule change 
that require a member to restrict or prohibit certain conduct by 
establishing, maintaining and enforcing particular written policies and 
procedures. Specifically, the rule provides that, consistent with FINRA 
Rule 0140, persons associated with a member must comply with such 
member's policies and procedures as established pursuant to proposed 
FINRA Rule 2241.\86\ Failure of an associated person to comply with 
such policies and procedures shall constitute a violation of the rule 
itself. In addition, consistent with Rule 0140, the rule states that it 
shall be a rule violation for an associated person to engage in the 
restricted or prohibited conduct to be addressed through the 
establishment, maintenance and enforcement of policies and procedures 
required by provisions of Rule 2241, including applicable Supplementary 
Material, that embed in the policies and procedures specific 
obligations on individuals. This Supplementary Material reflects 
FINRA's position that associated persons can be held liable for 
engaging in conduct that is proscribed by the member under FINRA rules. 
FINRA is clarifying this point in the Supplementary Material because 
the proposed rule change would adopt a policies and procedures approach 
to restricted and prohibited conduct with respect to research in place 
of specific proscriptions in the current rules.
---------------------------------------------------------------------------

    \86\ See proposed FINRA Rule 2241.09. FINRA Rule 0140(a), among 
other things, provides that persons associated with a member shall 
have the same duties and obligations as a member under the Rules.
---------------------------------------------------------------------------

    Thus, for example, where the proposed rule requires a member to 
establish policies and procedures to prohibit research analyst 
participation in road shows, associated persons also are directly 
prohibited from engaging in such conduct, even where a member has 
failed to establish policies and procedures. FINRA believes that it is 
incumbent upon each associated person to familiarize themselves with 
the regulatory requirements applicable to his or her business and 
should not be able to avoid responsibility where minimum standards of 
conduct have been established for members.
General Exemptive Authority
    The proposed rule change would provide FINRA, pursuant to the Rule 
9600 Series, with authority to conditionally or unconditionally grant, 
in exceptional and unusual circumstances, an exemption from any 
requirement of the proposed rule for good cause shown, after taking 
into account all relevant factors and provided that such exemption is 
consistent with the purposes of the rule, the protection of investors, 
and the public interest.\87\ Given the scope of the rule's subject 
matter and the diversity of firm sizes, structures and research 
business and distribution models, FINRA believes it would be useful and 
appropriate to have the ability to provide relief from a particular 
provision of the proposed rules under specific factual circumstances.
---------------------------------------------------------------------------

    \87\ See proposed FINRA Rule 2241(j).
---------------------------------------------------------------------------

    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be no later than 180 days 
following publication of the Regulatory Notice announcing Commission 
approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\88\ which requires, among 
other things, that FINRA rules must 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. FINRA believes the proposed rule change protects 
investors and the public interest by maintaining, and in some cases 
expanding, structural safeguards to insulate research analysts from 
influences and pressures that could compromise the objectivity of 
research reports and public appearances on which investors rely to make 
investment decisions. FINRA further believes that the proposed rule 
change prevents fraudulent and manipulative acts and practices by 
requiring firms to identify and manage, often with extensive 
disclosure, conflicts of interest related to the preparation, content 
and distribution of research. At the same time, the proposal furthers 
the public interest by increasing information flow to investors in 
select circumstances--e.g., before and after the expiration of lock up 
provisions--where FINRA believes the integrity of research will not be 
compromised.
---------------------------------------------------------------------------

    \88\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    Moreover, the proposed rule change is consistent with Section 15D 
of the Act,\89\ which requires rules reasonably designed to address 
conflicts of interest that can arise when research analysts recommend 
equity securities in research reports and public appearances. The 
proposed rule change requires firms to establish, maintain and enforce 
written policies and procedures reasonably designed to achieve 
compliance with the provisions of Section 15D, including: Restricting 
prepublication clearance or approval of research reports by investment 
banking personnel or other persons not directly responsible for the 
preparation, content and distribution of research reports; prohibiting 
persons engaged in investment banking activities from supervision or 
control of research analysts, including influence or control over 
research analyst compensation evaluation and determination; prohibiting 
retaliation or threat of retaliation against research analysts for 
research or public appearances that are unfavorable to the member's 
business interests; establishing quiet periods after public offerings 
during which members that have participated in the offering may not 
publish or otherwise distribute research; and establishing structural 
or institutional safeguards to protect analysts from the review, 
pressure or oversight of investment bankers or other non-research 
personnel that might be biased in their judgment or supervision. In 
addition, the proposed rule change

[[Page 69951]]

requires disclosures consistent with Section 15D, including the 
requirement to disclose any material conflict of interest of the 
research analyst or member that the research analyst knows or has 
reason to know at the time of publication or distribution of a research 
report or during a public appearance.
---------------------------------------------------------------------------

    \89\ 15 U.S.C. 78o-6.
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. The proposed rule change 
primarily reorganizes and restructures the current research rules, 
while maintaining the core provisions that have generally proven 
effective to promote objective and reliable research, as detailed 
through academic studies and other observations in the Joint Report and 
the GAO Report.\90\ The GAO Report, for example, concluded that 
empirical results suggest the rules have resulted in increased analyst 
independence and weakened the influence of conflicts of interest on 
analyst recommendations.\91\ The proposed rule change also amends the 
current rules to ensure the objectives of independent research analysts 
and unbiased research are achieved in the most effective manner.
---------------------------------------------------------------------------

    \90\ See Joint Report, supra note 6 at 16-26; see GAO Report, 
supra note 7 at 12-23.
    \91\ See GAO Report, supra note 7 at 12-15.
---------------------------------------------------------------------------

    In some places, the proposed rule change reduces regulatory 
uncertainty around the applicability of current rules. For example, the 
new provision regarding distribution of member research clarifies an 
existing interpretation prohibiting selective dissemination of research 
and provides guidance as to how members may differentiate research 
products to customers. In other places, the proposed rule change 
extends existing protections and adds new protections to fill gaps in 
the rules. Thus, the proposed rule change requires members to 
proactively identify and mitigate emerging conflicts related to the 
production and distribution of research, as members are best situated 
to spot such conflicts that may arise based on their particular 
business models or structures. As another example, the proposed rule 
change also extends the obligation to disclose material conflicts to 
associated persons with the ability to influence the content of a 
research report. This provision would close a gap that exists whereby 
persons who oversee research and research analysts could influence the 
recommendation or conclusions in a research report without disclosing 
their own material conflicts of interest or those of the member of 
which only they, and not the research analyst, know or have reason to 
know.
    The new rules would impose burdens primarily arising from 
establishing, maintaining and enforcing new written policies and 
procedures to comply with the rule change, as well as a few new 
disclosures to customers to the extent a member's research activities 
require them. FINRA believes the additional burdens associated with 
these new provisions are minimal, but necessary to ensure the 
protections of the rules cannot be frustrated. At the same time, the 
proposed rule change provides increased flexibility for members to 
create compliance programs more closely tailored to their businesses 
and organizational structures, without diminishing investor protection. 
For example, as detailed in Item 3 of this filing, the proposed rule 
change replaces the many current prescriptive requirements with respect 
to personal trading by research analyst accounts with a more flexible 
approach that requires policies and procedures to ensure that such 
accounts do not benefit in their trading from knowledge of the content 
and timing of research before the intended recipients have a reasonable 
opportunity to act on the information. FINRA believes this proposed 
change will maintain the current protection against a research analyst 
putting his or her own financial interests ahead of the analyst's 
customers' interest, but the increased flexibility will reduce costs 
and create fewer impediments to competition.
    The proposed rule change also promotes capital formation and 
lessens compliance costs for firms by eliminating or reducing quiet 
periods during which research cannot be published or otherwise 
disseminated. FINRA further analyzed deal data to confirm that the 
parameters for the exemption for firms with limited investment banking 
activity remain appropriate and extended the exemption to include 
compensation determination provisions, thereby relieving eligible firms 
from an appreciable burden. The proposed rule change also lessens costs 
by creating a new limited exemption from the registration requirements 
for ``research reports'' produced by persons whose primary job function 
is something other than producing research and by eliminating the 
annual attestation requirement.
    To help assess and minimize any burden on competition resulting 
from the proposal, FINRA consulted with several of its advisory 
committees and other industry members to solicit suggested changes to 
the existing rules and to obtain feedback on FINRA's proposed changes. 
Finally, as set forth in Item 5 of this filing, FINRA carefully 
considered comments to an earlier version of the proposed rule change 
and made several changes in response to those comments.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    FINRA solicited comments on an earlier iteration of the proposed 
rule change in Regulatory Notice 08-55 (``Notice Proposal''). The 
comment deadline expired on November 14, 2008. FINRA received five 
responses to the Notice Proposal.\92\ Commenters expressed support for 
many aspects of the proposal, including reductions to the quiet period 
provisions, the exemption for members with limited investment banking 
activity and the more flexible supervisory approach with respect to 
research analyst account trading. SIFMA further expressed appreciation 
for the guidance with respect to selective dissemination of research 
products. Commenters nevertheless urged several modifications to the 
proposal, some of which have been incorporated into the proposed rule 
change. FINRA responds to the material comments to the Notice Proposal 
below.
---------------------------------------------------------------------------

    \92\ Letter from Daniel H. Kolber, to Marcia E. Asquith, 
Corporate Secretary, FINRA, dated November 10, 2008 (``Kolber''); 
letter from John I. Fitzgerald, Leerink Swann LLC, to Marcia E. 
Asquith, Corporate Secretary, FINRA, dated November 10, 2008 
(``Leerink''); letter from Goodwin Procter LLP, to Marcia E. 
Asquith, Corporate Secretary, FINRA, dated November 11, 2008 
(``NVCA''); letter from Elliot R. Curzon, Dechert LLP, to Marcia E. 
Asquith, Corporate Secretary, FINRA, dated November 14, 2008 
(``Dechert''); and letter from Amal Aly, Managing Director and 
Associate General Counsel, Securities Industry and Financial Markets 
Association, to Marcia E. Asquith, Corporate Secretary, FINRA, dated 
November 14, 2008 (``SIFMA'').
---------------------------------------------------------------------------

Policies and Procedures
    Both the Notice Proposal and the proposed rule change differ in 
several respects from current NASD Rule 2711, perhaps most notably in 
adopting a policies and procedures approach to identification and 
management of equity research-related conflicts. FINRA has reintroduced 
several current provisions to the proposed rule change to clarify 
certain minimum standards and disclosure requirements. However, FINRA 
notes that the proposed rule change also establishes new standards of 
conduct. FINRA will provide

[[Page 69952]]

guidance, where appropriate, as to the application of the new 
standards. FINRA cautions that members should not conclude that, where 
specific conduct prohibitions or disclosure requirements that exist in 
the current provisions have not been expressly included in the proposed 
rule change, such conduct is now permissible or such disclosures are no 
longer required. Firms must apply the new proposed standards to make 
those determinations. FINRA notes that some of the new standards are 
intended to require thoughtful compliance by members that may require 
them to adapt and change their policies and procedures as they gain 
experience and encounter new circumstances that may impact on the 
objectivity and reliability of research.
    SIFMA endorsed the principle in the Notice Proposal and proposed 
rule change that members must implement policies and procedures 
reasonably designed to identify and effectively manage conflicts of 
interest related to the preparation, content and distribution of 
research reports and public appearances by research analysts. Yet SIFMA 
found ambiguous and overbroad the companion principle that such 
policies and procedures should promote ``reliable'' research that 
reflects the ``truly held opinions'' of research analysts and prevent 
the use of research to ``manipulate or condition the market'' or 
``favor the interests of the member or certain current or prospective 
clients.'' SIFMA asked FINRA to delete this introductory sentence and 
substitute the following alternative: ``a member's policies and 
procedures must be reasonably designed to promote independent and 
objective research that reflects the personal views of the analyst.'' 
Among other things, SIFMA asserted that the concept of ``reliable'' 
research is new and undefined.
    FINRA believes that the term ``reliable'' is commonly understood. 
FINRA further believes that the other terms referenced above and cited 
by SIFMA as vague are similarly unambiguous in describing the conduct 
that a member's policies and procedures must address or guard against. 
SIFMA made similar comments with respect to the words ``reliable 
information'' in the content and disclosure requirements of the Notice 
Proposal. As discussed below in response to that comment, that term is 
used in Sarbanes-Oxley without definition.
    SIFMA requested that FINRA confirm that with respect to the 
proposed prohibitions on analyst compensation, consistent with current 
rules, the proposal would not prevent a member from compensating 
analysts for engaging in permissible vetting, commitment committee 
participation, due diligence, teach-ins, investor education, and other 
permissible banking-related activities. SIFMA also recommended that the 
proposal be amended so that compensation committees are required to 
consider the enumerated factors when reviewing a research analyst's 
compensation only to the extent they are applicable. SIFMA suggested 
adding two new factors that are permissible for members to consider in 
determining analyst compensation, including the analyst's seniority and 
experience, and the market for hiring and retention of analysts, noting 
that these factors are critical to the proper determination of analyst 
compensation and are specifically identified in the Global Settlement.
    The proposal prohibits compensation based upon specific investment 
banking transactions or contributions to a member's investment banking 
services activities. It also requires the compensation review committee 
to consider the research analyst's productivity and quality of 
research. Both of these standards exist in the current rules. As SIFMA 
noted, FINRA staff previously stated that ``screening potential 
investment banking clients is one of many factors to measure the 
quality of an analyst's research.'' \93\ As such, FINRA concluded that 
the activity could be considered in determining a research analyst's 
compensation but ``may not be given undue weight relative to evaluating 
the quality of other research work product.'' FINRA further cautioned, 
however, that ``the size of any resultant or excluded investment 
banking deals should be irrelevant in assessing the quality of 
research.'' \94\ The same guidance applies to the compensation 
provisions in the proposed rule change. FINRA considers commitment 
committee participation to be part of the vetting process and further 
views permissible due diligence and education of the sales force and 
investors as other legitimate factors to consider in measuring the 
productivity and quality of research, with the same caveats previously 
articulated regarding undue weight and the size of related investment 
banking services transactions. FINRA has amended the proposed rule text 
to clarify that the enumerated factors must be considered only to the 
extent applicable. The proposed rule change does not preclude 
consideration of additional factors, including the analyst's experience 
and market factors. The proposed rule change only sets out requirements 
and prohibitions with respect to compensation, and therefore FINRA has 
not included in the rule text the suggested permissible factors.
---------------------------------------------------------------------------

    \93\ See Letter from Philip A. Shaikun, Associate General 
Counsel, NASD, to James A. Brigagliano, Assistant Director, Division 
of Market Regulation, SEC, dated July 29, 2003, at page 8.
    \94\ Id.
---------------------------------------------------------------------------

    SIFMA stated its support for ``the general principle that members 
should implement policies and procedures reasonably designed to prevent 
market manipulation or front running of research.'' However, SIFMA 
questioned the necessity of FINRA's language in proposed Rule 
2241(b)(2) that would require a firm's policies and procedures to be 
reasonably designed to prevent the use of research reports or research 
analysts to ``manipulate or condition the market or favor the interests 
of the member or certain current or prospective clients.'' According to 
SIFMA, that principle is already codified in existing SEC anti-
manipulation rules and FINRA's front running prohibition in FINRA Rule 
5270. Even if true, FINRA believes it is entirely appropriate to 
include that important principle as it relates to research reports and 
research analysts in a rule that is dedicated to research conflicts of 
interest and the conduct of research analysts. Moreover, FINRA notes 
that the proscribed conduct in its proposal is not congruent with 
either the SEC anti-manipulation or FINRA front running rules.
    The Notice Proposal required members to ``establish information 
barriers and other institutional safeguards to ensure that research 
analysts are insulated from the review, pressure or oversight of 
persons engaged in investment banking services activities or other 
persons who might be biased in their judgment or supervision.'' SIFMA 
suggested that members should be able to establish information barriers 
or other institutional safeguards to foster the required research 
analyst objectivity, since some information barriers are not always the 
most appropriate or efficient means to manage research conflicts. FINRA 
agrees and has amended the proposed rule change accordingly.
    SIFMA further urged FINRA to replace the phrase ``persons who might 
be biased in their judgment or supervision'' with ``persons within the 
firm who may try to improperly influence analysts' views'' because 
SIFMA contended that the former might sweep in salespeople, traders or 
subject companies that could have biases. FINRA notes that the proposed 
rule text came directly from the provisions of Sarbanes-Oxley related 
to management of research conflicts. FINRA believes

[[Page 69953]]

that language is intended to apply only to persons within the firm and 
does not extend to subject companies, which have no oversight or 
supervisory role with respect to research analysts within a broker-
dealer. Moreover, FINRA believes it's appropriate for this conflict 
management provision to include salespeople or traders to the extent 
that a member employs such individuals in an oversight or supervisory 
capacity and has reason to know that some or all of those individuals 
might be biased in discharging those obligations. As such, FINRA has 
maintained the provision in the proposed rule change.
    The Notice Proposal required members to prevent direct or indirect 
retaliation or threat of retaliation against research analysts by 
persons engaged in investment banking or other employees as the result 
of content of a research report. The proposed rule change maintains 
this requirement, but substitutes ``prohibit'' for ``prevent'' to align 
with the current rule language. SIFMA stated that the proposed 
provision is too broad because it applies to all employees, not just 
those involved in the investment banking department, and recommended 
that FINRA retain the current anti-retaliation provision in NASD Rule 
2711(j). FINRA disagrees. As stated in the Joint Report, FINRA believes 
that under no circumstances is retaliation appropriate against a 
research analyst who expresses his or her truly held beliefs about a 
subject company. To the extent a person outside the investment banking 
department is in a position to retaliate or threaten to retaliate 
against a research analyst--e.g., if the person is the chief executive 
officer, supervises the research analyst or is a member of the 
compensation review committee--FINRA believes the ban should cover 
them.
    The Notice Proposal provided a more flexible supervisory approach 
with respect to trading by analyst accounts in securities of companies 
covered by the research analyst. SIFMA supported the proposed approach 
but asked FINRA to confirm that if members have adopted internal 
policies prohibiting analysts from owning securities issued by 
companies the analyst covers, members may permit an analyst to divest 
any such holdings pursuant to a reasonable plan of liquidation within 
120 days of the effective date of the member's policy even if the sale 
is inconsistent with the analyst's current recommendation.
    In response, FINRA has included in the proposed rule change 
Supplementary Material .10, which states that FINRA shall not consider 
a research analyst account to have traded in a manner inconsistent with 
a research analyst's recommendation where a member has instituted a 
policy that prohibits any research analyst from holding securities, or 
options on or derivatives of such securities, of the companies in the 
analyst's coverage universe, provided that the member establishes a 
reasonable plan to liquidate such holdings consistent with the 
principles that prohibit an analyst from benefitting from his or her 
personal trading based on the knowledge of the timing or content of a 
research report and that such plan is approved by the member's legal or 
compliance department.
    The Notice Proposal required members to establish, maintain and 
enforce policies and procedures that prohibit participation by research 
analysts in ``road shows and other marketing on behalf of issuers.'' 
SIFMA asked FINRA to clarify that the proscription does not apply to 
``investor education activities'' and further is limited only to 
activities in connection with investment banking services transactions. 
By way of example, SIFMA suggested that the proposal would prohibit the 
practice by research analysts to facilitate meetings between investors 
and company management--so-called ``non-deal road shows.'' Leerink also 
questioned the scope of the provision and requested clarification with 
respect to whether the proposed language intends to eliminate the 
condition in Rule 2711 that the prohibition relate to the analyst's 
participation in the marketing of a specific investment banking 
services transaction and, instead, would prohibit all participation in 
marketing by research analysts whether or not related to investment 
banking services. Leerink noted that not every contact with a company 
should be viewed as marketing the investment banking services of the 
analyst's firm or jeopardizing the analyst's objectivity. Leerink 
further noted that it would deprive analysts of important information 
necessary for their role if they are prohibited from contacts with an 
issuer in circumstances where the issuer may be marketing itself, 
including attendance by a research analyst at a research conference or 
investor forum. SIFMA also requested that FINRA confirm that consistent 
with existing guidance (NASD Notice to Members 07-04 and NYSE 
Information Memo 07-11) analysts may listen to or view a live webcast 
of a transaction-related road show or other widely attended 
presentation by investment banking to investors or the sales force from 
a remote location, or another room if they are in the same location.
    FINRA agrees that research analysts should be able to educate 
investors, provided such education occurs outside the presence of 
investment bankers and issuer management and any such presentations are 
done in a fair and balanced manner. The proposed rule change therefore 
contains Supplementary Material .03 setting forth such permissible 
conduct, thus maintaining the current standard.
    As discussed in the Purpose section, FINRA believes the primary 
role of research analysts is to function as unbiased intermediaries 
between issuers and the investors who buy the issuers' securities. 
FINRA believes marketing by research analysts on behalf of issuers is 
antithetical to promoting objective research on such issuers' 
securities. FINRA is primarily concerned with marketing by research 
analysts in connection with an investment banking services transaction, 
and therefore FINRA has added that clarification to the provision in 
the proposed rule change.
    FINRA notes, however, that the overarching requirement to have 
policies and procedures to manage conflicts related to the interaction 
between research analysts and, among others, subject companies would 
apply to other marketing activity on behalf of an issuer. FINRA does 
not believe that merely facilitating a meeting between issuer 
management and investors, absent other facts, would constitute 
marketing on behalf of the issuer. Similarly, to Leerink's question, 
FINRA does not believe that mere attendance by a research analyst at a 
conference or forum where an issuer makes a presentation about its 
business prospects constitutes marketing ``on behalf of an issuer.'' 
Nor would FINRA consider it marketing on behalf on an issuer for a 
member to sponsor such a conference or forum and permit its research 
analysts to attend or facilitate discussion. FINRA believes that there 
is a fundamental distinction between an issuer that markets itself and 
a research analyst who markets on behalf of the issuer. It is the 
latter conduct that FINRA believes creates a conflict for a research 
analyst that must be prohibited or otherwise managed.
    As noted in the Purpose section, the existing guidance in Notice to 
Members 07-04 would continue to apply to research analyst participation 
in road shows. Therefore, a research analyst would be able to listen to 
or view a live webcast of a transaction-related road show or other 
widely attended presentation by investment banking to

[[Page 69954]]

investors or the sales force from a remote location, or another room if 
they are in the same location.
Distribution of Member Research Reports
    Leerink sought clarification regarding the scope of proposed Rule 
2241(g) in the Notice Proposal, a codification of an interpretation to 
then NASD Rule 2110 \95\ that prohibits selective dissemination of a 
research report to internal trading personnel or a particular customer 
or class of customers in advance of other customers that are entitled 
to receive the report. Leerink questioned whether the proposed 
Supplementary Material regarding that provision would extend the 
prohibition beyond research reports to other services because it refers 
to ``research products and services'' and is not limited to ``research 
reports.'' Leerink requested clarification as to how FINRA would define 
``research products and services'' and whether it would prohibit more 
generally favoring one type of client over another. The proposed 
Supplementary Material requires a member that provides different 
research products and services to different customers to notify the 
other customers that its alternative research products and services may 
reach different conclusions or recommendations that could impact the 
price of the equity security. Leerink also asked whether there should 
be a carve out from the notification provision for institutional 
clients, and, if not, whether an oral notification would be sufficient, 
given the nature of firms' relationships with institutional clients.
---------------------------------------------------------------------------

    \95\ FINRA has since adopted NASD Rule 2110 as FINRA Rule 2010 
without change. See Securities Exchange Act Release No. 58643 
(September 25, 2008), 73 FR 57174 (October 1, 2008) (Order Approving 
File No. SR-FINRA-2008-028).
---------------------------------------------------------------------------

    FINRA first notes that Leerink mistakenly believed that FINRA was 
proposing to modify its prohibition regarding trading ahead of research 
reports found in then NASD IM-2110-4. In fact, that Interpretive 
Material referred to similar but distinct conduct regarding adjusting a 
member's inventory based upon non-public information regarding the 
timing or content of an impending research report. The Commission has 
since approved FINRA Rule 5280, which transferred NASD IM-2110-4 into 
the Consolidated FINRA Rulebook with changes.\96\ The proposed rule 
change incorporates the aspect in FINRA Rule 5280 that the content of a 
research report may not be provided to internal trading personnel prior 
to public dissemination, but goes beyond that more narrow focus to 
address dissemination of a research report to one or more customers 
prior to other customers that the firm has previously determined are 
entitled to that report. The provision and accompanying Supplementary 
Material in the proposed rule change are limited by their terms to the 
dissemination of research products and services and do not address the 
broader question of when a member may not favor one client over 
another. FINRA included research ``products and services'' because 
FINRA understands that some customers receive not only different types 
of research reports than other customers, but also might receive other 
additional services related to research, such as more opportunity to 
interact directly with a research analyst. The Supplementary Material 
explains that offering those different services are permissible, 
provided they do not include differential timing in the receipt of 
potentially market moving information, including oral dissemination.
---------------------------------------------------------------------------

    \96\ See Securities Exchange Act Release No. 59254 (January 15, 
2009), 74 FR 4271 (January 23, 2009) (Order Approving File No. SR-
FINRA-2008-054).
---------------------------------------------------------------------------

    FINRA believes that the notification requirement in the 
Supplementary Material should apply to all customers that receive a 
research product or service from the member if the member provides 
different research products to different customers. FINRA notes that, 
consistent with Sarbanes-Oxley, the other provisions of the current and 
proposed rules do not differentiate between retail and institutional 
customers and further notes that not all institutional customers have 
the sophistication and experience to know without disclosure the nature 
and impact of differing research products and services. However, FINRA 
believes firms may put in place any reasonably designed notification 
process, provided they can evidence compliance with the requirement.
Quiet Periods
    SIFMA, Leerink and NVCA generally supported the provisions in the 
Notice Proposal that would reduce the quiet period after IPOs for 
managers and co-managers from 40 days to 10 days, eliminate the quiet 
period after secondary offerings and eliminate the quiet periods around 
the waiver, expiration or termination of a lock-up agreement. These 
commenters believed that the Notice Proposal struck an appropriate 
balance between addressing conflicts and facilitating the flow of 
important information to investors. NVCA agreed with FINRA that other 
provisions of the Notice Proposal, together with SEC Regulation AC, 
would sufficiently maintain the integrity of research issued during 
what are now quiet periods.\97\ The proposed rule change maintains 
these provisions, except that it imposes a minimum three-day quiet 
period after a secondary offering, unless an exception applies. FINRA 
made this change because SEC staff determined that Sarbanes-Oxley 
mandates a minimum quiet period for underwriters after a secondary 
offering. FINRA believes the proposed three-day period will fairly 
effectuate that mandate while minimizing the effect on information 
flow.
---------------------------------------------------------------------------

    \97\ The remainder of the NVCA letter addressed more general 
matters concerning the strength and competitiveness of the U.S. IPO 
market that were not specifically directed at the FINRA proposal.
---------------------------------------------------------------------------

Content and Disclosure in Research Reports
    With a couple of modifications, the Notice Proposal and the 
proposed rule change maintain the current content and disclosure 
requirements. The proposed rule change adds a requirement that a member 
must establish, maintain and enforce written policies and procedures 
reasonably designed to ensure that purported facts in its research 
reports are based on reliable information. The proposed rule change 
maintains the mandated Sarbanes-Oxley disclosure requirements,\98\ as 
well as additional disclosure obligations--meanings and distribution of 
ratings and price charts, for example--that are designed to provide 
investors with useful information on which to base their investment 
decisions.
---------------------------------------------------------------------------

    \98\ See Section 501 Sarbanes-Oxley Act, Public Law 107-204, 116 
Stat. 745 (2002).
---------------------------------------------------------------------------

    SIFMA was concerned by the use of the term ``reliable'' in the 
proposed provision that would require members to ensure that purported 
facts in their research reports are based on reliable information. As 
stated above, FINRA believes that term ``reliable'' is commonly 
understood. We note, for example, that the term ``reliable 
information'' is used in the research provisions of Sarbanes-Oxley 
without definition. Furthermore, SIFMA recommended the following as an 
alternative to the provision that members ensure that purported facts 
in research reports be based on reliable information: ``Policies and 
procedures reasonably designed to ensure that facts are based on 
`sources believed by the member firm to be reliable.' '' (emphasis 
added). SIFMA appears to have borrowed the latter phrase from Exchange 
Act Rule 15c2-11(a), which also uses the term ``reliable'' without 
definition.

[[Page 69955]]

    The Notice Proposal required a member to ensure that any 
recommendation, rating or price target have a ``reasonable basis in 
fact'' and be accompanied by a ``clear explanation of the valuation 
method utilized and a fair presentation of the risks that may impede 
achievement of the recommendation, rating or price target.'' SIFMA 
recommended two changes to this provision. First, SIFMA suggested that 
FINRA substitute the term ``reasonable basis'' rather than ``reasonable 
basis in fact.'' FINRA believes that even judgments and estimates on 
which recommendations, ratings and price targets are based must be 
grounded in certain facts, but we also believe that the term 
``reasonable basis'' implies as much. Therefore, the proposed rule 
change maintains the ``reasonable basis'' standard in the current rule. 
SIFMA also noted that not all ratings are based on a valuation method, 
so FINRA has modified the language in the proposed rule change to that 
effect.
    SIFMA also objected to the requirement in the proposal that a 
member must disclose in any research report ``all conflicts that 
reasonably could be expected to influence the objectivity of the 
research report and that are known or should have been known by the 
member or research analyst on the date of publication or distribution 
of the report.'' SIFMA contended that the language would require 
members to identify ``all possible conflicts (material or immaterial) 
that may be known to anyone at the member.'' SIFMA recommended that 
FINRA revise the language to require only the enumerated disclosures, 
including the ``catch-all'' disclosure of ``any other material conflict 
of interest of the research analyst or member that the research analyst 
or an associated person of the member with the ability to influence the 
content of a research report knows or has reason to know at the time of 
the publication or distribution of the research report.'' In addition, 
SIFMA urged FINRA to revise this provision so that it is consistent 
with current requirements because the mandate that the disclosures be 
made with respect to material conflicts of interest that are known not 
only at the time of publication, but also at the time of the 
distribution of a research report, is unworkable.
    In general, FINRA believes that an immaterial conflict could not 
reasonably be expected to influence the objectivity of a research 
report, and therefore a materiality standard is essentially congruent 
with the proposed standard. FINRA agrees that the ``catch-all'' 
disclosure provision captures such material conflicts that the research 
analyst and persons with the ability to influence the content of a 
research report know or have reason to know. Therefore, FINRA has 
amended the proposal to delete as superfluous the overarching 
obligation to disclose ``all conflicts that reasonably could be 
expected to influence the objectivity of the research report and that 
are known or should have been known by the member or research analyst 
on the date of publication or distribution of the report.'' FINRA notes 
that the term ``distribution'' is drawn from the provisions of 
Sarbanes-Oxley that apply to equity research reports and is intended to 
capture research that may only be distributed electronically as opposed 
to published in hard copy. However, FINRA interprets this language to 
require the disclosures to be current only as of the date of first 
publication or distribution, provided that the research report is 
prominently dated, and the disclosures are not known to be misleading.
    SIFMA also labeled as unnecessary and burdensome the proposal's 
requirement to disclose if the member or its affiliates maintain a 
significant financial interest in the debt of a subject company. It 
asserted that such disclosure has little utility for investors, yet 
would require considerable resources to track such information. SIFMA 
also noted that to the extent that a member's ownership interest in a 
debt security presents a material conflict of interest, disclosure is 
already required by the ``catch-all'' provision that requires a member 
to disclose ``any other material conflict of interest of the research 
analyst or member that the research analyst or a person associated with 
a member with the ability to influence the content of a research report 
knows or has reason to know at the time of the publication or 
distribution of a research report.''
    FINRA believes that a significant debt holding in the subject 
company could very well present a material conflict of interest that 
could inform an investor's decision making. For example, a negative 
equity research report that discusses a subject company's ability to 
meet its debt service or certain bond covenants could impact the value 
of high yield or other debt held by the member. FINRA also notes that 
the proposed disclosure is similar to that required by the United 
Kingdom's Financial Conduct Authority, whose rules many of SIFMA's 
members with global operations are already subject to. And while it is 
true that material conflicts can be captured by the ``catch-all'' 
provision, that should not preclude FINRA from delineating specific 
disclosures as it has with several other disclosures, including 
investment banking relationships.
    SIFMA stated that it continues to believe that web-based disclosure 
promotes efficiency, provides important information to investors in a 
meaningful and effective manner, and is consistent with important 
initiatives by the SEC to promote the use of electronic media, 
particularly with respect to price charts and ratings distribution 
tables, which are often cumbersome and difficult to produce in 
individual research reports. SIFMA contended that web-based disclosure 
would greatly ease production burdens and streamline the research 
reports themselves if they could be provided through Web sites. SIFMA 
also urged FINRA to consider permitting a web-based disclosure regime 
for public appearances because it would allow investors to consider and 
appreciate more fully the disclosures related to these activities. 
SIFMA states that web-based disclosures would allow investors to 
download, review, and assess the disclosures (as opposed to simply 
hearing them recited before or after an appearance, at which time 
investors may not focus on the substance of the disclosures). As stated 
in the Purpose section, FINRA was informed by SEC staff that it 
believes a web-based disclosure approach would not be consistent with 
Sarbanes-Oxley; therefore, FINRA has not proposed it here.
Third-Party Research
    SIFMA noted that the Notice Proposal would impose a new requirement 
that members adopt policies and procedures to ensure that third-party 
research distributed by a member ``is reliable and objective'' in 
addition to the review standard in current Rule 2711(h) that would also 
be required by the Notice Proposal and proposed rule change. The 
current standard requires a members to review non-independent third-
party research for any ``untrue statement of material fact or any false 
or misleading information that: (i) Should be known from reading the 
report; or (ii) is known based on information otherwise possessed by 
the member.'' Independent third-party research is excepted from the 
review requirements. SIFMA asked FINRA to eliminate the new requirement 
or, at a minimum, allow an exception for independent third-party 
research. Also, instead of requiring disclosure of the specific points 
of information delineated by the current rules, the Notice Proposal and 
the

[[Page 69956]]

proposed rule change would include an overarching requirement that 
members disclose ``any material conflict of interest that can 
reasonably be expected to have influenced the choice of a third party 
research provider or the subject company of a third party research 
report.'' SIFMA believed that the existing specific disclosure 
requirements struck the appropriate balance and urged FINRA to 
eliminate the proposed new requirement.
    We do not think it unreasonable to require screening procedures for 
third-party research to help ensure, for example, that the third-party 
provider is not being paid by the issuer or that the research has some 
kind of track record or good reputation. In fact, in a 2006 comment 
letter, SIFMA stated that firms should ``demand high standards'' from 
providers of third-party research.\99\ However, FINRA has amended the 
proposal to prohibit a member from distributing third-party research 
that it knows or has reason to know is not objective or reliable. FINRA 
believes this standard more appropriately requires reasonable diligence 
without a duty of inquiry to definitively ascertain whether the 
research is, in fact, objective and reliable. As for disclosures, FINRA 
has built back in to the proposed rule change the specific required 
third-party disclosures in the current rule, but we also think it 
reasonable to overlay a principle to require disclosure of any material 
conflict that may have influenced the choice of the third-party 
provider or subject company.
---------------------------------------------------------------------------

    \99\ See Letter from Michael D. Udoff, Vice President and 
Associate General Counsel, SIFMA, to Nancy M. Morris, Secretary, 
SEC, dated November 14, 2006.
---------------------------------------------------------------------------

Definitions
    SIFMA and Dechert supported the provisions in the Notice Proposal 
to exclude from the definition of ``research report'' any communication 
on an open-end registered investment company that is not listed or 
traded on an exchange or a public direct participation program 
(``DPP''), but strongly urged FINRA to go further by carving-out 
written communications covering open-end exchange traded funds 
(``ETFs'') as well as private funds. These commenters argued that the 
same rationale that applies to the determination to exclude open-end 
investment companies also equally applies to ETFs and private funds 
(e.g., sales materials on ETFs and private funds are already subject to 
an extensive regulatory regime). Dechert stated that even though 
private fund sales literature is not subject to post-use review by 
FINRA, it does not need to be, because unlike open-end registered 
investment companies and public DPPs, it is only distributed to 
sophisticated investors. Dechert also believed that sales material on 
private funds are clearly prepared for marketing purposes and do not 
contain an analysis and, therefore, should not be subject to a 
regulatory regime that is intended to preserve the objectivity of 
analysis. Dechert further noted that sales literature cannot manipulate 
the price of a private fund because its value is calculated as the 
value of an open-end registered investment company using the NAV, not 
by the market. SIFMA also recommended that FINRA exclude from the 
definition of ``research report'' any type of periodic report or other 
communication for any managed client account, whether such account is 
``discretionary,'' as the current rule provides, or non-discretionary 
in nature. SIFMA believed that the rationale for excluding 
discretionary accounts is equally applicable to non-discretionary 
accounts because clients who use these accounts, in general, rely on 
their individual money managers, not research reports, to make 
investment decisions in line with their goals.
    FINRA believes the carve-out should be limited to sales material 
related to mutual funds, which trade at NAV and are subject to the 
filing requirements of FINRA's advertising rules. ETFs, which are 
expanding in number and nature, are more susceptible to market-moving 
comments because they trade on an exchange and do not always trade at 
NAV, particularly if an ETF holds thinly traded securities or 
securities that are traded on a foreign exchange, or if an ETF is 
highly concentrated in a single or small number of securities.
    For many of the same reasons, FINRA has reconsidered the proposed 
exemption for research on DPPs. FINRA has recently become more aware of 
research reports on master limited partnerships (``MLPs'') that 
technically fall under the definition of a DPP due to questions that 
have arisen since FINRA's new Rule 2210 (Communications with the 
Public) became effective in February 2013. MLPs more closely resemble 
individual stocks since they do not invest in an underlying portfolio 
of securities and therefore do not have a NAV and, in fact, FINRA has 
observed that research on MLPs largely resembles research on any other 
exchange-traded stock. FINRA notes, however, that not every 
communication concerning a DPP will be a research report--only those 
that include an analysis of the equity securities of the issuer and 
information sufficient upon which to base an investment decision would 
meet the definition of a research report. Sales material on private 
funds is not subject to FINRA's advertising review filing requirements. 
To the extent that the sales material does not, as Dechert asserts, 
contain an analysis, then it would not meet the definition of a 
research report. FINRA further notes that the rules do not currently 
except research on private securities nor is there an institutional 
carve-out, so to except research on hedge funds, for example, might set 
up an inconsistency.
    SIFMA stated that the proposed revisions to the definition of 
``investment banking services'' are overly broad and that FINRA should 
retain the current definition for this term. SIFMA expressed concern 
that the added language would broaden the definition to include 
personnel and departments not traditionally viewed as related to 
investment banking, including sales activities. As noted in the Purpose 
section, the current definition includes, without limitation, many 
common types of investment banking services. FINRA added the language 
``or otherwise acting in furtherance of'' in the proposed rule change 
to further emphasize that the term should be broadly construed to cover 
all aspects of facilitating a public or private offering, as well as 
other investment banking activities. However, the new language is not 
intended to capture sales activities.
Pitch Book Materials
    The proposed rule change requires policies and procedures 
reasonably designed to prohibit research analyst participation in 
pitches and other solicitation of investment banking services 
transactions. Supplementary Material .01 codifies previous guidance in 
Notice to Members 07-04, which sets out the principle that pitch 
materials may not contain any information about a member's research 
capacity in a manner that suggests, directly or indirectly, that the 
member might provide favorable research coverage. The supplementary 
material specifies that members may include the fact of coverage and 
the name of the research analyst because such information alone does 
not imply favorable coverage. The supplementary material also states 
FINRA's view that including an analyst's industry ranking in pitch 
materials implies favorable research because of the manner in which 
such rankings are compiled; i.e., they are voted on by institutional 
investors that tend to benefit from positive coverage of their 
holdings. SIFMA requested that FINRA revise the example provided in

[[Page 69957]]

the proposed supplementary material to clarify what sort of materials 
are prohibited or provide an alternative example of prohibited pitch 
materials. SIFMA also asked that FINRA confirm that members may 
disclose in pitch materials the fact that research coverage will be 
provided for a particular issuer.
    FINRA believes the principle is clear and has included examples to 
illustrate FINRA's view of its application. Whether other information 
included in pitch materials violate the principle will depend on the 
facts and circumstances.
Effective Date
    SIFMA requested that FINRA provide a 120-day grace period between 
the adoption of the proposal and the implementation of the proposed 
rules because some of the proposals will require major systems changes 
to firms' information technology systems, research report templates, 
and policies and procedures. FINRA is sensitive to the time firms will 
require to update their policies and procedures and systems to comply 
with the proposed rule change and will take those factors into 
consideration when establishing an implementation date.
Other Comments
    Kolber supported the proposed change to exempt from FINRA's 
research analyst registration and qualification requirements those 
individuals who produce ``research reports'' but whose primary job 
function is something other than to provide investment research. The 
remainder of Kolber's comments with respect to the research 
registration and qualification requirements addressed more generally 
the scope and difficulty of the Series 86 examination, which is not the 
subject of the proposal. Kolber also stated that the definition of 
``research report'' can be difficult to apply because it sets forth a 
standard and then lists several exceptions from the definition. FINRA 
notes that the structure is very similar to the definition of research 
report in Regulation AC and is not an uncommon drafting method. 
Kolber's other comments are directed to the difficulty of 
distinguishing between the definitions of ``sales literature'' and 
``advertisement'' in former NASD Rule 2210. That rule has since been 
replaced by consolidated FINRA Rule 2210, where those definitions no 
longer exist.

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

    Within 45 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 or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change 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 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2014-047 on the subject line.

Paper Comments

     Send paper comments in triplicate to Brent J. Fields, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2014-047. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-FINRA-2014-047 and should be 
submitted on or before December 15, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\100\
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    \100\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-27700 Filed 11-21-14; 8:45 am]
BILLING CODE 8011-01-P


