Document ID: SEC-2015-1234-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2015-07-22T04:00Z

[Federal Register Volume 80, Number 140 (Wednesday, July 22, 2015)]
[Notices]
[Pages 43528-43547]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-17972]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-75472; File No. SR-FINRA-2014-048]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by 
Amendment No. 1 Thereto, To Adopt FINRA Rule 2242 (Debt Research 
Analysts and Debt Research Reports)

July 16, 2015.

I. Introduction

    On November 14, 2014, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule to adopt new FINRA Rule 2242 (Debt 
Research Analysts and Debt Research Reports) to address conflicts of 
interest relating to the publication and distribution of debt research 
reports. The proposal was published for comment in the Federal Register 
on November 24, 2014.\3\ The Commission received five comments on the 
proposal.\4\ On February 19, 2015, FINRA filed Amendment No. 1 
responding to the comments received to the proposal as well as to 
propose amendments in response to these comments. The proposal, as 
amended by Amendment No. 1, was published for comment in the Federal 
Register on March 18, 2015.\5\ On February 20, 2015, the Commission 
issued an order instituting proceedings pursuant to section 19(b)(2)(B) 
of the Act \6\ to determine whether to approve or disapprove the 
proposal. The order was published for comment in the Federal Register 
on February 26, 2015.\7\ The Commission received a further four 
comments regarding the proceedings or in response

[[Page 43529]]

to Amendment No. 1,\8\ to which FINRA responded via letter on May 5, 
2015.\9\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Exchange Act Release No. 73623 (Nov. 18, 2014); 79 FR 69905 
(Nov. 24, 2014) (``Notice''). On January 6, 2015, FINRA consented to 
extending the time period for the Commission to either approve or 
disapprove the proposed rule change, or to institute proceedings to 
determine whether to approve or disapprove the proposed rule change, 
to February 20, 2015.
    \4\ See Letter from Kevin Zambrowicz, Associate General Counsel 
& Managing Director and Sean Davy, Managing Director, SIFMA, dated 
Dec. 15, 2014 (``SIFMA''), Letter from Hugh D. Berkson, President-
Elect, Public Investors Arbitration Bar Association, dated Dec. 15, 
2014 (``PIABA Debt''), Letter from Yoon-Young Lee, WilmerHale, dated 
Dec. 16, 2014 (``WilmerHale Debt One''), Letter from William Beatty, 
President and Washington (State) Securities Administrator, North 
American Securities Administrators Association, Inc., dated Dec. 19, 
2014 (``NASAA Debt One''), and Letter from Kurt N. Schacht, CFA, 
Managing Director, Standards and Financial Market Integrity and 
Linda L. Rittenhouse, Director, Capital Markets Policy, CFA 
Institute, dated Feb. 9, 2015 (``CFA Institute One'').
    \5\ Exchange Act Release No. 74490 (Mar. 12, 2015); 80 FR 14198 
(Mar. 18, 2015) (``Amendment Notice'').
    \6\ 15 U.S.C. 78s(b)(2)(B).
    \7\ Exchange Act Release No. 74340 (Feb. 20, 2015); 80 FR 10538 
(Feb. 26, 2015). Specifically, the Commission instituted proceedings 
to allow for additional analysis of the proposed rule change's 
consistency with section 15A(b)(9) of the Act, which requires that 
FINRA's rules be designed to, among other things, promote just and 
equitable principles of trade, remove impediments to and perfect the 
mechanism of a free and open market and a national market system, 
and, in general, to protect investors and the public interest. See 
id.
    \8\ Letter from Stephanie R. Nicholas, WilmerHale, dated Apr. 6, 
2015 (``WilmerHale Debt Two''), Letter from Kurt N. Schacht, 
Managing Director, Standards and Financial Market Integrity, and 
Linda L. Rittenhouse, Director, Capital Markets Policy, CFA 
Institute, to Brent J. Fields, Secretary, SEC, dated Apr. 7, 2015 
(``CFA Institute Two''), an anonymous comment dated Apr. 8, 2015 
(``Anonymous''), and Letter from William Beatty, President and 
Washington (State) Securities Administrator, North American 
Securities Administrators Association, Inc., dated Apr. 17, 2015 
(``NASAA Debt Two'').
    \9\ Letter from Philip Shaikun, Vice President and Associate 
General Counsel, FINRA, dated May 5, 2015 (``FINRA Response'').
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    This order approves the proposed rule change.

II. Description of the Proposed Rule Change

    As described more fully in the Notice, FINRA proposed to adopt 
FINRA Rule 2242 to address conflicts of interest relating to the 
publication and distribution of debt research reports. Proposed FINRA 
Rule 2242 would adopt a tiered approach that FINRA believed, in 
general, would provide retail debt research recipients with extensive 
protections similar to those provided to recipients of equity research 
under current and proposed FINRA rules,\10\ with modifications to 
reflect differences in the trading of debt securities.
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    \10\ See Exchange Act Release No. 73622 (Nov. 18, 2014); 79 FR 
69939 (Nov. 24, 2014) (SR-FINRA-2014-047) (proposing amendments to 
current SRO rules relating to equity research).
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    As stated above, the Commission received five comments on the 
proposal. All of the relevant commenters expressed general support for 
the proposal. Of the four comments received in regards to the 
proceedings or Amendment No. 1, one was supportive of the proposal as 
amended by Amendment No. 1 with certain specific comments,\11\ one 
stated that Amendment No. 1 addressed their specific comments,\12\ one 
reiterated prior concerns regarding the principles-based nature of the 
proposal,\13\ and one did not seem to be related to the proposed rule 
change.\14\
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    \11\ WilmerHale Debt Two.
    \12\ CFA Institute Two.
    \13\ NASAA Debt Two.
    \14\ Anonymous. The comment, in total, was: ``[I]s this a due 
diligence report where numbers amounts are fabricated? Is a 
qualified professional `valuing' as a way of adjusting the 
amounts[?] I believe individuals should be leery of using `debt' 
excessively when processing accounting matters. Especially with the 
prevalence of automated software and attitude of today[']s 
workers.'' Id. Neither we nor FINRA see any issues raised by this 
comment relevant to the proposed rule change. See FINRA Response.
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A. Definitions

    FINRA represented that most of the defined terms closely follow the 
defined terms for equity research in NASD Rule 2711, as amended by the 
equity research filing, with minor changes to reflect their application 
to debt research. The proposed definitions are set forth below.
    Under the proposed rule change, the term ``debt research analyst'' 
would mean an associated person who is primarily responsible for, and 
any associated person who reports directly or indirectly to a debt 
research analyst in connection with, the preparation of the substance 
of a debt research report, whether or not any such person has the job 
title of ``research analyst.'' \15\ The term ``debt research analyst 
account'' would mean any account in which a debt research analyst or 
member of the debt research analyst's household has a financial 
interest, or over which such analyst has discretion or control. It 
would not, however, include an investment company registered under the 
Investment Company Act of 1940 over which the debt research analyst or 
a member of the debt research analyst's household has discretion or 
control, provided that the debt research analyst or member of a debt 
research analyst's household has no financial interest in such 
investment company, other than a performance or management fee. The 
term also would not include a ``blind trust'' account that is 
controlled by a person other than the debt research analyst or member 
of the debt research analyst's household where neither the debt 
research analyst nor a member of the debt research analyst's household 
knows of the account's investments or investment transactions.\16\
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    \15\ See proposed FINRA Rule 2242(a)(1).
    \16\ See proposed FINRA Rule 2242(a)(2). The exclusion for a 
registered investment company over which a research analyst has 
discretion or control in the proposed definition mirrors proposed 
changes to the definition of ``research analyst account'' in the 
equity research rules.
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    The proposed rule change would define the term ``debt research 
report'' as any written (including electronic) communication that 
includes an analysis of a debt security or an issuer of a debt security 
and that provides information reasonably sufficient upon which to base 
an investment decision, excluding communications that solely constitute 
an equity research report as defined in proposed Rule 2241(a)(11).\17\ 
The proposed definition and exceptions noted below would, in FINRA's 
view, generally align with the definition of ``research report'' in 
NASD Rule 2711, while incorporating aspects of the Regulation AC 
definition of ``research report.'' \18\
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    \17\ See proposed FINRA Rule 2242(a)(3). FINRA explained that 
the proposed rule change did not need to, similar to the equity 
proposal, explicitly exclude communications concerning open-end 
registered investment companies that are not listed or traded on an 
exchange (``mutual funds'') from the proposed rule as they would not 
be captured by the rule in the first place. See proposed FINRA Rule 
2242(a)(4) (defining ``debt securities'' as not including ``equity 
securities'' as defined in the Act). See also Exchange Act Release 
No. 74488 (Mar. 12, 2015); 80 FR 14174 (Mar. 18, 2015) (explaining 
the equity proposal as amended).
    \18\ In aligning the proposed definition with the Regulation AC 
definition of research report, FINRA pointed out that the proposed 
definition differs in minor respects from the definition of 
``research report'' in NASD Rule 2711. For example, the proposed 
definition of ``debt research report'' would apply to a 
communication that includes an analysis of a debt security or an 
issuer of a debt security, while the definition of ``research 
report'' in NASD Rule 2711 applies to an analysis of equity 
securities of individual companies or industries.
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    Communications that constitute statutory prospectuses that are 
filed as part of the registration statement would not be included in 
the definition of a debt research report. Further, communications that 
constitute private placement memoranda and comparable offering-related 
documents, other than those that purport to be research, would not be 
included in the definition of a debt research report. In general, the 
term debt research report also would not include communications that 
are limited to the following, if they do not include an analysis of, or 
recommend or rate, individual debt securities or issuers:
     Discussions of broad-based indices;
     Commentaries on economic, political, or market conditions;
     Commentaries on or analyses of particular types of debt 
securities or characteristics of debt securities;
     Technical analyses concerning the demand and supply for a 
sector, index, or industry based on trading volume and price;
     Recommendations regarding increasing or decreasing 
holdings in particular industries or sectors or types of debt 
securities; or
     Notices of ratings or price target changes, provided that 
the member simultaneously directs the readers of the notice to the most 
recent debt research report on the subject company that includes all 
current applicable disclosures required by the rule and that such debt 
research report does not contain materially misleading disclosures, 
including disclosures that are outdated or no longer applicable.
    The term debt research report also, in general, would not include 
the following communications, even if they include an analysis of an 
individual debt security or issuer and information

[[Page 43530]]

reasonably sufficient upon which to base an investment decision:
     Statistical summaries of multiple companies' financial 
data, including listings of current ratings that do not include an 
analysis of individual companies' data;
     An analysis prepared for a specific person or a limited 
group of fewer than 15 persons;
     Periodic reports or other communications prepared for 
investment company shareholders or discretionary investment account 
clients that discuss individual debt securities in the context of a 
fund's or account's past performance or the basis for previously made 
discretionary investment decisions; or
     Internal communications that are not given to current or 
prospective customers.
    The proposed rule change would define the term ``debt security'' as 
any ``security'' as defined in section 3(a)(10) of the Exchange 
Act,\19\ except for any ``equity security'' as defined in section 
3(a)(11) of the Exchange Act,\20\ any ``municipal security'' as defined 
in section 3(a)(29) of the Exchange Act,\21\ any ``security-based 
swap'' as defined in section 3(a)(68) of the Exchange Act,\22\ and any 
``U.S. Treasury Security'' as defined in paragraph (p) of FINRA Rule 
6710.\23\
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    \19\ 15 U.S.C. 78c(a)(10).
    \20\ 15 U.S.C. 78c(a)(11).
    \21\ 15 U.S.C. 78c(a)(29).
    \22\ 15 U.S.C. 78c(a)(68).
    \23\ See proposed FINRA Rule 2242(a)(4).
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    The proposed rule change would define the term ``debt trader'' as a 
person, with respect to transactions in debt securities, who is engaged 
in proprietary trading or the execution of transactions on an agency 
basis.\24\
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    \24\ See proposed FINRA Rule 2242(a)(5).
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    The proposed rule change would provide that the term ``independent 
third-party debt research report'' means a third-party debt research 
report, in which the person producing the report both (1) has no 
affiliation or business or contractual relationship with the 
distributing member or that member's affiliates that is reasonably 
likely to inform the content of its research reports, and (2) makes 
content determinations without any input from the distributing member 
or that member's affiliates.\25\
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    \25\ See proposed FINRA Rule 2242(a)(6).
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    The proposed rule change would define the term ``investment banking 
department'' as any department or division, whether or not identified 
as such, that performs any investment banking service on behalf of a 
member.\26\ The term ``investment banking services'' would include, 
without limitation, acting as an underwriter, participating in a 
selling group in an offering for the issuer or otherwise acting in 
furtherance of a public offering of the issuer; acting as a financial 
adviser in a merger or acquisition; providing venture capital or equity 
lines of credit or serving as placement agent for the issuer or 
otherwise acting in furtherance of a private offering of the 
issuer.\27\
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    \26\ See proposed FINRA Rule 2242(a)(8).
    \27\ See proposed FINRA Rule 2242(a)(9).
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    The proposed rule change would define the term ``member of a debt 
research analyst's household'' as any individual whose principal 
residence is the same as the debt research analyst's principal 
residence.\28\
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    \28\ See proposed FINRA Rule 2242(a)(10).
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    The proposed rule change would define ``public appearance'' as any 
participation in a conference call, seminar, forum (including an 
interactive electronic forum) or other public speaking activity before 
fifteen or more persons or before one or more representatives of the 
media, a radio, television or print media interview, or the writing of 
a print media article, in which a debt research analyst makes a 
recommendation or offers an opinion concerning a debt security or an 
issuer of a debt security.\29\
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    \29\ See proposed FINRA Rule 2242(a)(11).
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    Under the proposed rule change the term ``qualified institutional 
buyer'' has the same meaning as under Rule 144A of the Securities 
Act.\30\
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    \30\ See proposed FINRA Rule 2242(a)(12).
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    The proposed rule change would define ``research department'' as 
any department or division, whether or not identified as such, that is 
principally responsible for preparing the substance of a debt research 
report on behalf of a member.\31\ The proposed rule change would define 
the term ``subject company'' as the issuer whose debt securities are 
the subject of a debt research report or a public appearance.\32\ 
Finally, the proposed rule change would define the term ``third-party 
debt research report'' as a debt research report that is produced by a 
person or entity other than the member.\33\
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    \31\ See proposed FINRA Rule 2242(a)(14).
    \32\ See proposed FINRA Rule 2242(a)(15).
    \33\ See proposed FINRA Rule 2242(a)(16).
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B. Identifying and Managing Conflicts of Interest

    Similar to the proposed equity research rule, the proposed rule 
change contains an overarching provision that would require 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 debt 
research reports; public appearances by debt research analysts; and the 
interaction between debt research analysts and persons outside of the 
research department, including investment banking, sales and trading 
and principal trading personnel, subject companies, and customers.\34\
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    \34\ See proposed FINRA Rule 2242(b)(1).
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    The written policies and procedures would be required to be 
reasonably designed to promote objective and reliable debt research 
that reflects the truly held opinions of debt research analysts and to 
prevent the use of debt research reports or debt research analysts to 
manipulate or condition the market or favor the interests of the firm 
or current or prospective customers or class of customers.\35\
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    \35\ See proposed FINRA Rule 2242(b)(2).
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    The proposed rule change would introduce a distinction between 
sales and trading personnel and persons engaged in principal trading 
activities, where, in FINRA's opinion, the conflicts addressed by the 
proposal are of most concern.
1. Prepublication Review
    FINRA proposed that the required policies and procedures would be 
required to prohibit prepublication review, clearance or approval of 
debt research by persons involved in investment banking, sales and 
trading, or principal trading, and either restrict or prohibit such 
review, clearance, and approval by other non-research personnel other 
than legal and compliance.\36\ The policies and procedures also would 
be required to prohibit prepublication review of a debt research report 
by a subject company, other than for verification of facts.\37\ The 
proposed rule change would allow sections of a draft debt research 
report to be provided to non-investment banking personnel, non-
principal trading personnel, non-sales and trading personnel, or to the 
subject company for factual review, so long as: (1) The sections of the 
draft debt research report submitted do not contain the research 
summary, recommendation or rating; (2) A complete draft of the debt 
research report is provided to legal or compliance personnel before 
sections of the report are submitted to non-investment banking 
personnel, non-

[[Page 43531]]

principal trading personnel, non-sales and trading personnel or the 
subject company; and (3) If, after submitting sections of the draft 
debt research report to non-investment banking personnel, non-principal 
trading personnel, non-sales and trading personnel or the subject 
company, the research department intends to change the proposed rating 
or recommendation, it would be required to first provide written 
justification to, and receive written authorization from, legal or 
compliance personnel for the change. The member would be required to 
retain copies of any draft and the final version of such debt research 
report for three years after publication. \38\
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    \36\ See proposed FINRA Rule 2242(b)(2)(A) and (B).
    \37\ See proposed FINRA Rule 2242(b)(2)(N).
    \38\ See proposed FINRA Rule 2242.05 (Submission of Sections of 
a Draft Research Report for Factual Review).
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2. Coverage Decisions
    With respect to coverage decisions, a member's written policies and 
procedures would be required under the proposal to restrict or limit 
input by investment banking, sales and trading and principal trading 
personnel to ensure that research management independently makes all 
final decisions regarding the research coverage plan.\39\ However, the 
provision would not preclude personnel from these or any other 
department from conveying customer interests and coverage needs, so 
long as final decisions regarding the coverage plan are made by 
research management.
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    \39\ See proposed FINRA Rule 2242(b)(2)(C).
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3. Solicitation and Marketing of Investment Banking Transactions
    A member's written policies and procedures also would be required 
under the proposal to restrict or limit activities by debt research 
analysts that can reasonably be expected to compromise their 
objectivity.\40\ This would include prohibiting 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. The proposed rule change would adopt 
Supplementary Material that incorporates an existing FINRA 
interpretation for the equity research rules that prohibits in pitch 
materials any information about a member's debt research capacity in a 
manner that suggests, directly or indirectly, that the member might 
provide favorable debt research coverage.\41\ 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 debt research analyst, since that information alone does not imply 
favorable coverage.
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    \40\ See proposed FINRA Rule 2242(b)(2)(L).
    \41\ See proposed FINRA Rule 2242.01 (Efforts to Solicit 
Investment Banking Business).
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    The proposed rule change also would prohibit investment banking 
personnel from directing debt research analysts to engage in sales or 
marketing efforts related to an investment banking services transaction 
or any communication with a current or prospective customer about an 
investment banking services transaction.\42\ In addition, the proposed 
rule change would adopt Supplementary Material to provide that, 
consistent with this requirement, no debt research analyst may engage 
in any communication with a current or prospective customer in the 
presence of investment banking department personnel or company 
management about an investment banking services transaction.\43\
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    \42\ See proposed FINRA Rule 2242(b)(2)(M).
    \43\ See proposed FINRA Rule 2242.02(a) (Restrictions on 
Communications with Customers and Internal Personnel).
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4. Supervision
    A member's written policies and procedures would be required under 
the proposal to limit the supervision of debt research analysts to 
persons not engaged in investment banking, sales and trading or 
principal trading activities.\44\ In addition, the member would further 
be required under the proposal to establish information barriers or 
other institutional safeguards reasonably designed to ensure that debt 
research analysts are insulated from the review, pressure or oversight 
by persons engaged in investment banking services, principal trading or 
sales and trading activities or others who might be biased in their 
judgment or supervision.\45\
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    \44\ See proposed FINRA Rule 2242(b)(2)(D).
    \45\ See proposed FINRA Rule 2242(b)(2)(H).
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5. Budget and Compensation
    A member's written policies and procedures also would be required 
under the proposal to limit the determination of a firm's debt research 
department budget to senior management, excluding senior management 
engaged in investment banking or principal trading activities, and 
without regard to specific revenues or results derived from investment 
banking.\46\ However, the proposed rule change would expressly permit 
all persons to provide input to senior management regarding the demand 
for and quality of debt research, including product trends and customer 
interests. It further would allow consideration by senior management of 
a firm's overall revenues and results in determining the debt research 
budget and allocation of expenses.
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    \46\ See proposed FINRA Rule 2242(b)(2)(E).
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    With respect to compensation determinations, a member's written 
policies and procedures would be required under the proposal to 
prohibit compensation based on specific investment banking services or 
trading transactions or contributions to a firm's investment banking or 
principal trading activities and prohibit investment banking and 
principal trading personnel from input into the compensation of debt 
research analysts.\47\ Further, the firm's written policies and 
procedures would be required under the proposal to require that the 
compensation of a debt research analyst who is primarily responsible 
for the substance of a research report be reviewed and approved at 
least annually by a committee that reports to a member's board of 
directors or, if the member has no board of directors, a senior 
executive officer of the member.\48\ This committee would be required 
under the proposal to not have representation from investment banking 
personnel or persons engaged in principal trading activities and would 
be required to consider certain factors when reviewing a debt research 
analyst's compensation. Specifically, the proposal would require that 
the committee consider the debt research analyst's individual 
performance, including the analyst's productivity and the quality of 
the debt research analyst's research as well as the overall ratings 
received from customers and peers (independent of the member's 
investment banking department and persons engaged in principal trading 
activities) and other independent ratings services.
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    \47\ See proposed FINRA Rule 2242(b)(2)(D) and (F).
    \48\ See proposed FINRA Rule 2242(b)(2)(G).
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    Neither investment banking personnel nor persons engaged in 
principal trading activities would be required under the proposal to 
give input with respect to the compensation determination for debt 
research analysts. However, sales and trading personnel would be 
permitted to give input to debt research management as part of the 
evaluation process in order to convey customer

[[Page 43532]]

feedback, provided that final compensation determinations are made by 
research management, subject to review and approval by the compensation 
committee.\49\ The committee, which would not be permitted to have 
representation from investment banking or persons engaged in principal 
trading activities, would be required to document the basis for each 
debt research analyst's compensation, including any input from sales 
and trading personnel.
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    \49\ See proposed FINRA Rule 2242(b)(2)(D) and (G).
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6. Personal Trading Restrictions
    Under the proposed rule change, a member's written policies and 
procedures would be required to restrict or limit trading by a ``debt 
research analyst account'' in securities, derivatives and funds whose 
performance is materially dependent upon the performance of securities 
covered by the debt research analyst.\50\ The procedures would be 
required under the proposal to ensure that those accounts, supervisors 
of debt research analysts, and associated persons with the ability to 
influence the content of debt research reports do not benefit in their 
trading from knowledge of the content or timing of debt research 
reports before the intended recipients of such research have had a 
reasonable opportunity to act on the information in the report.\51\ 
Furthermore, the procedures would be required under the proposal to 
generally prohibit a debt research analyst account from purchasing or 
selling any security or any option or derivative of such security in a 
manner inconsistent with the debt research analyst's most recently 
published recommendation, except that the procedures would be permitted 
to define circumstances of financial hardship (e.g., unanticipated 
significant change in the personal financial circumstances of the 
beneficial owner of the research analyst account) in which the firm 
would permit a debt research analyst account to trade contrary to that 
recommendation. In determining whether a particular trade is contrary 
to an existing recommendation, firms would be permitted to take into 
account the context of a given trade, including the extent of coverage 
of the subject security. While the proposed rule change does not 
include a recordkeeping requirement, FINRA stated it expects members to 
evidence compliance with their policies and procedures and retain any 
related documentation in accordance with FINRA Rule 4511.
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    \50\ See proposed FINRA Rule 2242(b)(2)(J).
    \51\ See proposed FINRA Rule 2242.07 (Ability to Influence the 
Content of a Research Report).
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    The proposed rule change includes Supplementary Material .10, which 
would provide that FINRA would not consider a research analyst account 
to have traded in a manner inconsistent with a research analyst's 
recommendation where a member has instituted a policy that prohibits 
any research analyst from holding securities, or options on or 
derivatives of such securities, of the companies in the research 
analyst's coverage universe, provided that the member establishes a 
reasonable plan to liquidate such holdings consistent with the 
principles in paragraph (b)(2)(J)(i) and such plan is approved by the 
member's legal or compliance department.\52\
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    \52\ See proposed FINRA Rule 2242.10.
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7. Retaliation and Promises of Favorable Research
    A member's written policies and procedures would be required to 
prohibit direct or indirect retaliation or threat of retaliation 
against debt research analysts by any employee of the firm for 
publishing research or making a public appearance that may adversely 
affect the member's current or prospective business interests.\53\ The 
policies and procedures would also be required to prohibit explicit or 
implicit promises of favorable debt research, specific research content 
or a specific rating or recommendation as inducement for the receipt of 
business or compensation.\54\
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    \53\ See proposed FINRA Rule 2242(b)(2)(I).
    \54\ See proposed FINRA Rule 2242(b)(2)(K).
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8. Joint Due Diligence with Investment Banking Personnel
    The proposed rule change would establish limitations regarding 
joint due diligence activities--i.e., due diligence by the debt 
research analyst in the presence of investment banking department 
personnel--during a specified time period. Specifically, the proposed 
rule change states that FINRA would interpret the overarching principle 
which would, under the proposal, require members to, among other 
things, establish, maintain, and enforce written policies and 
procedures that address the interaction between debt research analysts 
and those outside the research department, including investment banking 
department personnel, sales and trading personnel, principal trading 
personnel, subject companies, and customers,\55\ to prohibit the 
performance of joint due diligence prior to the selection of 
underwriters for the investment banking services transaction.\56\
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    \55\ See proposed FINRA Rule 2242(b)(1)(C).
    \56\ See proposed FINRA Rule 2242.09 (Joint Due Diligence).
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9. Communications Between Debt Research Analysts and Trading Personnel
    The proposed rule change delineates what would be the prohibited 
and permissible interactions between debt research analysts and sales 
and trading and principal trading personnel. The proposed rule change 
would require members to establish, maintain and enforce written 
policies and procedures reasonably designed to prohibit sales and 
trading and principal trading personnel from attempting to influence a 
debt research analyst's opinions or views for the purpose of benefiting 
the trading position of the firm, a customer or a class of 
customers.\57\ It would further prohibit debt research analysts from 
identifying or recommending specific potential trading transactions to 
sales and trading or principal trading personnel that are inconsistent 
with such debt research analyst's currently published debt research 
reports or from disclosing the timing of, or material investment 
conclusions in, a pending debt research report.\58\
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    \57\ See proposed FINRA Rule 2242.03(a)(1) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
    \58\ See proposed FINRA Rule 2242.03(a)(2) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
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    The proposed rule change would permit sales and trading and 
principal trading personnel to communicate customers' interests to a 
debt research analyst, so long as the debt research analyst does not 
respond by publishing debt research for the purpose of benefiting the 
trading position of the firm, a customer or a class of customers.\59\ 
In addition, debt research analysts would be permitted to provide 
customized analysis, recommendations or trade ideas to sales and 
trading and principal trading personnel and customers, provided that 
any such communications are not inconsistent with the analyst's 
currently published or pending debt research, and that any subsequently 
published debt research is not for the purpose of benefiting the 
trading position of the firm, a customer or a class of customers.\60\
---------------------------------------------------------------------------

    \59\ See proposed FINRA Rule 2242.03(b)(1) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
    \60\ See proposed FINRA Rule 2242.03(b)(2) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
---------------------------------------------------------------------------

    The proposed rule change also would permit sales and trading and 
principal

[[Page 43533]]

trading personnel to seek the views of debt research analysts regarding 
the creditworthiness of the issuer of a debt security and other 
information regarding an issuer of a debt security that is reasonably 
related to the price or performance of the debt security, so long as, 
with respect to any covered issuer, such information is consistent with 
the debt research analyst's published debt research report and 
consistent in nature with the types of communications that a debt 
research analyst might have with customers. In determining what is 
consistent with the debt research analyst's published debt research, 
FINRA stated that a member would be permitted to consider the context, 
including that the investment objectives or time horizons being 
discussed differ from those underlying the debt research analyst's 
published views.\61\ Finally, FINRA also stated that debt research 
analysts would be permitted to seek information from sales and trading 
and principal trading personnel regarding a particular debt instrument, 
current prices, spreads, liquidity, and similar market information 
relevant to the debt research analyst's valuation of a particular debt 
security.\62\
---------------------------------------------------------------------------

    \61\ See proposed FINRA Rule 2242.03(b)(3) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
    \62\ See proposed FINRA Rule 2242.03(b)(4) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
---------------------------------------------------------------------------

    The proposed rule change clarifies that communications between debt 
research analysts and sales and trading or principal trading personnel 
that are not related to sales and trading, principal trading or debt 
research activities would be permitted to take place without 
restriction, unless otherwise prohibited.\63\
---------------------------------------------------------------------------

    \63\ See proposed FINRA Rule 2242.03(c) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
---------------------------------------------------------------------------

10. Restrictions on Communications With Customers and Internal Sales 
Personnel
    The proposed rule change would apply standards to communications 
with customers and internal sales personnel. Any written or oral 
communication by a debt research analyst with a current or prospective 
customer or internal personnel related to an investment banking 
services transaction would be required to be fair, balanced and not 
misleading, taking into consideration the overall context in which the 
communication is made.\64\
---------------------------------------------------------------------------

    \64\ See proposed FINRA Rule 2242.02(b) (Restrictions on 
Communications with Customers and Internal Personnel).
---------------------------------------------------------------------------

    Consistent with the proposed prohibition on investment banking 
department personnel directly or indirectly directing a debt research 
analyst to engage in sales or marketing efforts related to an 
investment banking services transaction or directing a debt research 
analyst to engage in any communication with a current or prospective 
customer about an investment banking services transaction, no debt 
research analyst would be permitted to engage in any communication with 
a current or prospective customer in the presence of investment banking 
department personnel or company management about an investment banking 
services transaction.

C. Content and Disclosure in Debt Research Reports

    The proposed rule change would, in general, adopt the disclosures 
in the equity research rule for debt research, with modifications to 
reflect the different characteristics of the debt market. The proposed 
rule change would require members to establish, maintain and enforce 
written policies and procedures reasonably designed to ensure that 
purported facts in their debt research reports are based on reliable 
information.\65\ In addition, the policies and procedures would be 
required to be reasonably designed to ensure that any recommendation or 
rating has a reasonable basis and is accompanied by a clear explanation 
of any valuation method used and a fair presentation of the risks that 
may impede achievement of the recommendation or rating.\66\ While there 
would be no obligation to employ a rating system under the proposed 
rule, members that choose to employ a rating system would be required 
to clearly define in each debt research report the meaning of each 
rating in the system, including the time horizon and any benchmarks on 
which a rating is based. In addition, the definition of each rating 
would be required to be consistent with its plain meaning.\67\
---------------------------------------------------------------------------

    \65\ See proposed FINRA Rule 2242(c)(1)(A).
    \66\ See proposed FINRA Rule 2242(c)(1)(B).
    \67\ See proposed FINRA Rule 2242(c)(2).
---------------------------------------------------------------------------

    Consistent with the equity rules, irrespective of the rating system 
a member employs, a member would be required to include in each debt 
research report limited to the analysis of an issuer of a debt security 
that includes a rating of the subject company the percentage of all 
subject companies rated by the member to which the member would assign 
a ``buy,'' ``hold'' or ``sell'' rating.\68\ In addition, a member would 
be required to disclose in each debt research report the percentage of 
subject companies within each of the ``buy,'' ``hold,'' and ``sell'' 
categories for which the member has provided investment banking 
services within the previous 12 months.\69\ All such information would 
be required to be current as of the end of the most recent calendar 
quarter or the second most recent calendar quarter if the publication 
date of the debt research report is less than 15 calendar days after 
the most recent calendar quarter.\70\
---------------------------------------------------------------------------

    \68\ See proposed FINRA Rule 2242(c)(2)(A).
    \69\ See proposed FINRA Rule 2242(c)(2)(B).
    \70\ See proposed FINRA Rule 2242(c)(2)(C).
---------------------------------------------------------------------------

    If a debt research report limited to the analysis of an issuer of a 
debt security contains a rating for the subject company and the member 
has assigned a rating to such subject company for at least one year, 
the debt research report would be required to show each date on which a 
member has assigned a rating to the debt security and the rating 
assigned on such date. This information would be required for the 
period that the member has assigned any rating to the debt security or 
for a three-year period, whichever is shorter.\71\ Unlike the equity 
research rules, the proposed rule change would not require those 
ratings to be plotted on a price chart because of limits on price 
transparency, including daily closing price information, with respect 
to many debt securities.
---------------------------------------------------------------------------

    \71\ See proposed FINRA Rule 2242(c)(3).
---------------------------------------------------------------------------

    The proposed rule change would require a member to disclose in any 
debt research report at the time of publication or distribution of the 
report: \72\
---------------------------------------------------------------------------

    \72\ See proposed FINRA Rule 2242(c)(4).
---------------------------------------------------------------------------

     If the debt research analyst or a member of the debt 
research analyst's household has a financial interest in the debt or 
equity securities of the subject company (including, without 
limitation, any option, right, warrant, future, long or short 
position), and the nature of such interest;
     If the debt research analyst has received compensation 
based upon (among other factors) the member's investment banking, sales 
and trading or principal trading revenues;
     If the member or any of its affiliates managed or co-
managed a public offering of securities for the subject company in the 
past 12 months, 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 investment banking

[[Page 43534]]

services from the subject company in the next three months;
     If, as of the end of the month immediately preceding the 
date of publication or distribution of a debt research report (or the 
end of the second most recent month if the publication date is less 
than 30 calendar days after the end of the most recent month), 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; \73\
---------------------------------------------------------------------------

    \73\ See also discussion of proposed FINRA Rule 2242.04 
(Disclosure of Compensation Received by Affiliates) below.
---------------------------------------------------------------------------

     If the subject company is, or over the 12-month period 
preceding the date of publication or distribution of the debt research 
report has been, a client of the member, and if so, the types of 
services provided to the issuer. Such services, if applicable, shall be 
identified as either investment banking services, non-investment 
banking securities-related services or non-securities services;
     If the member trades or may trade as principal in the debt 
securities (or in related derivatives) that are the subject of the debt 
research report;
     If the debt research analyst received any compensation 
from the subject company in the previous 12 months; and
     Any other material conflict of interest of the debt 
research analyst or member that the debt research analyst or an 
associated person of the member with the ability to influence the 
content of a debt research report knows or has reason to know at the 
time of the publication or distribution of a debt research report.
    The proposed rule change would incorporate a proposed amendment to 
the corresponding provision in the equity research rules that expands 
the existing ``catch all'' disclosure to require 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.'' The proposed rule change defines a 
person with the ``ability to influence the content of a research 
report'' as an associated person who is required to review the content 
of the debt research report or has exercised authority to review or 
change the debt research report prior to publication or distribution. 
This term would not include legal or compliance personnel who may 
review a debt research report for compliance purposes but are not 
authorized to dictate a particular recommendation or rating.\74\ The 
``reason to know'' standard in the provision would not impose a duty of 
inquiry on the debt research analyst or others who can influence the 
content of a debt 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.
---------------------------------------------------------------------------

    \74\ See proposed FINRA Rule 2242.07.
---------------------------------------------------------------------------

    The proposed rule change would mandate disclosure of firm ownership 
of debt securities in research reports or a public appearance to the 
extent those holdings constitute a material conflict of interest.\75\
---------------------------------------------------------------------------

    \75\ See proposed FINRA Rules 2242(c)(4)(H) and (d)(1)(E).
---------------------------------------------------------------------------

    The proposed rule change would adopt an exception for disclosure 
that would reveal material non-public information regarding specific 
potential future investment banking transactions.\76\ Similar to the 
equity research rules, the proposed rule change would require that 
disclosures be presented on the front page of debt research reports or 
the front page must refer to the page on which the disclosures are 
found. Electronic debt research reports, however, would be permitted to 
provide a hyperlink directly to the required disclosures. All 
disclosures and references to disclosures required by the proposed rule 
would need to be clear, comprehensive and prominent.\77\
---------------------------------------------------------------------------

    \76\ See proposed FINRA Rule 2242(c)(5).
    \77\ See proposed FINRA Rule 2242(c)(6).
---------------------------------------------------------------------------

    Like the equity research rule, the proposed rule change would 
permit a member that distributes a debt research report covering six or 
more companies (compendium report) to direct the reader in a clear 
manner to the applicable disclosures. Electronic compendium reports 
would be required to include a hyperlink to the required disclosures. 
Paper-based compendium reports would be required to provide either a 
toll-free number or a postal address to request the required 
disclosures and also may include a web address of the member where the 
disclosures can be found.\78\
---------------------------------------------------------------------------

    \78\ See proposed FINRA Rule 2242(c)(7).
---------------------------------------------------------------------------

D. Disclosure of Compensation Received by Affiliates

    The proposed rule change would provide that a member would not be 
required to disclose receipt of non-investment banking services 
compensation by an affiliate if it has implemented written policies and 
procedures reasonably designed to prevent the debt research analyst and 
associated persons of the member with the ability to influence the 
content of debt research reports from directly or indirectly receiving 
information from the affiliate as to whether the affiliate received 
such compensation.\79\ In addition, a member would be permitted to 
satisfy the disclosure requirement with respect to the receipt of 
investment banking compensation from a foreign sovereign by a non-U.S. 
affiliate of the member by implementing written policies and procedures 
reasonably designed to prevent the debt research analyst and associated 
persons of the member with the ability to influence the content of debt 
research reports from directly or indirectly receiving information from 
the non-U.S. affiliate as to whether such non-U.S. affiliate received 
or expects to receive such compensation from the foreign sovereign. 
However, a member would be required to disclose receipt of compensation 
by its affiliates from the subject company (including any foreign 
sovereign) in the past 12 months when the debt research analyst or an 
associated person with the ability to influence the content of a debt 
research report has actual knowledge that an affiliate received such 
compensation during that time period.
---------------------------------------------------------------------------

    \79\ See proposed FINRA Rule 2242.04 (Disclosure of Compensation 
Received by Affiliates).
---------------------------------------------------------------------------

E. Disclosure in Public Appearances

    The proposed rule change closely parallels the equity research 
rules with respect to disclosure in public appearances. Under the 
proposed rule, a debt research analyst would be required to disclose in 
public appearances: \80\
---------------------------------------------------------------------------

    \80\ See proposed FINRA Rule 2242(d)(1).
---------------------------------------------------------------------------

     If the debt research analyst or a member of the debt 
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;
     If, to the extent the debt research analyst knows or has 
reason to know, the member or any affiliate received any compensation 
from the subject company in the previous 12 months;
     If the debt research analyst received any compensation 
from the subject company in the previous 12 months;
     If, to the extent the debt research analyst knows or has 
reason to know, the subject company currently is, or during the 12-
month period preceding the date of publication or distribution of the 
debt research report, was, a client of the member. In such cases, the 
debt research analyst also must disclose the

[[Page 43535]]

types of services provided to the subject company, if known by the debt 
research analyst; or
     Any other material conflict of interest of the debt 
research analyst or member that the debt research analyst knows or has 
reason to know at the time of the public appearance.
    However, a member or debt research analyst would not be required to 
make any such disclosure to the extent it would reveal material non-
public information regarding specific potential future investment 
banking transactions.\81\ Unlike in debt research reports, the ``catch-
all'' disclosure requirement in public appearances would apply only to 
a conflict of interest of the debt research analyst or member that the 
analyst knows or has reason to know at the time of the public 
appearance. FINRA stated it understands that supervisors or legal and 
compliance personnel, who otherwise might be captured by the definition 
of an associated person ``with the ability to influence,'' typically do 
not have the opportunity to review and insist on changes to public 
appearances, many of which are extemporaneous in nature.
---------------------------------------------------------------------------

    \81\ See proposed FINRA Rule 2242(d)(2).
---------------------------------------------------------------------------

    The proposed rule change would require members to maintain records 
of public appearances by debt research analysts sufficient to 
demonstrate compliance by those debt research analysts with the 
applicable disclosure requirements for public appearances. Such records 
would be required to be maintained for at least three years from the 
date of the public appearance.\82\
---------------------------------------------------------------------------

    \82\ See proposed FINRA Rule 2242(d)(3).
---------------------------------------------------------------------------

F. Disclosure Required by Other Provisions

    With respect to both research reports and public appearances, the 
proposed rule change would require that, in addition to the disclosures 
required under the proposed rule, members and debt research analysts 
comply with all applicable disclosure provisions of FINRA Rule 2210 
(Communications with the Public) and the federal securities laws.\83\
---------------------------------------------------------------------------

    \83\ See proposed FINRA Rule 2242(e).
---------------------------------------------------------------------------

G. Distribution of Member Research Reports

    The proposed rule change would require firms to establish, maintain 
and enforce written policies and procedures reasonably designed to 
ensure that a debt 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 member has previously 
determined are entitled to receive the debt research report.\84\ The 
proposed rule change includes further guidance to explain that firms 
would be permitted to provide different debt 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.\85\
---------------------------------------------------------------------------

    \84\ See proposed FINRA Rule 2242(f).
    \85\ See proposed FINRA Rule 2242.06 (Distribution of Member 
Research Products).
---------------------------------------------------------------------------

    In addition, a member that provides different debt research 
products and services for certain customers would be required to inform 
its other customers that its alternative debt research products and 
services may reach different conclusions or recommendations that could 
impact the price of the debt security.\86\
---------------------------------------------------------------------------

    \86\ See id.
---------------------------------------------------------------------------

H. Distribution of Third-party Debt Research Reports

    FINRA proposed to apply the supervisory review and disclosure 
obligations applicable to the distribution of third-party equity 
research similarly to third-party retail debt research. Moreover, the 
proposed rule change would incorporate the current standards for third-
party equity research, including the distinction between independent 
and non-independent third-party research with respect to the review and 
disclosure requirements. In addition, the proposed rule change would 
adopt an expanded requirement in the proposed equity research rules 
that requires 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.
    The proposed rule change would prohibit a member from distributing 
third-party debt research if it knows or has reason to know that such 
research is not objective or reliable.\87\ 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.
---------------------------------------------------------------------------

    \87\ See proposed FINRA Rule 2242(g)(1).
---------------------------------------------------------------------------

    In addition, the proposed rule change would require a member to 
establish, maintain, and enforce written policies and procedures 
reasonably designed to ensure that any third-party debt research report 
it distributes contains no untrue statement of material fact and is 
otherwise not false or misleading.\88\ For the purpose of this 
requirement, a member's obligation to review a third-party debt 
research report would extend to any untrue statement of material fact 
or any false or misleading information that should be known from 
reading the debt research report or is known based on information 
otherwise possessed by the member.
---------------------------------------------------------------------------

    \88\ See proposed FINRA Rule 2242(g)(2).
---------------------------------------------------------------------------

    The proposed rule change would require that a member accompany any 
third-party debt research report it distributes with, or provide a web 
address that directs a recipient to, disclosure of any material 
conflict of interest that can reasonably be expected to have influenced 
the choice of a third-party debt research report provider or the 
subject company of a third-party debt research report, including:
     If the member or any of its affiliates managed or co-
managed a public offering of securities for the subject company in the 
past 12 months, 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 investment banking services from 
the subject company in the next three months;
     If the member trades or may trade as principal in the debt 
securities (or in related derivatives) that are the subject of the debt 
research report; and
     Any other material conflict of interest of the debt 
research analyst or member that the debt research analyst or an 
associated person of the member with the ability to influence the 
content of a debt research report knows or has reason to know at the 
time of the publication or distribution of a debt research report.\89\
---------------------------------------------------------------------------

    \89\ See proposed FINRA Rule 2242(g)(3).
---------------------------------------------------------------------------

    The proposed rule change would not require members to review a 
third-party debt research report prior to distribution if such debt 
research report is an independent third-party debt research report.\90\ 
For the purposes of the disclosure requirements for third-party 
research reports, a member would not be considered to have distributed 
a third-party debt research report where the research is an independent 
third-party debt research report and made available by a member upon 
request, through a member-maintained Web site, or to a customer in 
connection with a solicited order in which the registered 
representative has informed the

[[Page 43536]]

customer, during the solicitation, of the availability of independent 
debt research on the solicited debt security and the customer requests 
such independent debt research.\91\
---------------------------------------------------------------------------

    \90\ See proposed FINRA Rule 2242(g)(4).
    \91\ See proposed FINRA Rule 2242(g)(5).
---------------------------------------------------------------------------

    The proposed rule would require that members ensure that third-
party debt research reports are 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 debt research reports.\92\
---------------------------------------------------------------------------

    \92\ See proposed FINRA Rule 2242(g)(6). This requirement would 
codify guidance in Notice to Members 04-18 (March 2004) related to 
equity research reports.
---------------------------------------------------------------------------

I. Obligations of Persons Associated With a Member

    The proposed rule change would clarify the obligations of each 
associated person under those provisions of the proposed rule that 
require a member to restrict or prohibit certain conduct by 
establishing, maintaining, and enforcing particular policies and 
procedures. Specifically, the proposed rule change provides that, 
consistent with FINRA Rule 0140, persons associated with a member would 
be required to comply with such member's written policies and 
procedures as established pursuant to the proposed rule. In addition, 
consistent with Rule 0140, the proposed rule states in Supplementary 
Material .08 that it would be a violation of proposed Rule 2242 for an 
associated person to engage in the restricted or prohibited conduct to 
be addressed through the establishment, maintenance, and enforcement of 
written policies and procedures required by provisions of FINRA Rule 
2242, including applicable supplementary material.

J. Exemption for Members With Limited Investment Banking Activity

    Similar to the equity research rule, the proposed rule change would 
exempt from certain provisions regarding supervision and compensation 
of debt research analysts those members that over the previous three 
years, on average per year, have participated in ten or fewer 
investment banking services transactions as manager or co-manager and 
generated $5 million or less in gross investment banking revenues from 
those transactions.\93\ Specifically, members that meet those 
thresholds would be exempt from the requirement to establish, maintain, 
and enforce policies and procedures that (1) prohibit prepublication 
review of debt research reports by investment banking personnel or 
other persons not directly responsible for the preparation, content, or 
distribution of debt research reports (but not principal trading or 
sales and trading personnel, unless the member also qualifies for the 
limited principal trading activity exemption); (2) restrict or limit 
investment banking personnel from input into coverage decisions; (3) 
limit supervision of debt research analysts to persons not engaged in 
investment banking; (4) limit determination of the research department 
budget to senior management, excluding senior management engaged in 
investment banking activities; (5) require that compensation of a debt 
research analyst be approved by a compensation committee that may not 
have representation from investment banking personnel; and (6) 
establish information barriers to insulate debt research analysts from 
the review or oversight by persons engaged in investment banking 
services or other persons who might be biased in their judgment or 
supervision.\94\ However, the proposed rule would require that members 
with limited investment banking activity establish information barriers 
or other institutional safeguards reasonably designed to ensure debt 
research analysts are insulated from pressure by persons engaged in 
investment banking services activities or other persons, including 
persons engaged in principal trading or principal sales and trading 
activities, who might be biased in their judgment or supervision.\95\
---------------------------------------------------------------------------

    \93\ See proposed FINRA Rule 2242(h).
    \94\ See proposed FINRA Rule 2242(b)(2)(A)(i), (b)(2)(B), 
(b)(2)(C) (with respect to investment banking), (b)(2)(D)(i), 
(b)(2)(E) (with respect to investment banking), (b)(2)(G) and 
(b)(2)(H)(i) and (iii).
    \95\ For the purposes of proposed FINRA Rule 2242(h), FINRA 
clarified that the term ``investment banking services transactions'' 
includes the underwriting of both corporate debt and equity 
securities but not municipal securities.
---------------------------------------------------------------------------

    While small investment banks may need those who supervise debt 
research analysts under such circumstances also to be involved in the 
determination of those analysts' compensation, the proposal would still 
prohibit these firms from compensating a debt research analyst based 
upon specific investment banking services transactions or contributions 
to a member's investment banking services activities. Members that 
qualify for this exemption would be required to maintain records 
sufficient to establish eligibility for the exemption and also maintain 
for at least three years any communication that, but for this 
exemption, would be subject to all of the requirements of proposed 
FINRA Rule 2242(b).

K. Exemption for Limited Principal Trading Activity

    The proposed rule change includes an exemption from certain 
provisions regarding supervision and compensation of debt research 
analysts for members that engage in limited principal trading activity 
where: (1) In absolute value on an annual basis, the member's trading 
gains or losses on principal trades in debt securities are $15 million 
or less over the previous three years, on average per year; and (2) The 
member employs fewer than 10 debt traders; provided, however, that such 
members establish information barriers or other institutional 
safeguards reasonably designed to ensure debt research analysts are 
insulated from pressure by persons engaged in principal trading or 
sales and trading activities or other persons who might be biased in 
their judgment or supervision.\96\ Specifically, members that meet 
those thresholds would be exempt from the requirement to establish, 
maintain and enforce policies and procedures that: (1) Prohibit 
prepublication review of debt research reports by principal trading or 
sales and trading personnel or other persons not directly responsible 
for the preparation, content or distribution of debt research reports 
(but not investment banking personnel, unless the firm also qualifies 
for the limited investment banking activity exemption); (2) Restrict or 
limit principal trading or sales and trading personnel from input into 
coverage decisions; (3) Limit supervision of debt research analysts to 
persons not engaged in sales and trading or principal trading 
activities, including input into the compensation of debt research 
analysts; (4) Limit determination of the research department budget to 
senior management, excluding senior management engaged in principal 
trading activities; (5) Require that compensation of a debt research 
analyst be approved by a compensation committee that may not have 
representation from principal trading personnel; and (6) Establish 
information barriers to insulate debt research analysts from the review 
or oversight by persons engaged in principal trading or sales and 
trading activities or other persons who might be biased in their 
judgment or supervision.\97\
---------------------------------------------------------------------------

    \96\ See proposed FINRA Rule 2242(i).
    \97\ See proposed FINRA Rule 2242(b)(2)(A)(ii) and (iii), 
(b)(2)(B), (b)(2)(C) (with respect to sales and trading and 
principal trading), (b)(2)(D)(ii) and (iii), (b)(2)(E) (with respect 
to principal trading), (b)(2)(G) and (b)(2)(H)(ii) and (iii).
---------------------------------------------------------------------------

    As with the limited investment banking activity exemption, members

[[Page 43537]]

still would be required to establish information barriers or other 
institutional safeguards reasonably designed to ensure debt research 
analysts are insulated from pressure by persons engaged in principal 
trading or sales and trading activities or other persons who might be 
biased in their judgment or supervision. Members that qualify for this 
exemption must maintain records sufficient to establish eligibility for 
the exemption and also maintain for at least three years any 
communication that, but for this exemption, would be subject to all of 
the requirements of proposed FINRA Rule 2242(b).

L. Exemption for Debt Research Reports Provided to Institutional 
Investors

    Given the debt market and the needs of its participants, the 
proposed rule change would exempt debt research distributed solely to 
eligible institutional investors (``institutional debt research'') from 
most of the provisions regarding supervision, coverage determinations, 
budget and compensation determinations, and all of the disclosure 
requirements applicable to debt research reports distributed to retail 
investors (``retail debt research'').\98\ Under the proposed rule 
change, the term ``retail investor'' means any person other than an 
institutional investor.\99\
---------------------------------------------------------------------------

    \98\ See proposed FINRA Rule 2242(j)(1).
    \99\ See proposed FINRA Rule 2242(a)(13).
---------------------------------------------------------------------------

    The proposed rule distinguishes between larger and smaller 
institutions in the manner in which their opt-in decision is obtained. 
Larger institutions would be permitted to receive institutional debt 
research based on negative consent, while smaller institutions would be 
required to affirmatively consent in writing to receive that research.
    Specifically, the proposed rule would allow firms to distribute 
institutional debt research by negative consent to a person who meets 
the definition of a qualified institutional buyer (``QIB'') \100\ and 
where, pursuant to FINRA Rule 2111(b): (1) The member or associated 
person has a reasonable basis to believe that the QIB is capable of 
evaluating investment risks independently, both in general and with 
regard to particular transactions and investment strategies involving a 
debt security or debt securities; and (2) The QIB has affirmatively 
indicated that it is exercising independent judgment in evaluating the 
member's recommendations pursuant to FINRA Rule 2111 and such 
affirmation is broad enough to encompass transactions in debt 
securities. The proposed rule change would require written disclosure 
to the QIB that the member may provide debt research reports that are 
intended for institutional investors and are not subject to all of the 
independence and disclosure standards applicable to debt research 
reports prepared for retail investors. If the QIB does not contact the 
member and request to receive only retail debt research reports, the 
member would be permitted to reasonably conclude that the QIB has 
consented to receiving institutional debt research reports.\101\ FINRA 
stated that it would interpret this standard to allow an order placer, 
e.g., a registered investment adviser, for a QIB that satisfies the 
FINRA Rule 2111 institutional suitability requirements with respect to 
debt transactions to agree to receive institutional debt research on 
behalf of the QIB by negative consent should the rule be approved.
---------------------------------------------------------------------------

    \100\ See proposed FINRA Rule 2242(a)(12) under which a QIB has 
the same meaning as under Rule 144A of the Securities Act.
    \101\ See proposed FINRA Rule 2242(j)(1)(A)(i) and (ii).
---------------------------------------------------------------------------

    Institutional accounts that meet the definition of FINRA Rule 
4512(c) but do not satisfy the higher tier requirements described above 
would still be permitted to affirmatively elect in writing to receive 
institutional debt research. Specifically, a person that meets the 
definition of ``institutional account'' in FINRA Rule 4512(c) would be 
permitted to receive institutional debt research provided that such 
person, prior to receipt of a debt research report, has affirmatively 
notified the member in writing that it wishes to receive institutional 
debt research and forego treatment as a retail investor for the 
purposes of the proposed rule. Members would not be permitted to allow 
retail investors to choose to receive institutional debt research.\102\
---------------------------------------------------------------------------

    \102\ See proposed FINRA Rule 2242(j)(1)(B).
---------------------------------------------------------------------------

    FINRA stated that, to avoid a disruption in the receipt of 
institutional debt research, the proposed rule change would allow firms 
to send institutional debt research to any FINRA Rule 4512(c) account, 
except a natural person, without affirmative or negative consent for a 
period of up to one year after Commission approval of the proposed rule 
change while they obtain the necessary consents. Natural persons that 
qualify as an institutional account under FINRA Rule 4512(c) would be 
required to provide affirmative consent to receive institutional debt 
research during this transition period and thereafter.\103\
---------------------------------------------------------------------------

    \103\ See proposed FINRA Rule 2242.11 (Distribution of 
Institutional Debt Research During Transition Period).
---------------------------------------------------------------------------

    The proposed exemption would permit members that distribute 
institutional debt research to institutional investors to do so without 
meeting the proposed requirements to have written policies and 
procedures for this research with respect to: (1) Restricting or 
prohibiting prepublication review of institutional debt research by 
principal trading and sales and trading personnel or others outside the 
research department, other than investment banking personnel; (2) Input 
by investment banking, principal trading and sales and trading into 
coverage decisions; (3) Limiting supervision of debt research analysts 
to persons not engaged in investment banking, principal trading or 
sales and trading activities; (4) Limiting determination of the debt 
research department's budget to senior management not engaged in 
investment banking or principal trading activities and without regard 
to specific revenues derived from investment banking; (5) Determination 
of debt research analyst compensation; (6) Restricting or limiting debt 
research analyst account trading; and (7) Information barriers or other 
institutional safeguards reasonably designed to ensure debt research 
analysts are insulated from review or oversight by investment banking, 
sales and trading or principal trading personnel, among others (but 
members still must have written policies and procedures to guard 
against those persons pressuring analysts). The exemption further would 
apply to all disclosure requirements, including content and disclosure 
requirements for third-party research.
    Notwithstanding the proposed exemption, some provisions of the 
proposed rule still would apply to institutional debt research, 
including the prohibition on prepublication review of debt research 
reports by investment banking personnel and the restrictions on such 
review by subject companies. While prepublication review by principal 
trading and sales and trading personnel would not be prohibited 
pursuant to the exemption, other provisions of the rule would continue 
to require management of those conflicts, including the requirement to 
establish information barriers reasonably designed to insulate debt 
research analysts from pressure by those persons. Furthermore, the 
requirements in Supplementary

[[Page 43538]]

Material .05 related to submission of sections of a draft debt research 
report for factual review would apply to any permitted prepublication 
review by persons not directly responsible for the preparation, content 
or distribution of debt research reports. In addition, members would be 
required to prohibit debt research analysts from participating in the 
solicitation of investment banking services transactions, road shows, 
and other marketing on behalf of issuers and further prohibit 
investment banking personnel from directly or indirectly directing a 
debt research analyst to engage in sales and marketing efforts related 
to an investment banking deal or to communicate with a current or 
prospective customer with respect to such transactions. The provisions 
regarding retaliation against debt research analysts and promises of 
favorable debt research also would still apply with respect to research 
distributed to eligible institutional investors.\104\
---------------------------------------------------------------------------

    \104\ See proposed FINRA Rule 2242(j)(2).
---------------------------------------------------------------------------

    While the proposed rule change would not require institutional debt 
research to carry the specific disclosures applicable to retail debt 
research, it would require that such research carry general disclosures 
prominently on the first page warning that: (1) The report is intended 
only for institutional investors and does not carry all of the 
independence and disclosure standards of retail debt research reports; 
(2) If applicable, that the views in the report may differ from the 
views offered in retail debt research reports; and (3) If applicable, 
that the report may not be independent of the firm's proprietary 
interests and that the firm trades the securities covered in the report 
for its own account and on a discretionary basis on behalf of certain 
customers, and such trading interests may be contrary to the 
recommendation in the report.\105\ FINRA stated that the second and 
third disclosures described above would be required only if the member 
produces both retail and institutional debt research reports that 
sometimes differ in their views or if the member maintains a 
proprietary trading desk or trades on a discretionary basis on behalf 
of some customers and those interests sometimes are contrary to 
recommendations in institutional debt research reports.
---------------------------------------------------------------------------

    \105\ See proposed FINRA Rule 2242(j)(3).
---------------------------------------------------------------------------

    The proposed rule change would require members to establish, 
maintain and enforce written policies and procedures reasonably 
designed to ensure that institutional debt research is made available 
only to eligible institutional investors.\106\ A member would not be 
permitted to rely on the proposed exemption with respect to a debt 
research report that the member has reason to believe will be 
redistributed to a retail investor. The proposed rule change also 
states that the proposed exemption would not relieve a member of its 
obligations to comply with the antifraud provisions of the federal 
securities laws and FINRA rules.\107\
---------------------------------------------------------------------------

    \106\ See proposed FINRA Rule 2242(j)(4).
    \107\ See proposed FINRA Rule 2242(j)(5).
---------------------------------------------------------------------------

M. General Exemptive Authority

    The proposed rule change would provide FINRA, pursuant to the FINRA 
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.\108\
---------------------------------------------------------------------------

    \108\ See proposed FINRA Rule 2242(k).
---------------------------------------------------------------------------

III. Summary of Comment Letters, Discussion, and Commission Findings

    In response to the proposal as originally proposed by FINRA, the 
Commission received five comments on the proposal.\109\ All of the 
relevant commenters expressed general support for the proposal.\110\ 
The specifics of these comments were summarized when the Commission 
instituted proceedings and again when the Commission noticed Amendment 
No. 1.\111\ FINRA filed Amendment No. 1 as a response to these earlier 
comments as discussed when the amendment was noticed.\112\ In the time 
since Amendment No. 1 was filed the Commission has received four 
comment letters on the proposal.\113\ FINRA submitted a letter in 
response to these comments.\114\
---------------------------------------------------------------------------

    \109\ See note 4, supra.
    \110\ SIFMA, WilmerHale Debt One, PIABA Debt, NASAA Debt One and 
CFA Institute One.
    \111\ Exchange Act Release No. 74340 (Feb. 20, 2015); 80 FR 
10538 (Feb. 26, 2015) and Amendment Notice.
    \112\ Id.
    \113\ WilmerHale Debt Two, CFA Institute Two, Anonymous, and 
NASAA Debt Two.
    \114\ FINRA Response.
---------------------------------------------------------------------------

    All five of the commenters to the original proposal,\115\ and all 
three of the relevant commenters to the proposal in connection with 
instituting proceedings or with regards to Amendment No. 1,\116\ 
expressed general support for the proposal. The Commission notes this 
support.
---------------------------------------------------------------------------

    \115\ SIFMA, WilmerHale Debt One, PIABA Debt, NASAA Debt One, 
and CFA Institute One.
    \116\ WilmerHale Debt Two, CFA Institute Two, and NASAA Debt 
Two. As noted above the comment from Anonymous did not seem relevant 
to the proposed rule change as it seemed to be asking about 
accounting issues, which were not raised by the proposal. See note 
14, supra.
---------------------------------------------------------------------------

A. Comments and Discussion Regarding the Principles-Based Approach of 
the Proposed Rule Change

    The rule proposal as originally proposed would have adopted a 
policies and procedures approach to identification and management of 
research-related conflicts of interest and require those policies and 
procedures to, at a minimum, prohibit or restrict particular conduct. 
Commenters to the original proposal expressed several concerns with the 
approach.
    Two of these commenters asserted that the mix of a principles-based 
approach with prescriptive requirements was confusing in places and 
posed operational challenges. In particular, the commenters recommended 
eliminating the minimum standards for the policies and procedures.\117\ 
One of those commenters had previously expressed support for the 
proposed principles-based approach with minimum requirements,\118\ but 
asserted that the proposed rule text requiring procedures to ``at a 
minimum, be reasonably designed to prohibit'' specified conduct is 
superfluous or confusing. Another commenter to the original proposal 
favored utilizing a proscriptive approach similar to the current equity 
rules and also requiring that firms maintain policies and procedures 
designed to ensure compliance.\119\ Another commenter to the original 
proposal supported the types of communications between debt research 
analysts and other persons that may be permitted by a firm's policies 
and procedures.\120\ One commenter to the original proposal questioned 
the necessity of the ``preamble'' requiring policies and procedures 
that ``restrict or limit activities by research analysts that can 
reasonably be expected to compromise their objectivity'' that precedes 
specific prohibited activities related to investment banking 
transactions.\121\ Finally, some

[[Page 43539]]

commenters to the original proposal suggested FINRA eliminate language 
in the supplementary material that provides that the failure of an 
associated person to comply with the firm's policies and procedures 
constitutes a violation of the proposed rule itself.\122\ These 
commenters argued that because members may establish policies and 
procedures that go beyond the requirements set forth in the rule, the 
provision may have the unintended consequence of discouraging firms 
from creating standards in their policies and procedures that extend 
beyond the rule. One of those commenters suggested that the remaining 
language in the supplementary material adequately holds individuals 
responsible for engaging in restricted or prohibited conduct covered by 
the proposals.\123\
---------------------------------------------------------------------------

    \117\ SIFMA and WilmerHale Debt One.
    \118\ Letter from Amal Aly, Managing Director and Associate 
General Counsel, SIFMA, to Marcia E. Asquith, Corporate Secretary, 
FINRA, dated November 14, 2008 regarding Regulatory Notice 08-55 
(Research Analysts and Research Reports).
    \119\ NASAA Debt One.
    \120\ CFA Institute One.
    \121\ WilmerHale Debt One.
    \122\ SIFMA and WilmerHale Debt One.
    \123\ WilmerHale Debt One.
---------------------------------------------------------------------------

    FINRA, in response, stated it believes the framework will maintain 
the same level of investor protection in the current equity rules 
(which also would largely apply to retail debt research) while 
providing both some flexibility for firms to align their compliance 
systems with their business model and philosophy and imposing 
additional obligations to proactively identify and manage emerging 
conflicts. According to FINRA the proposal, even under a policies and 
procedures approach, ``would effectively maintain, with some 
modifications, the key proscriptions in the current rules'' \124\ 
(e.g., prohibitions on prepublication review, supervision of research 
analysts by investment banking and participation in pitches and road 
shows). FINRA disagreed that the ``preamble'' to some of those 
prohibitions is unnecessary. As with the more general overarching 
principles-based requirement to identify and manage conflicts of 
interest, the introductory principle that requires written policies and 
procedures to restrict or limit activities by research analysts that 
can reasonably be expected to compromise their objectivity recognizes 
that FINRA cannot identify every conflict related to research at every 
firm and therefore requires proactive monitoring and management of 
those conflicts. FINRA did not believe this ``preamble'' language is 
redundant with the broader overarching principle because it applies 
more specifically to the activities of research analysts and, unlike 
the broader principle, would preclude the use of disclosure as a means 
of conflict management for those activities.
---------------------------------------------------------------------------

    \124\ Presumably FINRA means the current equity research rules 
that would be carried over to debt research reports under the 
proposal.
---------------------------------------------------------------------------

    In light of the overarching principle that requires firms to 
establish, maintain, and enforce written policies and procedures 
reasonably designed to identify and effectively manage research-related 
conflicts, FINRA clarified that the ``at a minimum'' language was meant 
to convey that additional conflicts management policies and procedures 
may be needed to address emerging conflicts that may arise as the 
result of business changes, such as new research products, affiliations 
or distribution methods at a particular firm. As discussed in the 
Notice, FINRA stated that it intends for firms to proactively identify 
and manage those conflicts with appropriately designed policies and 
procedures. FINRA clarified that their inclusion of the ``at a 
minimum'' language was not, in their opinion, intended to suggest that 
firms' written policies and procedures must go beyond the specified 
prohibitions and restrictions in the proposal where no new conflicts 
have been identified. However, FINRA stated it believes the overarching 
requirement for policies and procedures reasonably designed to identify 
and effectively manage research-related conflicts suffices to achieve 
the intended regulatory objective, and therefore to eliminate any 
confusion, FINRA proposed to amend the proposals to delete the ``at a 
minimum'' language in Amendment No. 1. One of the commenters that 
raised this issue noted their approval of this change in their second 
letter.\125\
---------------------------------------------------------------------------

    \125\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    FINRA stated that it appreciates the commenters' concerns with 
respect to language in the supplementary material that would make a 
violation of a firm's policies a violation of the underlying rule. They 
further stated that the supplementary material was intended to hold 
individuals responsible for engaging in the conduct that the policies 
and procedures effectively restrict or prohibit. FINRA agreed that 
purpose is achieved with the language in the supplementary material 
that states that, consistent with FINRA Rule 0140, ``it shall be a 
violation of [the Rule] 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 [the Rule] or related Supplementary Material.'' Therefore, 
FINRA proposed, in Amendment No. 1, to amend the proposals to delete 
the language stating that a violation of a firm's policies and 
procedures shall constitute a violation of the rule itself. One of the 
commenters that raised this issue noted their approval of this change 
in their second letter.\126\
---------------------------------------------------------------------------

    \126\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    Another of the original commenters, in a second letter, repeated 
their concerns about utilizing a principles-based method in a rule in 
this area, noting that a proscriptive approach is known to be generally 
effective at addressing the types of conflicts of interest that the 
proposal is designed to address and repeated violations by industry of 
the current proscriptive equity research rule.\127\ FINRA disagreed 
with the commenter noting that the proposed rule change would establish 
for debt research reports, ``with a few modifications,'' the key 
requirements of the current equity rules as mandated policies and 
procedures members must establish.\128\
---------------------------------------------------------------------------

    \127\ NASAA Debt Two.
    \128\ FINRA Response.
---------------------------------------------------------------------------

B. Comments and Discussion Regarding the Definitions and Terms Used in 
the Proposed Rule Change

    One commenter to the original proposal requested that the proposal 
define the term ``sales and trading personnel'' as ``persons who are 
primarily responsible for performing sales and trading activities, or 
exercising direct supervisory authority over such persons.'' \129\ The 
commenter's proposed definition was intended to clarify that the 
proposed restrictions on sales and trading personnel activities should 
not extend to senior management who do not directly supervise those 
activities but have a reporting line from such personnel or persons who 
occasionally function in a sales and trading capacity. FINRA stated 
that it intends for the sales and trading personnel conflict management 
provisions to apply to individuals who perform sales and trading 
functions, irrespective of their job title or the frequency of engaging 
in the activities. As such, FINRA stated it did not intend for the rule 
to capture as sales and trading personnel senior management, such as 
the chief executive officer, who do not engage in or supervise day-to-
day sales and trading activities. However, FINRA stated it believes the 
applicable provisions should apply to individuals who may occasionally 
perform or directly supervise sales and trading activities. Otherwise, 
FINRA believes, investors could be put at risk with respect to the 
research or transactions involved when those individuals are

[[Page 43540]]

functioning in those capacities because the conflict management 
procedures and proscriptions and required disclosures would not apply. 
Therefore, FINRA proposed to amend the rule as part of Amendment No. 1 
to define sales and trading personnel to include ``persons in any 
department or division, whether or not identified as such, who perform 
any sales or trading service on behalf of a member.'' FINRA noted that 
this proposed definition is more consistent with the definition of 
``investment banking department'' in the proposed rule change.
---------------------------------------------------------------------------

    \129\ WilmerHale Debt One.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to include an 
exclusion from the definition of ``debt research report'' for private 
placement memoranda and similar offering-related documents prepared in 
connection with investment banking services transactions.\130\ The 
commenter noted that such offering-related documents typically are 
prepared by investment banking personnel or non-research personnel on 
behalf of investment banking personnel. The commenter asserted that 
absent an express exception, the proposals could turn investment 
banking personnel into research analysts and make the rule unworkable. 
The commenter noted that NASD Rule 2711(a) excludes communications that 
constitute statutory prospectuses that are filed as part of a 
registration statement and contended that the basis for that exception 
should apply equally to private placement memoranda and similar 
offering-related documents.
---------------------------------------------------------------------------

    \130\ WilmerHale Debt One.
---------------------------------------------------------------------------

    As FINRA had noted with respect to the definition of ``research 
report'' in the equity research filing, they also noted that a ``debt 
research report'' is generally understood not to include such offering-
related documents prepared in connection with investment banking 
services transactions. In the course of administering the filing review 
programs under FINRA Rules 2210 (Communications with the Public), 5110 
(Corporate Financing Rule), 5122 (Member Private Offerings) and 5123 
(Private Placements of Securities), FINRA stated it had not received 
any inquiries or addressed any issues that indicate there is confusion 
regarding the scope of the research analyst rules as applied to 
offering-related documents prepared in connection with investment 
banking activities. Regardless, to provide firms with greater clarity 
as to the status of such offering-related documents under the 
proposals, FINRA proposed to amend the proposed rule as part of 
Amendment No. 1 to exclude private placement memoranda and similar 
offering-related documents prepared in connection with investment 
banking services transactions other than those that purport to be 
research from the definition of ``debt research report.'' In their 
second comment letter, the commenter expressed support for this 
change.\131\
---------------------------------------------------------------------------

    \131\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to refrain from 
using the concept of ``reliable'' research in the proposal as it may 
inappropriately connote accuracy in the context of a research analyst's 
opinions.\132\ FINRA stated it believes that the term ``reliable'' is 
commonly understood and notes that the term is used in certain 
research-related provisions in the Sarbanes-Oxley Act of 2002 
(``Sarbanes-Oxley'') without definition. FINRA further stated it does 
not believe the term connotes accuracy of opinions.
---------------------------------------------------------------------------

    \132\ SIFMA.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to eliminate as 
redundant the term ``independently'' from the provisions permitting 
non-research personnel to have input into research coverage, so long as 
research management ``independently makes all final decisions regarding 
the research coverage plan.'' \133\ The commenter asserted that 
inclusion of ``independently'' is confusing since the proposal would 
permit input from non-research personnel into coverage decisions. FINRA 
stated it had included ``independently'' to make clear that research 
management alone is vested with making final coverage decisions. Thus, 
for example, a firm could not have a committee that includes a majority 
of research management personnel but also other individuals make final 
coverage decisions by a vote. As such, FINRA declined to eliminate the 
term as suggested.
---------------------------------------------------------------------------

    \133\ WilmerHale Debt One.
---------------------------------------------------------------------------

    One commenter to the original proposal requested that the proposal 
define the terms ``principal trading activities,'' ``principal trading 
personnel,'' and ``persons engaged in principal trading activities'' to 
exclude traders who are primarily involved in customer accommodation or 
customer facilitation trading, such as market makers that trade on a 
principal basis.\134\ The commenter stated that the exclusion is 
necessary to allow those traders to provide feedback from clients for 
the purposes of evaluating debt research analysts for compensation 
determination. More directly to that point, the same commenter and an 
additional commenter to the original proposal asserted that the 
proposal should not prohibit those engaged in principal trading 
activities from providing customer feedback as part of the evaluation 
and compensation process for a debt research analyst.\135\ They 
contended that the fixed income markets operate primarily on a 
principal basis and prohibiting such input would have a broad impact on 
research management's ability to appropriately evaluate and compensate 
debt research analysts.
---------------------------------------------------------------------------

    \134\ Id.
    \135\ SIFMA and WilmerHale Debt One.
---------------------------------------------------------------------------

    The proposal would allow sales and trading personnel, but not 
personnel engaged in principal trading activities, to provide input to 
debt research management into the evaluation of debt research analysts. 
As discussed in detail in the Notice in response to the similar comment 
raised to earlier iterations of the debt proposal,\136\ given the 
importance of principal trading operations to the revenues of many 
firms, FINRA stated it believes there is increased risk that a 
principal trader could improperly pressure or influence debt research 
if he or she has a say concerning analyst compensation or can 
selectively relay customer feedback. FINRA also stated it believes the 
risk to retail investors--the compensation evaluation restrictions 
would not apply to institutional debt research--outweighs the benefit 
of an additional data point for research management to assess the 
quality of research produced by those that they oversee. FINRA also 
noted that the proposal would allow sales and trading personnel to 
provide customer feedback. For these reasons, FINRA declined to define 
the terms as the commenter suggested. One of the commenters, in their 
second letter, expressed disappointment in this decision, but noted 
their acceptance that FINRA has already considered the issue a number 
of times and did not reiterate the comment.\137\
---------------------------------------------------------------------------

    \136\ 79 FR 69905, 69924.
    \137\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    Another commenter to the original proposal asked for clarification 
of the term ``principal trading'' because it believes the term ``sales 
and trading'' already encompasses all agency, principal and proprietary 
trading activities.\138\ FINRA clarified in response to this comment 
that the debt proposal imposes greater restrictions on interaction 
between debt research analysts and principal trading personnel than 
between debt research analysts and sales and trading personnel because 
the

[[Page 43541]]

magnitude of the conflict is greater with respect to the former. 
According to FINRA, this structure evolved based on extensive 
consultation and feedback from the industry. Based on those 
communications, FINRA stated it understands and intends for the term 
``sales and trading'' to exclude principal and proprietary trading 
activities. FINRA further stated it will consider providing guidance 
where it is unclear whether a particular job function or activity falls 
within ``sales and trading'' or ``principal trading'' activities.
---------------------------------------------------------------------------

    \138\ SIFMA.
---------------------------------------------------------------------------

    One commenter to the original proposal suggested that FINRA revise 
the definition of ``subject company'' to specify that the term means 
the ``issuer (rather than the ``company'') whose debt securities are 
the subject of a debt research report or a public appearance.'' \139\ 
The commenter noted that, among other things, the proposal would cover 
debt issued by persons other than corporate entities, such as foreign 
sovereigns or special purpose vehicles. FINRA agreed that the change is 
appropriate and proposed to amend the definition accordingly in 
Amendment No. 1.
---------------------------------------------------------------------------

    \139\ WilmerHale Debt One.
---------------------------------------------------------------------------

C. Comments and Discussion Regarding Information Barriers

    The proposed rule would require written policies and procedures to 
``establish information barriers or other institutional safeguards 
reasonably designed to ensure that research analysts are insulated from 
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.'' Some commenters to the original proposal suggested that 
``review'' was unnecessary in this provision because the review of debt 
research analysts was addressed sufficiently in other parts of the 
proposed rule.\140\ One such commenter further suggested that the terms 
``review'' and ``oversight'' are redundant.\141\ FINRA stated it does 
not agree that the terms ``review'' and ``oversight'' are coextensive, 
as the former may connote informal evaluation, while the latter may 
signify more formal supervision or authority. FINRA noted that while 
other provisions of the proposed rule change may address related 
conduct--for example, the provision that prohibits investment banking 
personnel, principal trading personnel and sales and trading personnel 
from supervision or control of debt research analysts--this provision 
extends to ``other persons'' who may be biased in their judgment or 
supervision. Finally, FINRA stated it included the ``review, pressure 
or oversight'' language to mirror the requirements for equity rules in 
Sarbanes-Oxley and therefore promote consistency. For these reasons, 
FINRA declined to revise the proposed rule change.
---------------------------------------------------------------------------

    \140\ SIFMA and WilmerHale Debt One.
    \141\ WilmerHale Debt One.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to clarify that 
the information barriers or other institutional safeguards required by 
the proposed rule are not intended to prohibit or limit activities that 
would otherwise be permitted under other provisions of the rule.\142\ 
In the Amendment Notice, FINRA stated that was their intent.
---------------------------------------------------------------------------

    \142\ WilmerHale Debt One.
---------------------------------------------------------------------------

    This commenter stated in their comment in response to Amendment No. 
1 that they interpreted this to mean that the proposal would permit 
members to allow persons engaged in sales and trading activities to 
provide informal and formal feedback on research analysts as one factor 
to be considered by research management for the purposes of the 
evaluation of the analyst.\143\ FINRA stated that, in general, it 
agreed with the commenter's interpretation.\144\
---------------------------------------------------------------------------

    \143\ WilmerHale Debt Two.
    \144\ FINRA Response.
---------------------------------------------------------------------------

    The commenter also asserted that the terms ``bias'' and 
``pressure'' are broad and ambiguous on their face and requested that 
FINRA clarify that for purposes of the information barriers requirement 
that they are intended to address persons who may try to improperly 
influence research.\145\ As an example, the commenter asked whether a 
bias would be present if an analyst was pressured to change the format 
of a research report to comply with the research department's standard 
procedures or the firm's technology specifications. FINRA stated it 
believes the terms ``pressure'' and ``bias'' are commonly understood, 
particularly in the context of rules intended to promote analyst 
independence and objectivity. FINRA further noted that the terms appear 
in certain research-related provisions of Sarbanes-Oxley without 
definition. With respect to the commenter's example, FINRA stated it 
does not believe a bias would be present simply because someone insists 
that a research analyst comply with formatting or technology 
specifications that do not otherwise implicate the rules.
---------------------------------------------------------------------------

    \145\ WilmerHale Debt One.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to modify the 
information barriers or other institutional safeguards requirement to 
conform the provision to FINRA's ``reasonably designed'' standard for 
related policies and procedures.\146\ FINRA stated it believed the 
change would be consistent with the standard for policies and 
procedures elsewhere in the proposal, and therefore proposed to amend 
the provision as requested in Amendment No. 1. The commenter noted with 
support this change in their second letter.\147\
---------------------------------------------------------------------------

    \146\ WilmerHale Debt One.
    \147\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    One commenter to the original proposal opposed as overbroad the 
proposed expansion of the current ``catch-all'' disclosure requirement 
to include ``any other material conflict of interest of the research 
analyst or member that a research analyst or an associated person of 
the member with the ability to influence the content of a research 
report knows or has reason to know'' (emphasis added) at the time of 
publication or distribution of research report.\148\ The commenter 
expressed concern about the emphasized language.
---------------------------------------------------------------------------

    \148\ WilmerHale Debt One.
---------------------------------------------------------------------------

    FINRA stated it proposed the change to capture material conflicts 
of interest known by persons other than the research analyst (e.g., a 
supervisor or the head of research) who are in a position to improperly 
influence a debt research report. FINRA defined ``ability to influence 
the content of a debt research report'' in the proposed rule's 
supplementary material 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.'' The commenter stated that the proposed change could 
capture individuals (especially legal and compliance personnel) who 
possess confidential information regarding potential future investment 
banking transactions and thus mandate disclosure of this confidential 
information. Further, it was possible that this information would not 
have been excepted from disclosure by a proposed exception in the 
original proposal that would have excluded disclosure where it would 
``reveal material non-public information regarding specific potential 
future investment banking transactions of the subject company.'' This 
is because, according to the commenter, legal and compliance may be 
aware of material conflicts of interest relating to the subject company 
that involve material

[[Page 43542]]

non-public information regarding specific future investment banking 
transactions of a competitor of the subject company. The commenter also 
expressed concern that the provision would slow down dissemination of 
research to canvass all research supervisors and management for 
conflicts. The commenter suggested that the change was unnecessary 
given other objectivity safeguards in the proposals that would guard 
against improper influence.
    FINRA stated it continues to believe that the catch-all provision 
must include persons with the ability to influence the content of a 
debt research report to avoid creating a gap where a supervisor or 
other person with the authority to change the content of a research 
report knows of a material conflict. However, FINRA clarified that it 
intended for the provision to capture only those individuals who are 
required to review the content of a particular research report or have 
exercised their authority to review or change the research report prior 
to publication or distribution. In addition, FINRA stated it did not 
intend to capture legal or compliance personnel who may review a 
research report for compliance purposes but are not authorized to 
dictate a particular recommendation or rating. FINRA proposed to amend 
the supplementary material in the proposals consistent with this 
clarification in Amendment No. 1. In addition, FINRA proposed to modify 
in Amendment No. 1 the exception in proposed Rules 2242(c)(5) and 
(d)(2) (applying to public appearances) so as to not require disclosure 
that would otherwise reveal material non-public information regarding 
specific potential future investment banking transactions, whether or 
not the transaction involves the subject company.
    This commenter in their comment in response to Amendment No. 1, 
while expressing their support for these changes, asked FINRA to make a 
modification of the parties who trigger disclosure of any other 
material conflict of interest. Specifically, the commenter asked FINRA 
to limit this disclosure to only be required when someone has authority 
to dictate a particular recommendation, rating, or price target.\149\ 
The commenter was seeking to extend this authority requirement to other 
parities that can trigger the disclosure, specifically persons who 
review the report and persons who have exercised authority to review or 
change the report generally. FINRA declined to make further changes, 
noting that the change in Amendment No. 1 ``was meant to limit 
application of the provision where there is a discrete review by [legal 
or compliance personnel] outside of the research department who do not 
have primary content review responsibilities'' and that ``those 
individuals that a firm requires to review research reports (e.g., a 
Supervisory Analyst) or who exercise their authority to change a 
research report (e.g., a Director of Research) by definition have the 
ability to influence the content of a research report.'' \150\
---------------------------------------------------------------------------

    \149\ WilmerHale Debt Two.
    \150\ FINRA Response.
---------------------------------------------------------------------------

    One commenter to the original proposal requested confirmation that 
members may rely on hyperlinked disclosures for research reports that 
are delivered electronically, even if these reports are subsequently 
printed out by customers.\151\ As long as a research report delivered 
electronically contains a hyperlink directly to the required 
disclosures, FINRA stated that the standard will be satisfied.
---------------------------------------------------------------------------

    \151\ WilmerHale Debt One.
---------------------------------------------------------------------------

D. Comments and Discussion Regarding Research Products With Differing 
Recommendations

    The proposed rule change would require firms to establish, maintain 
and enforce written policies and procedures reasonably designed to 
ensure that a research report is not distributed selectively to 
internal trading personnel or a particular customer or class of 
customers in advance of other customers that the firm has previously 
determined are entitled to receive the research report. The proposals 
also include supplementary material that explains that firms may 
provide different research products to different classes of customers--
e.g., long term fundamental research to all customers and short-term 
trading research to certain institutional customers--provided the 
products are not differentiated based on the timing of receipt of 
potentially market moving information and the firm discloses, if 
applicable, that one product may contain a different recommendation or 
rating from another product.
    One commenter to the original proposal supported the provisions as 
proposed with general disclosure,\152\ while another contended that 
FINRA should require members to disclose when its research products and 
services do, in fact, contain a recommendation contrary to the research 
product or service received by other customers.\153\ The commenter 
favoring general disclosure asserted that disclosure of specific 
instances of contrary recommendations would impose significant burdens 
unjustified by the investor protection benefits. The commenter stated 
that a specific disclosure requirement would require close tracking and 
analysis of every research product or service to determine if a 
contrary recommendation exists. The commenter further stated that the 
difficulty of complying with such a requirement would be exacerbated in 
large firms by the number of research reports published and research 
analysts employed and the differing audiences for research products and 
services.\154\ The commenter asserted that some firms may publish tens 
of thousands of research reports each year and employ hundreds of 
analysts across various disciplines and that a given research analyst 
or supervisor could not reasonably be expected to know of all other 
research products and services that may contain differing views.
---------------------------------------------------------------------------

    \152\ WilmerHale Debt One.
    \153\ PIABA Debt.
    \154\ WilmerHale Debt One.
---------------------------------------------------------------------------

    The opposing commenter stated that they believed that permitting 
contrary opinions while only disclosing the possibility of this 
contrary research to investors was insufficient to adequately protect 
investors because the use of ``may'' in a disclosure is not the same as 
disclosing that there actually are opposing opinions. Further, they 
questioned whether such disclosure was consistent with the Act in that 
it may contrary to Rule 10b-5 by permitting the omission of a material 
fact in the research report. They did not believe that the disclosure 
of actual opposing views would be burdensome on members as they should 
be aware of contrasting opinions. As a result, FINRA should require 
specific disclosures.\155\
---------------------------------------------------------------------------

    \155\ PIABA Debt.
---------------------------------------------------------------------------

    Another commenter to the original proposal expressed concern that 
the proposal raises issues about the parity of information received by 
retail and institutional investors, and whether research provided to 
institutional investors could contain views that differ from those in 
research to retail investors.\156\
---------------------------------------------------------------------------

    \156\ CFA Institute One.
---------------------------------------------------------------------------

    The supplementary material states that products may lead to 
different recommendations or ratings, provided that each is consistent 
with the member's ratings system for each respective product. In other 
words, according to FINRA, all differing recommendations or ratings 
must be reconcilable such that they are not truly at odds with one 
another. As such, the proposed rule change would not, in

[[Page 43543]]

FINRA's view, allow research provided to an institutional investor to 
contain views inconsistent with those offered in retail debt 
research.\157\ FINRA provided the following example from the filing 
regarding equity research: A firm might define a ``buy'' rating in its 
long-term research product to mean that a stock will outperform the S&P 
500 over the next year, while a ``sell'' rating in its short-term 
trading product might mean the stock will underperform its sector index 
over the next month. In this case, FINRA stated that the firm could, 
under the proposal, maintain a ``buy'' in the long-term research and a 
``sell'' in its trading research at the same time if the firm believed 
the stock would temporarily drop near term based on failing to meet 
expectations in an earnings report but still outperform the S&P over 
the next year. One commenter, in their second letter, stated that this 
clarification addressed their concerns that investor protections were 
being impacted.\158\
---------------------------------------------------------------------------

    \157\ According to FINRA, the proposed rule change would not 
require that all investors receive all research products, nor would 
it preclude a firm from offering, for example, a research product to 
select customers that includes greater depth of analysis. However, 
it would not, in FINRA's view, be consistent with the proposed rule 
change to provide inconsistent views to different classes of 
customers or to advantage one class of customers based on the timing 
of receipt of a recommendation, rating or potentially market moving 
information.
    \158\ CFA Institute Two.
---------------------------------------------------------------------------

    Since the proposed rule change would not allow inconsistent 
recommendations that could mislead one or more investors, FINRA stated 
that it believes general disclosure of alternative products with 
different objectives and recommendations is appropriate relative to its 
investor protection benefits. The commenter who supported this approach 
expressed support for FINRA's decision in their second letter.\159\
---------------------------------------------------------------------------

    \159\ WilmerHale Debt Two.
---------------------------------------------------------------------------

E. Comments and Discussion Regarding Structural and Procedural 
Safeguards

    One commenter to the original proposal asked that FINRA clarify 
that members that have developed policies and procedures consistent 
with FINRA Rule 5280 (Trading Ahead of Research Reports) would also be 
in compliance with the debt proposal's expectation of structural 
separation between investment banking and debt research, and between 
sales and trading and principal trading and debt research.\160\ FINRA 
indicated in the proposed rule change that while the proposed rule 
would not require physical separation, FINRA would expect such physical 
separation except in extraordinary circumstances where the costs are 
unreasonable due to a firm's size and resource limitations. FINRA Rule 
5280 does not, according to FINRA, specify physical separation between 
all of the persons involved. While similar in design and purpose to 
some aspects of the proposed requirements in the debt proposal, FINRA 
clarified that FINRA Rule 5280 is not congruent with the proposal to 
the point where compliance with the policies and procedures provision 
of that rule would be deemed compliance with the debt proposal 
separation requirements. FINRA stated that both FINRA Rule 5280 and the 
debt proposal require policies and procedures reasonably designed to 
limit information flow.
---------------------------------------------------------------------------

    \160\ WilmerHale Debt One.
---------------------------------------------------------------------------

    FINRA also stated it believes that physical separation is an 
effective component to a reasonably designed compliance system that 
requires information barriers.
    The same commenter asked that FINRA modify the prohibition on debt 
analyst attendance at road shows to permit passive participation since 
there is less opportunity to meet and assess issuer management than in 
the equity context.\161\ FINRA stated it believes that even passive 
participation by debt research analysts in road shows and other 
marketing may present conflicts of interest and, therefore, declined to 
revise the proposal as suggested.\162\ In their second letter, the 
commenter reiterated this suggested change because, while they note the 
need for analysts to maintain their objectivity, unlike equity research 
analysts who have frequent interactions with issuer management and may 
assist in the due diligence process for offerings, debt research 
analysts typically do not participate in due diligence and do not have 
the same opportunities to meet with issuer management and road shows 
may present the only opportunity to do so.\163\ For the same reasons as 
above, FINRA declined again to make this change.\164\
---------------------------------------------------------------------------

    \161\ WilmerHale Debt One.
    \162\ See also Notice.
    \163\ WilmerHale Debt Two.
    \164\ FINRA Response
---------------------------------------------------------------------------

F. Comments and Discussion Regarding Communications Between Research 
Analysts and Trading Desk Personnel

    A commenter to the original proposal asked FINRA to delete the term 
``attempting'' in the proposed Supplementary Material .03(a)(1), which 
would require members to have policies and procedures reasonably 
designed to prohibit sales and trading and principal trading personnel 
from ``attempting to influence a debt research analyst's opinion or 
views for the purpose of benefitting the trading position of the firm, 
a customer, or a class of customers.'' \165\ The commenter stated that 
it is unclear how a firm should enforce a prohibition on attempts to 
influence. FINRA notes that Supplementary Material .03(b)(2) sets forth 
permissible communications between debt research analysts and sales and 
trading and principal trading personnel, including, for example, 
allowing a debt research analyst to provide ``customized analysis, 
recommendations or trade ideas'' to customers or traders upon request, 
provided that the communications are ``not inconsistent with the 
analyst's current or pending debt research, and that any subsequently 
published debt research is not for the purpose of benefitting the 
trading position of the firm, a customer or a class of customers.'' In 
the context of such a request, FINRA stated that is not hard to 
envision the possibility that a trader, for example, might attempt to 
influence the analyst's view by emphasizing that a particular 
recommendation would be beneficial to the firm. FINRA expressed its 
belief that there are a variety of policies and procedures that could 
address such attempts, including periodic monitoring of such 
communications. As such, FINRA declined to delete ``attempting'' from 
the provision.
---------------------------------------------------------------------------

    \165\ WilmerHale Debt One.
---------------------------------------------------------------------------

    The commenter further expressed concern that the term ``pending'' 
is vague in the above-cited provision.\166\ The commenter suggested 
that FINRA delete the term or confirm that ``pending'' means ``imminent 
publication of a debt research report.'' FINRA stated it believes it is 
important that any customized analysis, recommendations or trade ideas 
be consistent not only with published research, but also any research 
being drafted in anticipation of publication or distribution that may 
contain changed or additional view or opinions. FINRA stated it 
considers such research in draft to be pending and therefore declined 
to delete the term or adopt an ``imminent'' standard as suggested by 
the commenter.
---------------------------------------------------------------------------

    \166\ Id.
---------------------------------------------------------------------------

    Proposed Supplementary Material .03(b)(3) would provide that, in 
determining what is consistent with a debt research analyst's published 
debt research for purposes of sharing certain views with sales and 
trading and principal trading personnel, members

[[Page 43544]]

may consider the context, including that the investment objectives or 
time horizons being discussed may differ from those underlying the debt 
analyst's published views. One commenter to the original proposal asked 
FINRA to clarify that the standard may be applied wherever consistency 
with a debt research analyst's views may be assessed under the proposed 
debt rule, such as with respect to debt research analyst account 
trading or providing customized analysis, recommendations, or trade 
ideas to sales and trading, principal trading, and customers.\167\ 
FINRA agreed in the Amendment Notice that context may be considered 
whenever consistency of research or views is at issue.
---------------------------------------------------------------------------

    \167\ Id.
---------------------------------------------------------------------------

G. Comments and Discussion Regarding Disclosure Requirements

    One commenter to the original proposal expressed concern about the 
proposed requirements that a member disclose in retail debt research 
reports its distribution of all debt security ratings (and the 
percentage of subject companies in each buy/hold/sell category for 
which the member has provided investment banking services within the 
previous twelve months) and historical ratings information on the debt 
securities that are the subject of the debt research report for a 
period of three years or the time during which the member has assigned 
a rating, whichever is shorter.\168\ The commenter asked FINRA to 
eliminate these provisions because the commenter believes that they are 
impractical and provide minimal benefit to investors in the context of 
debt research, even though they may be very useful in the equity 
context.\169\ The commenter stated that the large number of bond issues 
followed by analysts make the provisions especially burdensome and do 
not allow for helpful comparisons for investors across debt securities 
or issuers. With respect to the ratings distribution requirements, the 
commenter asserted that in some cases, a debt analyst may assign a 
rating to the issuer that applies to all of that issuer's bonds, 
thereby skewing the distribution because those issuers will be 
overrepresented in the distribution. The commenter also stated that the 
tracking requirements for these provisions would be particularly 
burdensome, given the numerous bonds issued by the same subject company 
and the fact that bonds are constantly being replaced with newer ones. 
Finally, the commenter stated that the three-year look back period is 
too long and suggested instead a one-year period if FINRA retains the 
historical rating table requirement.
---------------------------------------------------------------------------

    \168\ WilmerHale Debt One.
    \169\ Id.
---------------------------------------------------------------------------

    FINRA stated it believes that, similar to the current equity rules, 
to the extent that a firm produces retail debt research that assigns a 
rating to an issuer--i.e., a credit analysis--these disclosure 
provisions would provide value to retail investors to quickly gauge any 
apparent bias toward more or less favorable ratings or investment 
banking clients and to assess the accuracy of past ratings. Moreover, 
FINRA stated it understands that the burden to comply with the 
requirements with respect to this limited subset of debt research would 
be manageable for firms. Therefore, FINRA proposed to amend Rules 
2242(c)(2) and (3) in Amendment No. 1 to apply the ratings distribution 
requirement and historical rating table requirement only to each debt 
research report limited to the analysis of an issuer of a debt security 
that includes a rating of the subject company. Since the proposal would 
be limited to these issuer credit analyses and would not apply to 
individual bonds, FINRA expressed belief that many of the commenter's 
burden concerns would be alleviated and that it would be reasonable and 
appropriate to maintain the proposed three-year look back period with 
respect to the historical rating provision. In their second letter, the 
commenter expressed support for this change.\170\
---------------------------------------------------------------------------

    \170\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    While FINRA also believes that the disclosures would be valuable to 
retail investors with respect to debt research on individual debt 
securities, FINRA stated it recognizes the additional complexity and 
cost associated with compliance, particularly where a retail debt 
research report may include multiple ratings of individual debt 
securities, some of which may be positive and others negative or 
neutral. FINRA stated it believes it would be beneficial to obtain 
additional information about the array of debt research products that 
are now being distributed to retail investors, as well as the 
operational challenges and costs to apply these disclosure provisions 
to debt research on individual debt securities. Accordingly, FINRA 
proposed in Amendment No. 1 to eliminate for now the requirements with 
respect to debt research reports on individual debt securities. FINRA 
stated it will reconsider the appropriateness of the disclosure 
requirements as applied to research on individual debt securities after 
obtaining and assessing the additional information.
    The same commenter also requested that FINRA allow members to 
provide a hyperlink or web address to web-based disclosures in all debt 
research reports, rather than requiring the disclosures within a 
printed report.\171\ The commenter noted that while the Commission has 
interpreted section 15D(b) of the Exchange Act to require disclosure in 
each equity report, the law does not apply to debt research.\172\ FINRA 
stated it believes that disclosures in retail debt research reports 
should be proximate to the content of those reports and easily 
available to recipients of the research without requiring any 
substantive additional steps. Therefore, to the extent a debt research 
report is not delivered electronically with hyperlinked disclosures, 
FINRA stated it believes the disclosures must be in the research report 
itself. FINRA also expressed its belief that this will promote 
consistency between equity and retail debt research. FINRA further 
noted that institutional debt research would not require the specific 
disclosures.
---------------------------------------------------------------------------

    \171\ WilmerHale Debt One.
    \172\ See 15 U.S.C. 78o-6(b) and (d)(2).
---------------------------------------------------------------------------

H. Comments and Discussion Regarding the Institutional Debt Research 
Exemption

    The proposed rule change would exempt debt research provided solely 
to certain eligible institutional investors from many of the proposed 
rule's provisions, provided that a member obtains consent from the 
institutional investor to receive that research and the research 
reports contain specified disclosure to alert recipients that the 
reports do not carry the same protections as retail debt research. The 
proposal distinguishes between larger and smaller institutions in the 
manner in which the consent must be obtained. Firms would be permitted 
to use negative consent where the customer meets the definition of a 
QIB and satisfies the institutional suitability standards of FINRA Rule 
2111 with respect to debt transactions and strategies. Institutional 
accounts that meet the definition of FINRA Rule 4512(c), but do not 
satisfy the higher tier standard required for negative consent, would 
be permitted to affirmatively elect in writing to receive institutional 
debt research.
    One commenter to the original proposal opposed providing any 
exemption for debt research distributed solely to eligible 
institutional investors, contending that it would deprive the

[[Page 43545]]

market's largest participants of the important protections of the 
proposed rules for retail debt research.\173\ Another such commenter 
reiterated concerns expressed in response to an earlier iteration of 
the debt research proposal that the proposed standard for negative 
consent would be difficult to implement and would disadvantage 
institutional investors who are capable of, and in fact, make 
independent investment decisions about debt transactions and 
strategies. The commenter suggested as an alternative that the 
institutional investor standard should be based on only on the 
institutional suitability standard in Rule 2111.\174\
---------------------------------------------------------------------------

    \173\ PIABA Debt.
    \174\ SIFMA.
---------------------------------------------------------------------------

    Another commenter to the original proposal supported the proposed 
tiered approach for how institutional investors may receive research 
reports.\175\ The commenter stated that a QIB presumably has the 
sophistication and human and financial resources to evaluate debt 
research without the disclosures and other protections that accompany 
reports provided to retail investors. The commenter also supported 
permitting an institutional investor that does not fall within the 
higher tier category to receive the debt research without the retail 
investor protections if it notifies the firm in writing of its 
election.
---------------------------------------------------------------------------

    \175\ CFA Institute One.
---------------------------------------------------------------------------

    FINRA stated in the Notice and Amendment Notice that it believes an 
institutional exemption is appropriate to allow more sophisticated 
institutional market participants that can assess risks associated with 
debt trading and are aware of conflicts that may exist between a 
member's recommendations and trading interests, to continue to receive 
the timely flow of analysis and trade ideas that they value. FINRA 
noted that institutional debt research still would remain subject to 
several provisions of the rules, including the required separation 
between debt research and investment banking and the requirements for 
conflict management policies and procedures to insulate debt analysts 
from pressure by traders and others. In addition, FINRA noted that no 
institutional investor will be exposed to this less-protected 
institutional research without either negative or affirmative consent, 
as applicable.
    FINRA noted, with regard to the standard for negative consent, it 
does not believe that less sophisticated institutional investors should 
be required to take any additional steps to receive the full 
protections of the proposed rules. To the extent the QIB standard for 
negative consent is too difficult to implement, the proposal would 
provide an alternative to obtain a one-time affirmative consent for any 
Rule 4512(c) institutional account and further provides a one-year 
grace period to obtain that consent, so as not to disrupt the current 
flow of debt research to institutional customers. As discussed in the 
rule filing, FINRA included the alternative methods of consent and the 
grace period to satisfy the differing industry views on which of two 
consent options would be most cost effective.
    Another commenter to the original proposal asked that FINRA confirm 
that, in distributing debt research reports under the institutional 
debt research framework to certain non-U.S. institutional investors who 
are customers of a member's non-U.S. broker-dealer affiliate, the 
member may rely on similar classifications in the non-U.S. 
institutional investors' home jurisdictions.\176\ The commenter 
contended that this is necessary because some global firms distribute 
their debt research reports to non-U.S. institutional investors who may 
not have been vetted as QIBs for a variety of reasons. The debt 
proposal never contemplated recognizing equivalent institutional 
standards in other jurisdictions, and FINRA stated it does not believe 
that approach is appropriate or workable. FINRA questioned whether 
there are standards in other jurisdictions that are truly the 
equivalent of the QIB standard, and stated that it is impractical for 
FINRA to survey and assess the institutional standards around the world 
to determine equivalency, not to mention whether the home jurisdiction 
adequately examines for and enforces compliance with the standard. 
FINRA noted that, under the proposal, to the extent non-U.S. 
institutional investors have not been vetted as QIBs, firms have the 
option of either vetting them if they wish to send them institutional 
debt research by negative consent or obtaining affirmative written 
consent to the extent the institution satisfies the Rule 4212(c) 
standard.
---------------------------------------------------------------------------

    \176\ WilmerHale Debt One.
---------------------------------------------------------------------------

    The same commenter asked FINRA to clarify the application of the 
institutional debt research framework to desk analysts or other 
personnel who are part of the trading desk and are not ``research 
department'' personnel. In particular, the commenter suggested that 
proposed Rules 2242(b)(2)(H) (with respect to pressuring) and (b)(2)(L) 
(which would require policies and procedures reasonably designed to, 
among other things, restrict or limit activities by debt research 
analysts that can reasonably be expected to compromise their 
objectivity) should not apply when sales and trading personnel or 
principal trading personnel publish debt research reports in reliance 
on the institutional research exemption because the requirements of 
those provisions cannot be reconciled with the inherent nature of 
conflicts present.\177\ Those provisions would require firms to have 
policies and procedures to both establish information barrier or other 
institutional safeguards reasonably designed to insulate debt research 
analysts from pressure by, among others, principal trading or sales and 
trading personnel and restrict or limit activities by debt research 
analysts that can reasonably be expected to compromise their 
objectivity. FINRA disagreed with the commenter. They stated that they 
believe that minimum objectivity standards should apply to 
institutional debt research regardless of whether the research is 
published by research department personnel, sales and trading personnel 
or principal trading personnel. FINRA further stated it believes that a 
firm can and should put in place policies and procedures reasonably 
designed to ensure that other traders or sales and trading personnel do 
not overtly pressure a trader who produces debt research to express a 
particular view and to prevent that trader from participating in 
solicitations of investment banking or road show participation.
---------------------------------------------------------------------------

    \177\ Id.
---------------------------------------------------------------------------

I. Comments and Discussion Regarding the Exemptions for Limited 
Investment Banking Activity and Limited Principal Trading Activity

    The proposed rule change would exempt members with limited 
principal trading activity or limited investment banking activity from 
the review, supervision, budget, and compensation provisions in the 
proposed rule related to principal trading and investment banking 
personnel, respectively. The limited principal trading exemption would 
apply to firms that engage in principal trading activity where, in 
absolute value on an annual basis, the member's trading gains or losses 
on principal trades in debt securities are $15 million or less over the 
previous three years, on average per year, and the member employs fewer 
than ten debt traders. The limited investment banking exemption would 
apply, as it does in the equity rules, to firms that have managed or 
co-managed ten or fewer investment banking services

[[Page 43546]]

transactions on average per year, over the previous three years and 
generated $5 million or less in gross investment banking revenues from 
those transactions.
    One commenter to the original proposal questioned whether the 
exemptions could compromise the independence and accuracy of the 
analysis and opinions provided.\178\ The commenter further expressed 
concern that the exemption might allow traders to act on debt research 
prior to publication and distribution of that research. The commenter 
noted FINRA's commitment to monitor firms that avail themselves of the 
exemptions to evaluate whether the thresholds for the exemptions are 
appropriate and asked FINRA to publish findings that could help 
properly weigh the burdens on small firms while ensuring the 
independence of investment research. The commenter also encouraged 
FINRA to provide additional guidance as to what specific measures 
should be taken to ensure that debt research analysts are insulated 
from pressure by persons engaged in principal trading or sales and 
trading activities or other persons who might be biased in their 
judgment or supervision.
---------------------------------------------------------------------------

    \178\ CFA Institute One.
---------------------------------------------------------------------------

    FINRA stated in the Notice and the Amendment Notice that it 
included the exemptions to balance the burdens of compliance with the 
level or risk to investors. FINRA stated that it determined the 
thresholds for each exemption based on data analysis and a survey of 
firms that engage in principal trading activity or investment banking 
activity, respectively. FINRA clarified that it has not found abuses 
with respect to the limited investment banking exemption in the equity 
context and notes that some important separation requirements would 
still apply to the eligible firms, such as the prohibition on 
compensating a debt research analyst based on a specific investment 
banking transaction or contributions to a member's investment banking 
services activities.
    FINRA clarified that the proposed limited principal trading 
exemption would apply where, based on the survey and data analysis, it 
reasonably believes the amount of potential principal trading profits 
poses appreciably lower risk of pressure on debt research analysts by 
sales and trading or principal trading personnel and where there would 
be a significant marginal cost to add a trader dedicated to producing 
research relative to the increase in investor protection. FINRA further 
noted that the proposal would still prohibit debt research analysts at 
exempt firms from being compensated based on specific trading 
transactions.
    With respect to both exemptions, as the commenter noted, firms 
would still be required to establish information barriers or other 
institutional safeguards reasonably designed to ensure debt research 
analysts are insulated from pressure by persons engaged in investment 
banking or principal trading activities, among others. FINRA stated it 
believes a number of policies could be implemented to achieve 
compliance with this requirement. For example, in the context of 
principal trading, these measures might include monitoring of 
communications between debt research analysts and individuals on the 
trading desk and reviewing published research in relation to 
transactions executed by the firm in the subject company's debt 
securities. FINRA also noted that neither exemption would allow trading 
ahead of research by firm traders, as FINRA Rule 5280 would continue to 
apply to both debt and equity research and prohibits such conduct. 
Finally, as noted by the commenter, FINRA stated it intends to monitor 
the research produced by firms that avail themselves of the exemptions 
to assess whether the thresholds to qualify for the exemptions are 
appropriate or should be modified.
    The commenter responded in its second letter that, while FINRA 
addressed their concerns, they still had concerns that the examples 
given by FINRA in the Amendment Notice were insufficient. They 
recommended additional guidance by FINRA to help ensure adequate 
compliance. They also approved of FINRA's commitment to continue to 
monitor this issue and urged publication of the results.\179\ In their 
response, FINRA noted that the examples were not intended to be 
exhaustive and that, in light of the principles-based approach of the 
proposal there will be different ways for members to design policies 
and procedures reasonably designed to protect against pressure. FINRA 
stated it will continue to monitor the issue and will consider sharing 
its findings as appropriate.\180\
---------------------------------------------------------------------------

    \179\ CFA Institute Two.
    \180\ FINRA Response.
---------------------------------------------------------------------------

J. Comments and Discussion Regarding the Filing Requirement Exclusion

    One commenter to the original proposal asked FINRA to consider 
amending FINRA Rule 2210 to exclude debt research reports from that 
rule's filing requirements, since there is an exception from the filing 
requirements for equity research reports that concern only equity 
securities that trade on an exchange.\181\ FINRA stated it is willing 
to separately consider the merits of the request, but does not believe 
the issue is appropriate for resolution in the context of the debt 
proposal since it primarily relates to the provisions of a rule that 
are not the subject of the proposed rule change.
---------------------------------------------------------------------------

    \181\ WilmerHale Debt One.
---------------------------------------------------------------------------

K. Comments and Discussion Regarding the Implementation Date

    One commenter to the original proposal requested that the 
implementation date be at least twelve months after Commission approval 
of the proposed rule change and that FINRA sequence the compliance 
dates of the equity research filing and the proposed rule change in 
that order.\182\ Another such commenter requested that FINRA provide a 
``grace period'' of one year or the maximum time permissible, if that 
is less than one year, between the adoption of the proposed rule and 
the implementation date.\183\ FINRA stated that it 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 implementation dates. As 
stated in the Amendment Notice, 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. FINRA further stated 
that the effective date will be no later than 180 days following 
publication of the Regulatory Notice announcing Commission approval.
---------------------------------------------------------------------------

    \182\ SIFMA.
    \183\ WilmerHale Debt One.
---------------------------------------------------------------------------

J. Summary of Findings and Conclusion

    The Commission has carefully considered the proposed rule change, 
all of the comments received, and FINRA's responses to the comments. 
Based on its review of the record, the Commission finds that the 
proposed rule change, as amended by Amendment No. 1, is consistent with 
the requirements of the Act and the rules and regulations thereunder 
applicable to a national securities association.\184\ In particular, 
the Commission finds that the proposed rule change, as amended by 
Amendment No. 1, is consistent with section 15A(b)(6) of the Act, which 
requires, among other things, that FINRA's rules be designed to prevent 
fraudulent and manipulative acts and

[[Page 43547]]

practices, to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest.\185\
---------------------------------------------------------------------------

    \184\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \185\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    FINRA stated in its proposal that it ``believes that the proposed 
rule change would promote increased quality, objectivity and 
transparency of debt research distributed to investors by requiring 
firms to identify and mitigate conflicts in the preparation and 
distribution of such research'' and that ``the [proposed] rule will 
provide investors with more reliable information on which to base 
investment decisions in debt securities, while maintaining timely flow 
of information important to institutional market participants and 
providing those institutional investors with appropriate safeguards.''
    We generally agree with these assertions. The potential abuses 
spawned by the conflicts of interest between research and the business 
interests of broker-dealers in the equity space are well-known and 
well-established.\186\ As FINRA explained in the Notice, debt research 
is not immune to the challenges that these conflicts create. For 
example, the Massachusetts Secretary of the Commonwealth in 2008 
alleged that a FINRA member ``co-opted its supposedly independent 
[r]esearch [d]epartment to assist in sales efforts geared towards 
reducing its inventory'' of debt instruments.\187\ These allegations 
are similar to those raised in the allegations that led to the global 
research analyst settlement as a result of the abuses found regarding 
equity research.\188\ As a result, as noted by the U.S. Government 
Accountability Office, ``until FINRA adopts a fixed-income research 
rule, investors continue to face a potential risk.'' \189\ The proposed 
rule change attempts to address this need in a way that seems to 
effectively balance the public interest in effectively managing debt 
research conflicts of interest with the ability of members to also 
effectively provide research, and thus information, to the investing 
public. We also note that the relevant commenters to the proposal as 
amended, all of which were commenters to the original proposal, stated 
in their second comment letters that they generally agree with the 
proposal as amended.\190\
---------------------------------------------------------------------------

    \186\ See, e.g., ``Ten of Nation's Top Investment Firms Settle 
Enforcement Actions Involving Conflicts of Interest Between Research 
and Investment Banking,'' Press Release 2003-54 (available at http://www.sec.gov/news/press/2003-54.htm). As one commenter noted, these 
conflicts can still influence equity research. NASAA Debt Two. See 
also ``FINRA Fines 10 Firms a Total of $43.5 Million for Allowing 
Equity Research Analysts to Solicit Investment Banking Business and 
for Offering Favorable Research Coverage in Connection With 
Toys`R'Us IPO,'' FINRA News Release (available at http://www.finra.org/newsroom/2014/finra-fines-10-firms-total-435-million).
    \187\ Commonwealth of Massachusetts, Office of the Secretary of 
the Commonwealth, Securities Division, In the Matter of Merrill 
Lynch, Pierce, Fenner & Smith, Incorporated, Administrative 
Complaint, Docket No. 2008-0058 (Jul. 31, 2008) (available at http://archives.lib.state.ma.us/bitstream/handle/2452/213560/ocn886547410.pdf?sequence=1&isAllowed=y).
    \188\ See, ``Ten of Nation's Top Investment Firms Settle 
Enforcement Actions Involving Conflicts of Interest Between Research 
and Investment Banking,'' Press Release 2003-54 (available at http://www.sec.gov/news/press/2003-54.htm) (stating that ``[t]he 
enforcement actions allege that, from approximately mid-1999 through 
mid-2001 or later, all of the firms engaged in acts and practices 
that created or maintained inappropriate influence by investment 
banking over research analysts, thereby imposing conflicts of 
interest on research analysts that the firms failed to manage in an 
adequate or appropriate manner'').
    \189\ U.S. Government Accountability Office, GAO-12-209, 
Securities Research: Additional Actions Could Improve Regulatory 
Oversight of Analyst Conflicts of Interest, at 41 (Jan. 12, 2012) 
(available at http://www.gao.gov/assets/590/587613.pdf).
    \190\ WilmerHale Debt Two, CFA Institute Two, and NASAA Debt 
Two.
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    Regarding concerns raised by commenters regarding the principles-
based structure of the proposal, we note the proposed rule change 
establishes the key provisions of NASD Rule 2711 for debt research and 
includes a number of protections for investors beyond those currently 
found in that rule, including the requirement that research management 
make independent decisions regarding research coverage,\191\ 
maintenance of information barriers or other institutional safeguards 
between research and investment banking, sales and trading, and other 
persons who might be biased in their judgment or supervision including, 
for certain members, requiring physical separation,\192\ information 
barriers between research analysts and trading desk personnel,\193\ and 
ensure that purported facts in research reports are based on reliable 
information.\194\ Further, FINRA's responses to interpretive questions 
posed by the commenters to the original proposal in the Amendment 
Notice should help eliminate uncertainty regarding how the proposal 
will operate. For instance, one commenter noted with approval the 
clarification regarding the ``at a minimum'' requirement which seemed 
to be the source of the commenter's confusion.\195\ FINRA also provided 
further guidance on other issues in the FINRA Response, such as whether 
sales and trading personnel can provide feedback for purposes of 
evaluating an analyst.
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    \191\ Proposed FINRA Rule 2242(b)(2)(B).
    \192\ Proposed FINRA Rule 2242(b)(2)(H) and Notice (``Among the 
structural safeguards, FINRA believes separation between investment 
banking and debt research, and between sales and trading and 
principal trading and debt research, is of particular importance. As 
such, while the proposed rule change does not mandate physical 
separation between the debt research department and the investment 
banking, sales and trading and principal trading 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 debt research and 
investment banking, sales and trading and principal trading 
personnel.'')
    \193\ Proposed FINRA Rule 2242.03.
    \194\ Proposed FINRA Rule 2242(c)(1)(A).
    \195\ WilmerHale Debt Two.
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    In approving this proposal, however, we expect that FINRA will 
continue to monitor the effectiveness of the rule proposal, especially 
with regards to the treatment of research provided to institutional 
investors, and modify the rule should it prove to be unworkable or fail 
to provide an appropriate level of protection to investors.\196\
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    \196\ We note that, as one commenter to the equity version of 
this proposal noted, the interpretation of what constitutes 
``reasonableness'' may prove difficult for FINRA and member alike. 
See Letter from Egidio Mogavero, Managing Director and Chief 
Compliance Officer, JMP Securities, dated Mar. 19, 2015.
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    For the reasons stated above, the Commission finds that the 
proposed rule change is consistent with the Act and the rules and 
regulations thereunder.

IV. Conclusion

    IT IS THEREFORE ORDERED, pursuant to section 19(b)(2) of the 
Act,\197\ that the proposed rule change (SR-FINRA-2014-048), as 
modified by Amendment No. 1 thereto, be, and it hereby is, approved.
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    \197\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\198\

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    \198\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2015-17972 Filed 7-21-15; 8:45 am]
BILLING CODE 8011-01-P