Document ID: SEC-2015-1225-0001
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 43482-43497]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-17971]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-75471; File No. SR-FINRA-2014-047]

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 2241 (Research Analysts 
and Research Reports) in the Consolidated FINRA Rulebook

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'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule to adopt NASD Rule 2711 (Research Analysts and Research 
Reports) as a FINRA rule, with several modifications, amend NASD Rule 
1050 (Registration of Research Analysts) and Incorporated NYSE Rule 344 
to create an exception from the research analyst qualification 
requirement, and renumber NASD Rule 2711 as FINRA Rule 2241 in the 
consolidated FINRA rulebook. The proposal was published for comment in 
the Federal Register on November 24, 2014.\3\ The Commission received 
four comments on the original proposal.\4\ On February 19, 2015, FINRA 
filed Amendment No. 1 responding to these original 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. This order was published for 
comment in the Federal Register on February 26, 2015.\7\ The Commission 
received a further three comments regarding the proceedings or in 
response 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. 73622 (Nov. 18, 2014); 79 FR 69939 
(Nov. 24, 2014) (``Notice''). On January 6, 2015, FINRA consented to 
extending the time period for the Commission to either approve or 
disapprove the proposed rule change, or to institute proceedings to 
determine whether to approve or disapprove the proposed rule change, 
to February 20, 2015.
    \4\ See Letter from Kevin Zambrowicz, Associate General Counsel 
& Managing Director and Sean Davy, Managing Director, SIFMA, dated 
Dec. 15, 2014 (``SIFMA''), Letter from Hugh D. Berkson, President-
Elect, Public Investors Arbitration Bar Association, dated Dec. 15, 
2014 (``PIABA Equity''), Letter from Stephanie R. Nicholas, 
WilmerHale, dated Dec. 16, 2014 (``WilmerHale Equity One''), and 
Letter from William Beatty, President and Washington (State) 
Securities Administrator, North American Securities Administrators 
Association, Inc., dated Dec. 19, 2014 (``NASAA Equity One'').
    \5\ Exchange Act Release No. 74488 (Mar. 12, 2015); 80 FR 14174 
(Mar. 18, 2015) (``Amendment Notice'').
    \6\ 15 U.S.C. 78s(b)(2)(B).
    \7\ Exchange Act Release No. 74339 (Feb. 20, 2015); 80 FR 10528 
(Feb. 26, 2015).
    \8\ Letter from Egidio Mogavero, Managing Director and Chief 
Compliance Officer, JMP Securities, dated Mar. 19, 2015 (``JMP''), 
Letter from Stephanie R. Nicholas, WilmerHale, dated Apr. 6, 2015 
(``WilmerHale Equity Two''), and Letter from William Beatty, 
President and Washington (State) Securities Administrator, North 
American Securities Administrators Association, Inc., dated Apr. 17, 
2015 (``NASAA Equity 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, in 
the Consolidated FINRA Rulebook, NASD Rule 2711 (Research Analysts and 
Research Reports), with several modifications, as FINRA Rule 2241. The 
proposed rule change also would amend NASD Rule 1050 (Registration of 
Research Analysts) and Incorporated NYSE Rule 344 (Research Analysts 
and Supervisory Analysts) to create an exception from the research 
analyst qualification requirements.
    FINRA believes that the proposed rule change would retain the core 
provisions of the current rules, broaden the obligations on members to 
identify and manage research-related conflicts of interest, restructure 
the rules to provide some flexibility in compliance without diminishing 
investor protection, extend

[[Page 43483]]

protections where gaps have been identified, and provide clarity to the 
applicability of existing rules. Where consistent with protection of 
users of research, FINRA believes that the proposed rule change reduces 
burdens where appropriate. The description below is the proposal as 
amended by Amendment No. 1.\10\
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    \10\ See Notice for a description of the original proposal. See 
also Exhibit 4 to SR-FINRA-2014-047 for a comparison of changes made 
in the rule text in Amendment No. 1.
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    As stated above, the Commission originally received four comments 
on the proposal. Of these, three expressed general support for the 
proposal,\11\ but one objected to the general formulation of the 
proposal as a principles-based rule.\12\ Of the three comments received 
in regards to the proceedings or Amendment No. 1, one had comments 
limited to specific provisions of the proposal,\13\ one was supportive 
of the proposal as amended by Amendment No. 1 with certain specific 
comments,\14\ and one reiterated prior concerns regarding the 
principles-based nature of the proposal.\15\
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    \11\ SIFMA, PIABA Equity, and WilmerHale Equity One.
    \12\ NASAA Equity One.
    \13\ JMP.
    \14\ WilmerHale Equity Two.
    \15\ NASAA Equity Two.
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A. Definitions

    FINRA proposed to mostly maintain the definitions in current NASD 
Rule 2711, with certain modifications. Specifically, FINRA made minor 
changes to the definition of ``investment banking services'' to clarify 
that such services include all acts in furtherance of a public or 
private offering on behalf of an issuer.\16\ FINRA also would clarify, 
in the definition of ``research analyst account,'' that the definition 
does not apply to a registered investment company over which a research 
analyst or member of the research analyst's household has discretion or 
control, provided that the research analyst or member of the research 
analyst's household has no financial interest in the investment 
company, other than a performance or management fee.\17\ FINRA proposed 
to exclude from the definition of ``research report'' communications 
concerning open-end registered investment companies that are not listed 
or traded on an exchange (i.e., mutual funds).\18\ FINRA further 
proposed to exclude from the definition of ``research report'' 
communications that constitute private placement memoranda and 
comparable offering-related documents prepared in connection with 
investment banking services transactions, other than those that purport 
to be research.\19\ FINRA sought to move the definitions of ``third-
party research report'' and ``independent third-party research report'' 
into the definitional section of the proposed rule that are, in NASD 
Rule 2711, in a different section of that rule.\20\ Lastly, FINRA would 
adopt a definition of ``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.\21\
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    \16\ See proposed FINRA Rule 2241(a)(5). The current definition 
includes, without limitation, many common types of investment 
banking services. FINRA proposed to add the language ``or otherwise 
acting in furtherance of'' either a public or private offering to 
further emphasize that the term ``investment banking services'' is 
meant to be construed broadly.
    \17\ See proposed FINRA Rule 2241(a)(9).
    \18\ See proposed FINRA Rule 2241(a)(11). In the Notice, FINRA 
explained that it was proposing this change because ``sales material 
regarding mutual funds is already subject to a separate regulatory 
regime . . . [t]he extensive content standards of these rules, 
combined with the filing and review of mutual fund sales material by 
FINRA staff, substantially reduce the likelihood that such material 
will include materially misleading information about the funds.'' 
FINRA also stated their belief that because these products are 
pooled investment vehicles, ``it is much less likely that a report 
on a mutual fund would affect the fund's NAV to the same extent that 
a research report on a single stock might impact its share price.''
    \19\ See proposed FINRA Rule 2241(a)(11)(D).
    \20\ See proposed FINRA Rules 2241(a)(3) and (14). FINRA stated 
it believes this change would create a more streamlined and user 
friendly rule to combine defined terms in a single definitional 
section.
    \21\ See proposed FINRA Rule 2241(a)(12).
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B. Identifying and Managing Conflicts of Interest

    FINRA proposed to create a new section entitled ``Identifying and 
Managing Conflicts of Interest.'' This section contains an overarching 
provision that requires members to establish, maintain, and enforce 
written policies and procedures reasonably designed to identify and 
effectively manage conflicts of interest related to the preparation, 
content, and distribution of research reports and public appearances by 
research analysts and the interaction between research analysts and 
persons outside of the research department, including investment 
banking and sales and trading personnel, the subject companies, and 
customers.\22\ The written policies and procedures would be required to 
be reasonably designed to promote objective and reliable research that 
reflects the truly held opinions of research analysts and to prevent 
the use of research or research analysts to manipulate or condition the 
market or favor the interests of the member or a current or prospective 
customer or class of customers.\23\ These provisions, FINRA asserted, 
set out the fundamental obligation for a member to establish and 
maintain a system to identify and mitigate conflicts and to foster 
integrity and fairness in its research products and services. The 
proposed rule change then sets forth the requirements for those written 
policies and procedures. According to FINRA, this approach would allow 
for some flexibility to manage identified conflicts, with some 
specified prohibitions and restrictions where disclosure does not 
adequately mitigate them. FINRA asserted that most of these 
requirements have been experience tested and found effective.\24\
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    \22\ See proposed FINRA Rule 2241(b)(1).
    \23\ See proposed FINRA Rule 2241(b)(2).
    \24\ See, e.g.,Joint Report by NASD and the NYSE on the 
Operation and Effectiveness of the Research Analyst Conflict of 
Interest Rules (December 2005), available at http://www.finra.org/web/groups/industry/@ip/@issues/@rar/documents/industry/p015803.pdf.
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1. Prepublication Review
    As proposed, the first of these minimum requirements would require 
that the policies and procedures prohibit prepublication review, 
clearance, or approval of research reports by persons engaged in 
investment banking services activities and restrict or prohibit such 
review, clearance, or approval by other persons not directly 
responsible for the preparation, content, and distribution of research 
reports, other than legal and compliance personnel.\25\
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    \25\ See proposed FINRA Rule 2241(b)(2)(A).
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2. Coverage Decisions
    The proposed rule change would require that the policies and 
procedures restrict or limit input by the investment banking department 
into research coverage decisions to ensure that research management 
independently makes all final decisions regarding the research coverage 
plan.\26\
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    \26\ See proposed FINRA Rule 2241(b)(2)(B).
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3. Supervision and Control of Research Analysts
    The proposed rule change would require that the policies and 
procedures prohibit persons engaged in investment banking activities 
from supervision or control of research analysts, including influence 
or control over research analyst compensation evaluation and 
determination.\27\
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    \27\ See proposed FINRA Rule 2241(b)(2)(C).
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4. Research Budget Determinations
    The proposed rule change would require that the policies and 
procedures

[[Page 43484]]

limit determination of the research department budget to senior 
management, excluding senior management engaged in investment banking 
services activities.\28\
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    \28\ See proposed FINRA Rule 2241(b)(2)(D).
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5. Compensation
    The proposed rule change would require that the policies and 
procedures prohibit compensation based upon specific investment banking 
services transactions or contributions to a member's investment banking 
services activities.\29\ The policies and procedures further would 
require a committee that reports to the member's board of directors--or 
if none exists, a senior executive officer--to review and approve at 
least annually the compensation of any research analyst who is 
primarily responsible for preparation of the substance of a research 
report. The committee would not be permitted to have representation 
from a member's investment banking department. The committee would be 
required to consider, among other things, the productivity of the 
research analyst and the quality of his or her research and would also 
be required to document the basis for each research analyst's 
compensation.\30\ FINRA stated that these provisions are consistent 
with the requirements in current Rule 2711(d).
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    \29\ See proposed FINRA Rule 2241(b)(2)(E).
    \30\ See proposed FINRA Rule 2241(b)(2)(F).
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6. Information Barriers
    The proposed rule change would require that the policies and 
procedures establish information barriers or other institutional 
safeguards reasonably designed to ensure that research analysts are 
insulated from the review, pressure, or oversight by persons engaged in 
investment banking services activities or other persons, including 
sales and trading personnel, who might be biased in their judgment or 
supervision.\31\
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    \31\ See proposed FINRA Rule 2241(b)(2)(G).
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7. Retaliation
    The proposed rule change would require that the policies and 
procedures prohibit direct or indirect retaliation or threat of 
retaliation against research analysts employed by the member or its 
affiliates by persons engaged in investment banking services activities 
or other employees as the result of an adverse, negative, or otherwise 
unfavorable research report or public appearance written or made by the 
research analyst that may adversely affect the member's present or 
prospective business interests.\32\
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    \32\ See proposed FINRA Rule 2241(b)(2)(H).
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8. Quiet Periods
    The proposed rule change would require that the policies and 
procedures define quiet periods of a minimum of ten days after an 
initial public offering (``IPO''), and a minimum of three days after a 
secondary offering, during which the member must not publish or 
otherwise distribute research reports, and research analysts must not 
make public appearances, relating to the issuer if the member has 
participated as an underwriter or dealer in the IPO or, with respect to 
the quiet periods after a secondary offering, acted as a manager or co-
manager of that offering.\33\
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    \33\ See proposed FINRA Rule 2241(b)(2)(I). Consistent with the 
Jumpstart Our Business Startups Act (``JOBS Act''), those quiet 
periods do not apply following the IPO or secondary offering of an 
Emerging Growth Company (``EGC''), as that term is defined in 
section 3(a)(80) of the Act.
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    With respect to these quiet-period provisions, the proposed rule 
change would reduce the current forty day quiet period for IPOs to a 
minimum of ten days after the completion of the offering for any member 
that participated as an underwriter or dealer, and reduces the ten day 
secondary offering quiet period to a minimum of three days after the 
completion of the offering for any member that has acted as a manager 
or co-manager in the secondary offering. The proposed rule change would 
maintain exceptions to these quiet periods for research reports or 
public appearances concerning the effects of significant news or a 
significant event on the subject company and, for secondary offerings, 
research reports or public appearances pursuant to Rule 139 under the 
Securities Act of 1933 regarding a subject company with ``actively-
traded securities.''
    The proposed rule change also eliminates the current quiet periods 
of fifteen days before and after the expiration, waiver or termination 
of a lock-up agreement.
9. Solicitation and Marketing
    In addition, the proposed rule change would require firms to adopt 
written policies and procedures to restrict or limit activities by 
research analysts that can reasonably be expected to compromise their 
objectivity.\34\ This would include the existing prohibitions on 
participation in pitches and other solicitations of investment banking 
services transactions as well as road shows and other marketing on 
behalf of issuers related to such transactions. We understand these to 
be a non-exhaustive list of the types of activities that can violate 
this provision.\35\ FINRA noted that, consistent with existing 
guidance, analysts may listen to or view a live webcast of a 
transaction-related road show or other widely attended presentation by 
investment banking to investors or the sales force from a remote 
location, or another room if they are in the same location.\36\
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    \34\ See proposed FINRA Rule 2241(b)(2)(L).
    \35\ See id. (requiring procedures that ``restrict or limit 
activities by research analysts that can reasonably be expected to 
compromise their objectivity, including prohibiting [participation 
in pitches and other solicitations and participation in certain road 
shows]'') (emphasis added).
    \36\ See NASD Notice to Members 07-04 (January 2007) and NYSE 
Information Memo 07-11 (January 2007).
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    The proposed rule change also would add Supplementary Material .01, 
which would codify FINRA's existing interpretation that the 
solicitation provision prohibits members from including in pitch 
materials any information about a member's research capacity in a 
manner that suggests, directly or indirectly, that the member might 
provide favorable research coverage.\37\
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    \37\ See proposed FINRA Rule 2241.01 and Notice to Members 07-04 
(January 2007).
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10. Joint Due Diligence and Other Interactions With Investment Banking
    The proposed rule would establish a new proscription with respect 
to joint due diligence activities--i.e., due diligence by the research 
analyst in the presence of investment banking department personnel--
during a specified time period. Specifically, proposed Supplementary 
Material .02 states that FINRA interprets the overarching principle 
requiring members to, among other things, establish, maintain and 
enforce written policies and procedures that address the interaction 
between research analysts and those outside of the research department, 
including investment banking and sales and trading personnel, subject 
companies and customers, to prohibit the performance of joint due 
diligence prior to the selection of underwriters for the investment 
banking services transaction. FINRA clarified that, in response to a 
comment that this provision may interfere with the JOBS Act,\38\ they 
``would interpret the provision to apply only to the extent it is not 
contrary to the JOBS Act'' and ``[t]hus, for example, would not 
interpret the joint due diligence prohibition to apply where the joint 
due diligence activities involve a communication with the management of 
an EGC that is attended by both the

[[Page 43485]]

research analyst and an investment banker.'' \39\
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    \38\ JMP.
    \39\ FINRA Response.
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    The proposed rule would continue to prohibit investment banking 
department personnel from directly or indirectly directing a research 
analyst to engage in sales or marketing efforts related to an 
investment banking services transaction, and directing a research 
analyst to engage in any communication with a current or prospective 
customer about an investment banking services transaction.\40\ 
Supplementary Material .03 clarifies that three-way meetings between 
research analysts and a current or prospective customer in the presence 
of investment banking department personnel or company management about 
an investment banking services transaction would be prohibited by this 
provision.\41\ FINRA believes that the presence of investment bankers 
or issuer management could compromise a research analyst's candor when 
talking to a current or prospective customer about a deal. 
Supplementary Material .03 would also retain the current requirement 
that any written or oral communication by a research analyst with a 
current or prospective customer or internal personnel related to an 
investment banking services transaction must be fair, balanced, and not 
misleading, taking into consideration the overall context in which the 
communication is made.
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    \40\ See proposed FINRA Rule 2241(b)(2)(M).
    \41\ See proposed FINRA Rule 2241.03.
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11. Promises of Favorable Research and Prepublication Review by Subject 
Company
    FINRA proposed to maintain the current prohibition against promises 
of favorable research, a particular research recommendation, rating, or 
specific content as inducement for receipt of business or 
compensation.\42\ The proposed rule would further require policies and 
procedures to prohibit prepublication review of a research report by a 
subject company for purposes other than verification of facts.\43\ 
Supplementary Material .05 would maintain the current guidance 
applicable to the prepublication submission of a research report to a 
subject company. Specifically, sections of a draft research report 
would be permitted to be provided to non-investment banking personnel 
or the subject company for factual review, provided that: (1) The draft 
sections do not contain the research summary, research rating, or price 
target; (2) a complete draft of the report is provided to legal or 
compliance personnel before sections are submitted to non-investment 
banking personnel or the subject company; and (3) any subsequent 
proposed changes to the rating or price target are accompanied by a 
written justification to legal or compliance and receive written 
authorization for the change. The member also would be required to 
retain copies of any draft and the final version of the report for 
three years.\44\
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    \42\ See proposed FINRA Rule 2241(b)(2)(K).
    \43\ See proposed FINRA Rule 2241(b)(2)(N).
    \44\ See proposed FINRA Rule 2241.05.
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12. Personal Trading Restrictions
    FINRA proposed to require that firms establish written policies and 
procedures that restrict or limit research analyst account trading in 
securities, any derivatives of such securities and funds whose 
performance is materially dependent upon the performance of securities 
covered by the research analyst.\45\ Such policies and procedures would 
be required to ensure that research analyst accounts, supervisors of 
research analysts, and associated persons with the ability to influence 
the content of research reports do not benefit in their trading from 
knowledge of the content or timing of a research report before the 
intended recipients of such research have had a reasonable opportunity 
to act on the information in the research report.\46\ The proposal 
would maintain the current prohibitions on research analysts receiving 
pre-IPO shares in the sector they cover and trading against their most 
recent recommendations. However, members would be permitted to define 
financial hardship circumstances, if any, in which a research analyst 
would be permitted to trade against his or her most recent 
recommendation.\47\ 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.\48\
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    \45\ See proposed FINRA Rule 2241(b)(2)(J).
    \46\ See proposed FINRA Rule 2241(b)(2)(J)(i).
    \47\ See proposed FINRA Rule 2241(b)(2)(J)(ii).
    \48\ See proposed FINRA Rule 2241.10.
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C. Content and Disclosure in Research Reports

    With some modification, the proposed rule change would maintain the 
current disclosure requirements. The proposed rule change would add a 
requirement that a member must establish, maintain and enforce written 
policies and procedures reasonably designed to ensure that purported 
facts in its research reports are based on reliable information.\49\ 
FINRA stated that it has included this provision because it believes 
members should have policies and procedures to foster verification of 
facts and trustworthy research on which investors may rely. The 
policies and procedures would also be required to be reasonably 
designed to ensure that any recommendation, rating or price target has 
a reasonable basis and is accompanied by a clear explanation of any 
valuation method used and a fair presentation of the risks that may 
impede achievement of the recommendation, rating or price target.\50\
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    \49\ See proposed FINRA Rule 2241(c)(1)(A).
    \50\ See proposed FINRA Rule 2241(c)(1)(B).
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    In addition, the proposed rule change would require a member to 
disclose in any research report at the time of publication or 
distribution of the report: \51\
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    \51\ See proposed FINRA Rule 2241(c)(4).
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     If the research analyst or a member of the research 
analyst's household has a financial interest in the debt or equity 
securities of the subject company (including, without limitation, 
whether it consists of any option, right, warrant, future, long or 
short position), and the nature of such interest; \52\
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    \52\ See proposed FINRA Rule 2241(c)(4)(A).
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     If the research analyst has received compensation based 
upon (among other factors) the member's investment banking revenues; 
\53\
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    \53\ See proposed FINRA Rule 2241(c)(4)(B).
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     If the member or any of its affiliates: (i) Managed or co-
managed a public offering of securities for the subject company in the 
past 12 months; (ii) received compensation for investment banking 
services from the subject company in the past 12 months; or (iii) 
expects to receive or intends to seek compensation for investment 
banking services from the subject company in the next three months; 
\54\
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    \54\ See proposed FINRA Rule 2241(c)(4)(C).
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     If, as of the end of the month immediately preceding the 
date of publication or distribution of a research report (or the end of 
the second most recent month if the publication or distribution date is 
less than 30 calendar days after the end of the most recent

[[Page 43486]]

month), the member or its affiliates have received from the subject 
company any compensation for products or services other than investment 
banking services in the previous 12 months; \55\
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    \55\ See proposed FINRA Rule 2241(c)(4)(D).
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     If the subject company is, or over the 12-month period 
preceding the date of publication or distribution of the research 
report has been, a client of the member, and if so, the types of 
services provided to the issuer. Such services, if applicable, must be 
identified as either investment banking services, non-investment 
banking services, non-investment banking securities-related services or 
non-securities services; \56\
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    \56\ See proposed FINRA Rule 2241(c)(4)(E).
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     If the member was making a market in the securities of the 
subject company at the time of publication or distribution of the 
research report; \57\ and
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    \57\ See proposed FINRA Rule 2241(c)(4)(G).
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     If the research analyst received any compensation from the 
subject company in the previous 12 months.\58\
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    \58\ See proposed FINRA Rule 2241(c)(4)(H).
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    The proposed rule change would also expand upon the current 
``catch-all'' disclosure, which mandates disclosure of any other 
material conflict of interest of the research analyst or member that 
the research analyst knows or has reason to know of at the time of the 
publication or distribution of a research report. The proposed rule 
change would go beyond the existing provision by requiring disclosure 
of material conflicts known not only by the research analyst, but also 
by any ``associated person of the member with the ability to influence 
the content of a research report.'' \59\ 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 research report or has exercised authority to review or 
change the research report prior to publication or distribution. This 
term does not include legal or compliance personnel who may review a 
research report for compliance purposes but are not authorized to 
dictate a particular recommendation, rating or price target.\60\ FINRA 
stated that the ``reason to know'' standard in this provision would not 
impose a duty of inquiry on the research analyst or others who can 
influence the content of a research report. Rather, it would cover 
disclosure of those conflicts that should reasonably be discovered by 
those persons in the ordinary course of discharging their functions.
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    \59\ See proposed FINRA Rule 2241(c)(4)(I).
    \60\ See proposed FINRA Rule 2241.08.
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    The proposed rule change also maintains the requirement to disclose 
when a member or its affiliates beneficially own 1% or more of any 
class of common equity securities of the subject company.\61\ The 
determination of beneficial ownership would continue to be based upon 
the standards used to compute ownership for the purposes of the 
reporting requirements under section 13(d) of the Exchange Act.
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    \61\ See proposed FINRA Rule 2241(c)(4)(F).
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    The proposal would modify the exception for disclosure that would 
reveal material non-public information regarding specific potential 
future investment banking transactions of the subject company to also 
include specific potential future investment banking transactions of 
other companies, such as a competitor of the subject company.\62\ The 
proposal also continues to permit a member that distributes a research 
report covering six or more companies (compendium report) to direct the 
reader in a clear manner as to where the applicable disclosures can be 
found. An electronic compendium research report may hyperlink to the 
disclosures. A paper compendium report must include a toll-free number 
or a postal address where the reader may request the disclosures. In 
addition, paper compendium reports may include a web address where the 
disclosures can be found.\63\
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    \62\ See proposed FINRA Rule 2241(c)(5).
    \63\ See proposed FINRA Rule 2241(c)(7).
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D. Disclosures in Public Appearances

    The proposal would group in a separate provision the disclosures 
required when a research analyst makes a public appearance.\64\ The 
required disclosures would remain substantively the same as under the 
current rules,\65\ including if the member or its affiliates 
beneficially own 1% or more of any class of common equity securities of 
the subject company (as computed in accordance with section 13(d) of 
the Exchange Act). Unlike in research reports, the ``catch all'' 
disclosure requirement in public appearances would apply only to a 
conflict of interest of the research analyst or member that the 
research analyst knows or has reason to know at the time of the public 
appearance. 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. The proposal 
would also retain the current requirement in NASD Rule 2711(h)(12) to 
maintain records of public appearances sufficient to demonstrate 
compliance by research analysts with the applicable disclosure 
requirements.\66\
---------------------------------------------------------------------------

    \64\ See proposed FINRA Rule 2241(d).
    \65\ See NASD Rules 2711(h)(1), (h)(2)(B) and (C), (h)(3) and 
(h)(9).
    \66\ See proposed FINRA Rule 2241(d)(3).
---------------------------------------------------------------------------

E. Disclosure Required by Other Provisions

    With respect to both research reports and public appearances, 
members and research analysts would continue to be required to comply 
with applicable disclosure provisions of FINRA Rule 2210 and the 
federal securities laws.\67\
---------------------------------------------------------------------------

    \67\ See proposed FINRA Rule 2241(e).
---------------------------------------------------------------------------

F. Termination of Coverage

    The proposed rule change would retain, with non-substantive 
modifications, the provision in the current rules that requires a 
member to notify its customers if it intends to terminate coverage of a 
subject company.\68\ Such notification would need to be made 
promptly,\69\ using the member's ordinary means to disseminate research 
reports on the subject company to its various customers. Unless 
impracticable, the notice would be required to be accompanied by a 
final research report, comparable in scope and detail to prior research 
reports, and include a final recommendation or rating. If impracticable 
to provide a final research report, recommendation, or rating, a firm 
would be required to disclose to its customers the reason for 
terminating coverage. FINRA clarified in the Notice that it ``expects 
such circumstances to be exceptional, such as where a research analyst 
covering a subject company or sector has left the member or the member 
has discontinued coverage of the industry or sector.''
---------------------------------------------------------------------------

    \68\ See proposed FINRA Rule 2241(f).
    \69\ While current Rule 2711(f)(6) does not contain the word 
``promptly,'' FINRA has interpreted the provision to require prompt 
notification of termination of coverage of a subject company.
---------------------------------------------------------------------------

G. Distribution of Member Research Reports

    The proposal would require firms to establish, maintain and enforce 
written policies and procedures reasonably designed to ensure that a 
research report is not distributed selectively to internal trading 
personnel or a particular customer or class of customers in advance of 
other customers that the firm has previously determined are entitled to 
receive the research report.\70\ The

[[Page 43487]]

proposal includes further guidance to explain that firms would be 
permitted to provide different research products and services to 
different classes of customers, provided the products are not 
differentiated based on the timing of receipt of potentially market 
moving information and the firm discloses its research dissemination 
practices to all customers that receive a research product.\71\
---------------------------------------------------------------------------

    \70\ See proposed FINRA Rule 2241(g).
    \71\ See proposed FINRA Rule 2241.07.
---------------------------------------------------------------------------

H. Distribution of Third-Party Research Reports

    The proposal would maintain the existing third-party disclosure 
requirements,\72\ while incorporating a change to the ``catch-all'' 
provision to include material conflicts of interest that an associated 
person of the member with the ability to influence the content of a 
research report knows or has reason to know at the time of the 
distribution of the third-party research report. In addition, the 
proposed rule change would require members to disclose any other 
material conflict of interest that can reasonably be expected to have 
influenced the member's choice of a third-party research provider or 
the subject company of a third-party research report.\73\
---------------------------------------------------------------------------

    \72\ NASD Rule 2711(h)(13)(A) currently requires the 
distributing member firm to disclose the following, if applicable: 
(1) If the member owns 1% or more of any class of equity securities 
of the subject company; (2) if the member or any affiliate has 
managed or co-managed a public offering of securities of the subject 
company or received compensation for investment banking services 
from the subject company in the past 12 months, or expects to 
receive or intends to seek compensation for such services in the 
next three months; (3) if the member makes a market in the subject 
company's securities; and (4) any other actual, material conflict of 
interest of the research analyst or member of which the research 
analyst knows or has reason to know at the time the research report 
is distributed or made available.
    \73\ See proposed FINRA Rule 2241(h)(4).
---------------------------------------------------------------------------

    FINRA stated that the proposal would continue to address 
qualitative aspects of third-party research reports. For example, the 
proposal would maintain, but in the form of policies and procedures, 
the existing requirement that a registered principal or supervisory 
analyst review and approve third-party research reports distributed by 
a member. To that end, the proposed rule change would require a member 
to establish, maintain, and enforce written policies and procedures 
reasonably designed to ensure that any third-party research it 
distributes contains no untrue statement of material fact and is 
otherwise not false or misleading. For the purpose of this requirement, 
a member's obligation to review a third-party research report would 
extend to any untrue statement of material fact or any false or 
misleading information that should be known from reading the research 
report or is known based on information otherwise possessed by the 
member.\74\ The proposal further would prohibit a member from 
distributing third-party research if it knows or has reason to know 
that such research is not objective or reliable.\75\
---------------------------------------------------------------------------

    \74\ See proposed FINRA Rules 2241(h)(1) and (h)(3).
    \75\ See proposed FINRA Rule 2241(h)(2).
---------------------------------------------------------------------------

    The proposal would maintain the existing exceptions for 
``independent third-party research reports.'' Specifically, such 
research would not require principal pre-approval or, where the third-
party research is not ``pushed out,'' the third-party disclosures.\76\ 
As to the latter, a member would not be considered to have distributed 
independent third-party research where the research is made available 
by the member: (a) Upon request; (b) through a member-maintained Web 
site; or (c) to a customer in connection with a solicited order in 
which the registered representative has informed the customer, during 
the solicitation, of the availability of independent research on the 
solicited equity security and the customer requests such independent 
research.
---------------------------------------------------------------------------

    \76\ See proposed FINRA Rule 2241(h)(5) and (6).
---------------------------------------------------------------------------

    Finally, under the proposed rule change, members would be required 
to ensure that a third-party research report is clearly labeled as such 
and that there is no confusion on the part of the recipient as to the 
person or entity that prepared the research report.\77\
---------------------------------------------------------------------------

    \77\ See proposed FINRA Rule 2241(h)(7).
---------------------------------------------------------------------------

I. Exemption for Firms With Limited Investment Banking Activity

    The current rule exempts firms with limited investment banking 
activity--those that over the previous three years, on average per 
year, have managed or co-managed 10 or fewer investment banking 
transactions and generated $5 million or less in gross revenues from 
those transactions--from the provisions that prohibit a research 
analyst from being subject to the supervision or control of an 
investment banking department employee because the potential conflicts 
with investment banking are minimal.\78\ However, those firms remain 
subject to the provision that requires the compensation of a research 
analyst to be reviewed and approved annually by a committee that 
reports to a member's board of directors, or a senior executive officer 
if the member has no board of directors.\79\ That provision further 
prohibits representation on the committee by investment banking 
department personnel and requires the committee to consider the 
following factors when reviewing a research analyst's compensation: (1) 
The research analyst's individual performance, including the research 
analyst's productivity and the quality of research; (2) the correlation 
between the research analyst's recommendations and the performance of 
the recommended securities; and (3) the overall ratings received from 
clients, the sales force and peers independent of investment banking, 
and other independent ratings services.\80\ The proposed rule change 
would extend the exemption for firms with limited investment banking 
activity so that such firms would not be subject to the compensation 
committee provision. The proposal would still prohibit these firms from 
compensating a research analyst based upon specific investment banking 
services transactions or contributions to a member's investment banking 
services activities.\81\
---------------------------------------------------------------------------

    \78\ See NASD Rule 2711(k).
    \79\ See NASD Rule 2711(d)(2).
    \80\ See NASD Rule 2711(d) and (k).
    \81\ See proposed FINRA Rules 2241(b)(2)(E) and (i).
---------------------------------------------------------------------------

    The proposed rule change would further exempt firms with limited 
investment banking activity from the provisions restricting or limiting 
research coverage decisions and budget determinations. In addition, the 
proposal would exempt eligible firms from the requirement to establish 
information barriers or other institutional safeguards to insulate 
research analysts from the review or oversight by investment banking 
personnel or other persons, including sales and trading personnel, who 
may be biased in their judgment or supervision. However, those firms 
would still be required to establish information barriers or other 
institutional safeguards reasonably designed to ensure that research 
analysts are insulated from pressure by investment banking and other 
non-research personnel who might be biased in their judgment or 
supervision.

J. Exemption From Registration Requirements for Certain ``Research 
Analysts''

    The proposed rule change would amend the definition of ``research 
analyst'' for the purposes of the registration and qualification 
requirements to limit the scope to persons who produce ``research 
reports'' and whose primary job function is to provide investment 
research (e.g., registered representatives or traders

[[Page 43488]]

generally would not be included).\82\ FINRA stated that the revised 
definition is not intended to carve out anyone for whom the preparation 
of research is a significant component of their job. Rather, it is 
intended to provide relief for those who produce research reports on an 
occasional basis. The existing research rules, in accordance with the 
mandates of the Sarbanes-Oxley Act of 2002 (``Sarbanes-Oxley''), are 
constructed such that the author of a communication that meets the 
definition of a ``research report'' is a ``research analyst,'' 
irrespective of his or her title or primary job.
---------------------------------------------------------------------------

    \82\ See proposed NASD Rule 1050(b) and proposed Incorporated 
NYSE Rule 344.10.
---------------------------------------------------------------------------

K. Attestation Requirement

    The proposed rule change would delete the requirement to attest 
annually that the firm has in place written supervisory policies and 
procedures reasonably designed to achieve compliance with the 
applicable provisions of the rules, including the compensation 
committee review provision. As FINRA explained in the Notice, firms 
already are obligated pursuant to NASD Rule 3010 (Supervision) to have 
a supervisory system reasonably designed to achieve compliance with all 
applicable securities laws and regulations and FINRA rules. Moreover, 
the research rules also are subject to the supervisory control rules 
(NASD Rule 3012) and the annual certification requirement regarding 
compliance and supervisory processes (FINRA Rule 3130).\83\ As such, 
FINRA did not believe that a separate attestation requirement for the 
research rules was unnecessary.

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

    \83\ NASD Rules 3010 and 3012 have been adopted with changes as 
consolidated FINRA rules. The new rules become effective December 1, 
2014. See supra note 20.
---------------------------------------------------------------------------

L. Obligations of Persons Associated with a Member

    Proposed Supplementary Material .09 would clarify the obligations 
of each associated person under those provisions of the proposed rule 
change that require a member to restrict or prohibit certain conduct by 
establishing, maintaining and enforcing particular written policies and 
procedures. Specifically, the proposal provides that, consistent with 
FINRA Rule 0140, persons associated with a member would be required to 
comply with such member's policies and procedures as established 
pursuant to proposed FINRA Rule 2241.\84\ In addition, consistent with 
Rule 0140, Supplementary Material .09 states that it shall be a 
violation of proposed Rule 2241 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 Rule 2241, including applicable supplementary material.
---------------------------------------------------------------------------

    \84\ See proposed FINRA Rule 2241.09. FINRA Rule 0140(a), among 
other things, provides that persons associated with a member shall 
have the same duties and obligations as a member under the Rules.
---------------------------------------------------------------------------

M. General Exemptive Authority

    The proposed rule change would provide FINRA, pursuant to the Rule 
9600 Series, with authority to conditionally or unconditionally grant, 
in exceptional and unusual circumstances, an exemption from any 
requirement of the proposed rule for good cause shown, after taking 
into account all relevant factors and provided that such exemption is 
consistent with the purposes of the rule, the protection of investors, 
and the public interest.\85\
---------------------------------------------------------------------------

    \85\ See proposed FINRA Rule 2241(j).
---------------------------------------------------------------------------

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

    In response to the proposal as originally proposed by FINRA, the 
Commission received four comments.\86\ Of these, three expressed 
general support for the proposal,\87\ but one objected to the general 
formulation of the proposal as a principles-based rule.\88\ The 
specifics of these comments were summarized when the Commission 
instituted proceedings and again when the Commission noticed Amendment 
No. 1.\89\ FINRA filed Amendment No. 1 as a response to these earlier 
comments as discussed when the amendment was noticed.\90\ In the time 
since Amendment No. 1 was filed, the Commission has received three 
comment letters on the proposal.\91\ FINRA submitted a letter in 
response to these comments.\92\
---------------------------------------------------------------------------

    \86\ See note 4, supra.
    \87\ SIFMA, PIABA Equity, and WilmerHale Equity One.
    \88\ NASAA Equity One.
    \89\ Exchange Act Release No. 74339 (Feb. 20, 2015); 80 FR 10528 
(Feb. 26, 2015) and Amendment Notice.
    \90\ Id.
    \91\ JMP, WilmerHale Equity Two, and NASAA Equity Two.
    \92\ FINRA Response.
---------------------------------------------------------------------------

    Three of the four commenters to the original proposal,\93\ and one 
of the three commenters to the proposal in connection with instituting 
proceedings or with regards to Amendment No. 1,\94\ expressed general 
support for the proposal. The Commission notes this support.
---------------------------------------------------------------------------

    \93\ SIFMA, WilmerHale Equity One, and PIABA Equity.
    \94\ WilmerHale Equity Two.
---------------------------------------------------------------------------

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

    The rule proposal would adopt a policies and procedures approach to 
identification and management of research-related conflicts of interest 
and require those policies and procedures to prohibit or restrict 
particular conduct. Commenters both to the original proposal and after 
it was amended by Amendment No. 1 expressed several concerns with the 
approach.
    Two commenters, with regards to the original proposal, 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.\95\ One of those commenters 
had previously expressed support for the proposed policies-based 
approach with minimum requirements,\96\ 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 opposed a shift to a policies and procedures scheme 
``without also maintaining the proscriptive nature of the current 
rules.'' The commenter therefore favored retaining the proscriptive 
approach in the current rules and also requiring that firms maintain 
policies and procedures designed to ensure compliance.\97\ 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.\98\ Finally, 
some 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.\99\ 
These

[[Page 43489]]

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.\100\
---------------------------------------------------------------------------

    \95\ SIFMA and WilmerHale Equity One.
    \96\ 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).
    \97\ NASAA Equity One.
    \98\ WilmerHale Equity One.
    \99\ SIFMA and WilmerHale Equity One.
    \100\ WilmerHale Equity One.
---------------------------------------------------------------------------

    FINRA stated that it believes the framework will maintain the same 
level of investor protection in the current rules 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. Even under a 
policies and procedures approach, FINRA believes that the proposals 
would effectively maintain, with some modifications, the key 
proscriptions in the current rules--e.g., prohibitions on 
prepublication review, supervision of research analysts by investment 
banking and participation in pitches and road shows. FINRA stated it 
disagrees 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 stated it does 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.
    One commenter, with regards to the proposal as amended by Amendment 
No. 1, reiterated its earlier comments regarding their concerns 
relating to the principles-based nature of the proposal. This commenter 
stated that the historical mismanagement of the conflicts of interest 
inherent to equity research by firms necessitates a proscriptive, 
rather than principles-based approach. The commenter noted that 
violations in this area are ``recent and continued'' and that they and 
other commenters noted that the proposal seemed ``unclear and likely to 
result in confusion.'' \101\ FINRA disagreed with the commenter noting 
that ``the proposed framework effectively maintains, with a few 
modifications, the key proscriptions in the current rules . . . because 
the proposals require policies and procedures that must prohibit or 
restrict specified conduct, such as research analyst participation in 
soliciting investment banking business or road shows.'' \102\
---------------------------------------------------------------------------

    \101\ NASAA Equity Two. See also NASAA Equity One, SIFMA, and 
WilmerHale Equity One.
    \102\ FINRA Response.
---------------------------------------------------------------------------

    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, 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. FINRA stated it intends for firms to 
proactively identify and manage those conflicts with appropriately 
designed policies and procedures. Thus, FINRA's inclusion of the ``at a 
minimum'' language was not 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 in Amendment No. 1 to amend the proposal to 
delete the ``at a minimum'' language.
    One commenter regarding the proposal as amended by Amendment No. 1 
specifically took issue with this action of removing the ``at a 
minimum'' requirement as ``this language was helpful in maintaining the 
prescriptive nature of the current rules by ensuring that a firm's 
policies and procedures met at least a minimum standard.'' \103\ 
Another noted its approval.\104\ FINRA responded that this change ``was 
meant to clarify that FINRA did not expect firms' written policies and 
procedures to go beyond the specified prohibitions and restrictions in 
the proposals where no new conflicts had been identified . . . 
[h]owever . . . removing that language did not change the overarching 
requirement for written policies and procedures reasonably designed to 
identify and effectively manage emerging conflicts--a significant 
additional obligation that does not exist in the current rules.'' \105\
---------------------------------------------------------------------------

    \103\ NASAA Equity Two.
    \104\ WilmerHale Equity Two.
    \105\ FINRA Response.
---------------------------------------------------------------------------

    FINRA clarified in Amendment No. 1 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. According to FINRA, the supplementary material 
was intended to hold individuals responsible for engaging in the 
conduct that the policies and procedures effectively restrict or 
prohibit. FINRA stated that it agrees 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 
proposed rule change to delete the language stating that a violation of 
a firm's policies and procedures shall constitute a violation of the 
rule itself.
    One commenter responding to the proposal as amended by Amendment 
No. 1 objected to this change.\106\ Another noted its approval for the 
change.\107\ FINRA responded that the change would not affect the 
ability of FINRA to ``hold individuals responsible for engaging in 
conduct that the policies and procedures effectively restrict or 
prohibit.'' FINRA further suggested that it did not believe that 
individuals should be punished by FINRA where those individuals violate 
procedures members instituted voluntarily that go beyond the minimum 
requirements of the rule.\108\
---------------------------------------------------------------------------

    \106\ NASAA Equity Two.
    \107\ WilmerHale Equity Two.
    \108\ FINRA Response. See also WilmerHale Equity One (suggesting 
the change).
---------------------------------------------------------------------------

    Lastly, one commenter regarding the institution of proceedings 
sought leeway or guidance regarding examiners' interpretation of 
FINRA's rules, specifically, what constitutes ``reasonable,'' with 
regards to small firms who have only institutional

[[Page 43490]]

clients.\109\ FINRA stated that the proposal is principles-based and is 
designed to allow some flexibility, but will consider providing 
additional guidance, as appropriate, where questions arise.\110\
---------------------------------------------------------------------------

    \109\ JMP.
    \110\ FINRA Response.
---------------------------------------------------------------------------

B. Comments and Discussion Regarding Definitions and Terms Used in the 
Proposal

    One commenter requested that the original 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.'' \111\ The commenter's 
proposed definition was intended to clarify that the proposed 
restrictions on sales and trading personnel activities should not 
extend to: (1) Senior management who do not directly supervise those 
activities but have a reporting line from such personnel (e.g., the 
head of equity capital markets); or (2) persons who occasionally 
function in a sales and trading capacity. FINRA stated 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 clarified it does 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, 
investors could be put at risk with respect to the research or 
transactions involved when those individuals are functioning in those 
capacities because the conflict management procedures and proscriptions 
and required disclosures would not apply. Therefore, FINRA proposed in 
Amendment No. 1 to amend the rule 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 notes that it believes that this proposed 
definition is more consistent with the definition of ``investment 
banking department'' in the current and proposed rules.
---------------------------------------------------------------------------

    \111\ WilmerHale Equity One. For consistency with the debt 
research proposal, FINRA also proposed in Amendment No. 1 to amend 
the proposed rule change to use the term ``sales and trading 
personnel.''
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to include an 
exclusion from the definition of ``research report'' for private 
placement memoranda and similar offering-related documents prepared in 
connection with investment banking services transactions.\112\ 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.
---------------------------------------------------------------------------

    \112\ WilmerHale Equity One.
---------------------------------------------------------------------------

    FINRA clarified that the definition of ``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 has 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, FINRA proposed in Amendment No. 1 to amend the proposed 
rule change 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 ``research report'' to provide firms 
with greater clarity as to the status of such offering-related 
documents under the proposal. The commenter noted its approval in its 
comment letter regarding Amendment No. 1.\113\
---------------------------------------------------------------------------

    \113\ WilmerHale Equity Two.
---------------------------------------------------------------------------

    One commenter asked FINRA to refrain from using the concept of 
``reliable'' research in the proposals as it may inappropriately 
connote accuracy in the context of a research analyst's opinions.\114\ 
However, another commenter supported the requirement to have policies 
and procedures reasonably designed to ensure that research reports are 
based on reliable information.\115\ FINRA pointed to their discussion 
in Item 5 of the Proposing Release and stated it believes that the term 
``reliable'' is commonly understood and notes that the term is used in 
certain research-related provisions in Sarbanes-Oxley without 
definition. FINRA stated that it did not believe the term connotes 
accuracy of opinions.
---------------------------------------------------------------------------

    \114\ SIFMA.
    \115\ NASAA.
---------------------------------------------------------------------------

    One commenter asked FINRA to eliminate as redundant the term 
``independently'' from the provisions permitting non-research personnel 
to have input into research coverage, so long as research management 
``independently makes all final decisions regarding the research 
coverage plan.'' \116\ The commenter asserted that inclusion of 
``independently'' is confusing since the proposal would, in the 
commenter's view, permit input from non-research personnel into 
coverage decisions.\117\ One commenter who responded to the order 
instituting proceedings expressed support for this comment as 
well.\118\ FINRA stated it 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.
---------------------------------------------------------------------------

    \116\ WilmerHale Equity One.
    \117\ Proposed FINRA Rule 2241(b)(2)(B) specifically states that 
the policies and procedures must ``restrict or limit input by the 
investment banking department into research coverage decisions to 
ensure that research management independently makes all final 
decisions regarding the research coverage plan.'' Presumably, the 
commenter believes this permits investment banking input so long as 
the final decisions are made by research management.
    \118\ JMP.
---------------------------------------------------------------------------

    One commenter to the institution of proceedings suggested that the 
terms ``manager'' and ``co-manager'' used with regards to the quiet 
period provisions in the proposal were unclear.\119\ FINRA responded 
that the terms used in the proposal are commonly understood and there 
had been no previous comments about uncertainty in the terms. FINRA 
further pointed out that the terms mentioned by the commenter as those 
used in the industry, ``lead manager'' and ``book-running manager,'' 
are both

[[Page 43491]]

``managers'' for these purposes and that, for secondary offerings, both 
managers and co-managers have the same treatment.\120\
---------------------------------------------------------------------------

    \119\ Id.
    \120\ FINRA Response.
---------------------------------------------------------------------------

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 
the review, pressure or oversight by persons engaged in investment 
banking services activities or other persons, including sales and 
trading department personnel, who might be biased in their judgment or 
supervision.'' Some commenters to the original proposal suggested that 
``review'' was unnecessary in this provision because the review of 
research analysts was addressed sufficiently in other parts of the 
proposed rule.\121\ One of these commenters further suggested that the 
terms ``review'' and ``oversight'' are redundant.\122\ FINRA stated 
that 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. While other 
provisions of the proposed rule change may address related conduct--
e.g., the provision that prohibits investment banking personnel from 
supervision or control of research analysts--FINRA stated that this 
provision extends to ``other persons'' who may be biased in their 
judgment or supervision. Finally, FINRA noted that ``review, pressure 
or oversight'' mirrors language in Sarbanes-Oxley. Accordingly, FINRA 
declined to revise the proposed rule.
---------------------------------------------------------------------------

    \121\ SIFMA and WilmerHale Equity One.
    \122\ WilmerHale Equity 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.\123\ 
FINRA stated that was their intent and believed that the rules of 
statutory construction would compel that result.
---------------------------------------------------------------------------

    \123\ Id.
---------------------------------------------------------------------------

    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.\124\ FINRA stated that, in general, it 
agreed with the commenter's interpretation.\125\
---------------------------------------------------------------------------

    \124\ WilmerHale Equity Two.
    \125\ 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.\126\ 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 that 
it believes the terms ``pressure'' and ``bias'' are commonly 
understood, particularly in the context of rules intended to promote 
analyst independence and objectivity. To that end, FINRA noted that the 
terms appear in certain research-related provisions of Sarbanes-Oxley 
without definition. Thus, 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.
---------------------------------------------------------------------------

    \126\ WilmerHale Equity One.
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    One commenter asked FINRA to modify the information barriers or 
other institutional safeguards requirement to conform the provision to 
FINRA's ``reasonably designed'' standard for policies and procedures 
that members must adopt.\127\ FINRA stated it believed the change would 
be consistent with the standard for policies and procedures elsewhere 
in the proposals, and therefore proposed to amend the provision as 
requested in Amendment No. 1. The commenter noted its approval in its 
comment regarding Amendment No. 1.\128\
---------------------------------------------------------------------------

    \127\ Id.
    \128\ WilmerHale Equity 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'' at the time of publication or 
distribution of research report.\129\ (emphasis added) The commenter 
expressed concern about the emphasized language. Another commenter 
supported the proposed expansion of the current ``catch-all'' 
disclosure requirement.\130\
---------------------------------------------------------------------------

    \129\ WilmerHale Equity One.
    \130\ NASAA Equity One.
---------------------------------------------------------------------------

    FINRA stated that 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 research report. FINRA defined ``ability to 
influence the content of a research report'' in 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 might be required to disclose 
confidential information that is not covered by the exception in the 
proposals that would not require 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 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 a potential gap exists in 
the current rules where a supervisor or other person with the authority 
to change the content of a research report knows of a material 
conflict. However, FINRA stated 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,

[[Page 43492]]

rating or price target. FINRA proposed in Amendment No. 1 to amend the 
supplementary material in the proposals consistent with this 
clarification. In addition, FINRA proposed in Amendment No. 1 to modify 
the exception in proposed Rules 2241(c)(5) and (d)(2) (applying to 
public appearances) not to 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.\131\ 
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.'' \132\
---------------------------------------------------------------------------

    \131\ WilmerHale Equity Two.
    \132\ FINRA Response.
---------------------------------------------------------------------------

    One commenter 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.\133\ As long as a research report delivered electronically 
contains a hyperlink directly to the required disclosures, FINRA stated 
that the standard will be satisfied.
---------------------------------------------------------------------------

    \133\ WilmerHale Equity One.
---------------------------------------------------------------------------

D. Comments and Discussion Regarding Research Products with Differing 
Recommendations

    The proposal requires firms to establish, maintain and enforce 
written policies and procedures reasonably designed to ensure that a 
research report is not distributed selectively to internal trading 
personnel or a particular customer or class of customers in advance of 
other customers that the firm has previously determined are entitled to 
receive the research report. 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 supported the provisions as proposed with general 
disclosure,\134\ while another contended that FINRA should require 
members to disclose when their research products and services do, in 
fact, contain a recommendation contrary to the research product or 
service received by other customers.\135\ 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.\136\ They asserted that some firms may publish tens of 
thousands of research reports each year and employ hundreds of analysts 
across various disciplines and that a given research analyst or 
supervisor could not reasonably be expected to know of all other 
research products and services that may contain differing views.
---------------------------------------------------------------------------

    \134\ WilmerHale Equity One.
    \135\ PIABA Equity.
    \136\ WilmerHale Equity 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 be contrary to Rule 10b-5 by permitting the omission of a 
material fact in the research report. This commenter 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, 
they argue that FINRA should require specific disclosures.\137\
---------------------------------------------------------------------------

    \137\ PIABA Equity.
---------------------------------------------------------------------------

    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, all differing recommendations or ratings must be reconcilable 
such that they are not truly at odds with one another. Since the 
proposals 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 noted FINRA's 
position with approval in its comment regarding Amendment No. 1.\138\
---------------------------------------------------------------------------

    \138\ WilmerHale Equity Two.
---------------------------------------------------------------------------

E. Comments and Discussion Regarding Quiet Periods

    The proposal would eliminate or reduce the quiet periods during 
which a member may not publish or otherwise distribute research reports 
or make a public appearance following its participation in an offering. 
Citing recent enforcement actions in the research area, one commenter 
did not support elimination or reduction of the quiet periods.\139\ 
FINRA stated it believes that the separation, disclosure, and 
certification requirements in the current rules and Regulation AC have 
had greater impact on the objectivity of research than maintaining 
quiet periods during which research may not be distributed and research 
analysts may not make public appearances. FINRA noted that there is a 
cost to investors when they are deprived of information and analysis 
during quiet periods. FINRA stated it believes that the proposed 
changes to the quiet periods would promote information flow to 
investors without jeopardizing the objectivity of research. FINRA also 
noted that the enforcement actions cited by the commenter that favors 
retaining the existing quiet periods did not

[[Page 43493]]

involve the quiet period provisions of the rules, nor, in FINRA's view, 
would maintaining the current quiet periods have deterred the conduct 
in those cases.
---------------------------------------------------------------------------

    \139\ NASAA Equity One.
---------------------------------------------------------------------------

    This commenter restated its objection to the shortened quiet 
periods mandated by the proposal in its comments regarding Amendment 
No. 1. The commenter noted that ``[t]he current quiet periods allow 
firms to `cool off' after the completion of certain activities before 
their research departments can offer coverage on the subject securities 
or issuers'' and that the commenter had concerns that the shortened 
periods would lead to more promises of favorable research due to the 
research being distributed more quickly.\140\ FINRA stated its belief 
that the shorter periods were adequate,\141\ noting prior statements 
that, in their view, the remainder of the proposal as well as 
Regulation AC \142\ will be or is effective in deterring biased 
research without the need for the longer periods called for in NASD 
Rule 2711.\143\
---------------------------------------------------------------------------

    \140\ NASAA Equity Two.
    \141\ FINRA Response.
    \142\ 17 CFR 242.500-505.
    \143\ See Notice.
---------------------------------------------------------------------------

    Other commenters requested that FINRA retain the exceptions in NASD 
Rule 2711(f) that permits: (i) The publication and distribution of 
research or a public appearance concerning the effects of significant 
news or a significant event on the subject company during the quiet 
period; and (ii) the publication of distribution of research pursuant 
to Rule 139 under the Securities Act of 1933.\144\ FINRA agreed that 
those exceptions should be included and therefore amended the proposed 
rule change in Amendment No. 1. One of these commenters noted its 
approval of this change in its comment regarding Amendment No. 1.\145\
---------------------------------------------------------------------------

    \144\ SIFMA and WilmerHale Equity One.
    \145\ WilmerHale Equity Two.
---------------------------------------------------------------------------

F. Comments and Discussion Regarding Other Institutional Separation 
Issues

    One commenter with regards to the institution of proceedings 
suggested that FINRA clarify that the proposal would not interfere with 
senior managers who oversee research departments along with other non-
research departments as they represent is the practice at a number of 
smaller firms, including pre-publication review by such managers.\146\ 
FINRA responded that, while there is no express exception for managers 
who manage multiple departments in this way, the rule excepts firms 
with limited investment banking authority. Further, FINRA stated it did 
not intend to cover with this rule sales and trading or investment 
banking personnel who do not engage in or directly supervise day-to-day 
trading or investment banking activities.\147\ The implication of 
FINRA's response seems to be that, to the extent that the commenter's 
activities can fall within either of these concepts, it should be 
permitted under the proposed rule.
---------------------------------------------------------------------------

    \146\ JMP.
    \147\ FINRA Response.
---------------------------------------------------------------------------

    This commenter also suggested that FINRA interpret selling 
concessions from public financings be permitted to be included in 
compensation decisions for research analysts. This commenter stated 
that this is because ``[b]eing that analysts take part in these [sic] 
sale efforts, they should be permitted to be compensated from these 
specific sources of revenue.'' \148\ FINRA noted that such an 
interpretation ``would reintroduce the very conflict that FINRA 
believes the provision [prohibiting analyst compensation based on 
specific investment banking revenue] has, in combination with other 
provisions, effectively alleviated'' and declined to agree with the 
commenter's interpretation.\149\
---------------------------------------------------------------------------

    \148\ JMP.
    \149\ FINRA Response.
---------------------------------------------------------------------------

G. Comments and Discussion Regarding Disclosure Requirements

    Two commenters opposed the requirement in the proposal that members 
disclose, in an equity research report, if they or their affiliates 
maintain a significant financial interest in the debt of the research 
company.\150\ The commenters noted that the debt research analyst 
proposal does not contain a dedicated requirement to disclose 
significant debt holdings. Rather, that proposal relies on the ``catch-
all'' provision, which would require disclosure of a firm's debt 
holdings of a subject company only where it rises to an actual material 
conflict of interest.\151\ The commenters asserted that the reasoning 
in the debt proposal--e.g., that firms do not have systems to track 
ownership of debt securities and that the number and complexity of 
bonds and the fact that a firm may be both long and short different 
bonds of the same issuer makes real-time disclosure of credit exposure 
difficult--applies equally to equity research as far as a member's debt 
holdings. Another commenter supported the requirement in the equity 
proposal that members disclose, in an equity research report, if they 
or their affiliates maintain a significant financial interest in the 
debt of the research company.\152\ One commenter also stated that while 
FINRA correctly noted that the United Kingdom's Financial Conduct 
Authority rules require disclosure of debt holdings in equity research 
reports, that requirement is more akin to the ``catch-all'' provision 
because the disclosure is further limited to circumstances where the 
holdings ``may reasonably be expected to impair the objectivity of 
research recommendations'' or ``are significant in relation to the 
research recommendations.'' \153\ FINRA stated it believes that 
amending the equity proposal to the treat disclosure of debt holdings 
consistent with the debt proposal would promote consistency and 
efficiency while maintaining the same level of investor protection. 
Therefore, FINRA proposed to amend the proposed rule change in 
Amendment No. 1 accordingly, including modifying a similar disclosure 
requirement when making public appearances.
---------------------------------------------------------------------------

    \150\ SIFMA and WilmerHale Equity One.
    \151\ See Exchange Act Release No. 73623 (Nov. 18, 2014); 79 FR 
69905 (Nov. 24, 2014).
    \152\ NASAA Equity One.
    \153\ WilmerHale Equity One.
---------------------------------------------------------------------------

    One commenter regarding the institution of proceedings had concerns 
that the provision in the proposal requiring disclosure of when a 
member ``expects to receive or intends to seek'' investment banking 
compensation provides no meaningful disclosure, could mandate 
disclosure of material, non-public information, and is overly 
burdensome to track.\154\ FINRA noted that this is a disclosure 
currently required of members under NASD Rule 2711, an exception exists 
(in that rule and would be retained in the proposal) that does not 
mandate disclosure to the extent such disclosure would result in 
disclosure of material, non-public information regarding specific 
future transactions, and it provides investors with meaningful 
information regarding the member's objectivity that justify the burdens 
that it may create.\155\
---------------------------------------------------------------------------

    \154\ JMP.
    \155\ FINRA Response.
---------------------------------------------------------------------------

H. Comments and Discussion Regarding Impact on Global Settlement

    One commenter asked FINRA to confirm in any Regulatory Notice 
announcing adoption of the proposed rule change that provisions 
relating to research coverage and budget decisions and joint due 
diligence are intended to supersede the corresponding terms of the 
Global Research Analyst Settlement

[[Page 43494]]

(``Global Settlement'').\156\ FINRA reiterated its position, as 
discussed in the 2012 United States Government Accountability Office 
(``GAO'') Report on Securities Research,\157\ that it does not believe 
that the terms of the Global Settlement should be modified through 
FINRA rulemaking and instead should be determined by the court 
overseeing the enforcement action. Therefore, FINRA stated it does not 
intend for any provisions of the equity proposal that may be adopted to 
supersede provisions of the Global Settlement. One commenter supported 
this position.\158\
---------------------------------------------------------------------------

    \156\ WilmerHale Equity One.
    \157\ GAO, Securities Research, Additional Actions Could Improve 
Regulatory Oversight of Analyst Conflicts of Interest, January 2012.
    \158\ NASAA Equity Two.
---------------------------------------------------------------------------

I. Comments and Discussion Regarding FINRA's Exemptive Authority

    One commenter opposed the provision that would give FINRA the 
authority to grant, in exceptional or unusual circumstances, an 
exemption from the requirement of the proposed rule for good cause 
shown.\159\ The commenter stated that the provision had not been 
sufficiently justified by, among other things, providing examples of 
where an exemption would be justified. FINRA stated that the purpose of 
exemptive authority is to provide a mechanism of relief in unusual 
factual circumstances that cannot be foreseen, where application of the 
rule would frustrate or be inconsistent with its intended purposes. As 
such, FINRA believes that it is difficult if not impossible for it to 
provide examples of where it would be appropriate to use the authority. 
However, as FINRA stated in the proposal, it believes that the scope of 
the rule's subject matter and the diversity of firm sizes, structures 
and research business and distribution models make it more likely that 
factual circumstances may arise that had not been contemplated by the 
rule. In addition, FINRA notes that the authority is limited not only 
to unusual and exceptional circumstances, but also to a showing of good 
cause. The Commission notes that the proposal is consistent with other 
FINRA proposals \160\ and expects FINRA to consult with Commission 
staff prior to issuing such relief, and to discuss whether the proposed 
exception may be considered a proposed rule change pursuant to section 
19(b)(1) of the Act and Rule 19b-4 thereunder.\161\
---------------------------------------------------------------------------

    \159\ NASAA Equity One.
    \160\ See FINRA Rule 5131(f).
    \161\ 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4.
---------------------------------------------------------------------------

J. Comments and Discussion Regarding Implementation Date

    One commenter requested that the implementation date be at least 12 
months after Commission approval of the proposed rule change.\162\ 
Another commenter similarly requested that FINRA provide a ``grace 
period'' of one year or the maximum time permissible, if that is less 
than one year, between the adoption of the proposed rule and the 
implementation date.\163\ FINRA stated it is sensitive to the time 
firms may require to update their policies and procedures and systems 
to comply and will take those factors into consideration when 
establishing implementation dates.
---------------------------------------------------------------------------

    \162\ SIFMA.
    \163\ WilmerHale Equity.
---------------------------------------------------------------------------

K. The Proposal Meets the Requirements of Section 15D of the Act

    Section 15D requires the Commission, or upon the authorization and 
direction of the Commission, a registered securities association or 
national securities exchange to have adopted, not later than July 30, 
2003, rules reasonably designed to address conflicts of interest that 
can arise when securities analysts recommend equity securities in 
research reports and public appearances, in order to improve the 
objectivity of research and provide investors with more useful and 
reliable information, including rules designed to address certain 
specific requirements.\164\ NASD Rule 2711 and NYSE Rule 472 were 
adopted to meet this statutory mandate.\165\ As the proposed rule 
change would replace NASD Rule 2711, we considered whether the proposed 
rule continues to fulfill the mandates of section 15D and, in general, 
we believe that the proposal does.
---------------------------------------------------------------------------

    \164\ 15 U.S.C. 78o-6(a).
    \165\ See Exchange Act Release No. 48252 (Jul. 29, 2003); 68 FR 
45875 (Aug. 4, 2003).
---------------------------------------------------------------------------

    Section 15D requires a number of specific provisions, all of which 
are present in the proposed rule change in the form of required 
policies and procedures of members. Specifically, the proposed rule 
change will include rules designed (1) to foster greater public 
confidence in securities research, and to protect the objectivity and 
independence of securities analysts, by (a) restricting the 
prepublication clearance or approval of research reports by persons 
employed by the broker or dealer who are engaged in investment banking 
activities, or persons not directly responsible for investment 
research, other than legal or compliance staff,\166\ (b) limiting the 
supervision and compensatory evaluation of securities analysts to 
officials employed by the broker or dealer who are not engaged in 
investment banking activities,\167\ and (c) requiring that a broker or 
dealer and persons employed by a broker or dealer who are involved with 
investment banking activities may not, directly or indirectly, 
retaliate against or threaten to retaliate against any securities 
analyst employed by that broker or dealer or its affiliates as a result 
of an adverse, negative, or otherwise unfavorable research report that 
may adversely affect the present or prospective investment banking 
relationship of the broker or dealer with the issuer that is the 
subject of the research report, except that such rules may not limit 
the authority of a broker or dealer to discipline a securities analyst 
for causes other than such research report in accordance with the 
policies and procedures of the firm; \168\ (2) to define periods during 
which brokers or dealers who have participated, or are to participate, 
in a public offering of securities as underwriters or dealers should 
not publish or otherwise distribute research reports relating to such 
securities or to the issuer of such securities; \169\ and (3) establish 
structural and institutional safeguards within brokers or dealers to 
assure that securities analysts are separated by appropriate 
informational partitions within the firm from the review, pressure, or 
oversight of those whose involvement in investment banking activities 
might potentially bias their judgment or supervision.\170\
---------------------------------------------------------------------------

    \166\ 15 U.S.C. 78o-6(a)(1)(A) and proposed FINRA Rule 
2241(b)(2)(A).
    \167\ 15 U.S.C. 78o-6(a)(1)(B) and proposed FINRA Rule 
2241(b)(2)(C).
    \168\ 15 U.S.C. 78o-6(a)(1)(C) and proposed FINRA Rule 
2241(b)(2)(H).
    \169\ 15 U.S.C. 78o-6(a)(2) and proposed FINRA Rule 
2241(b)(2)(I).
    \170\ 15 U.S.C. 78o-6(a)(3) and proposed FINRA Rule 
2241(b)(2)(G).
---------------------------------------------------------------------------

    Further, the proposed rule change mandates the disclosures required 
by section 15D. Specifically, the proposed rule change requires 
disclosure of (1) the extent to which the securities analyst has debt 
or equity investments in the issuer that is the subject of the 
appearance or research report; \171\ (2) whether any compensation has 
been received by the broker or dealer, or any affiliate thereof, 
including the securities analyst, from the issuer that is the subject 
of the appearance or research report, subject to such exemptions as the 
Commission may determine as appropriate and necessary to prevent

[[Page 43495]]

disclosure by virtue of this paragraph of material non-public 
information regarding specific potential future investment banking 
transactions of such issuer, as is appropriate in the public interest 
and consistent with the protection of investors; \172\ (3) whether an 
issuer, the securities of which are recommended in the appearance or 
research report, currently is, or during the 1-year period preceding 
the date of the appearance or date of distribution of the report has 
been, a client of the broker or dealer, and if so, stating the types of 
services provided to the issuer; \173\ and (4) whether the securities 
analyst received compensation with respect to a research report, based 
upon (among any other factors) the investment banking revenues (either 
generally or specifically earned from the issuer being analyzed) of the 
broker or dealer.\174\
---------------------------------------------------------------------------

    \171\ 15 U.S.C. 78o-6(b)(1) and proposed FINRA Rule 
2241(c)(4)(A).
    \172\ 15 U.S.C. 78o-6(b)(2) and proposed FINRA Rule 
2241(c)(4)(B)-(D), (H), and (c)(5).
    \173\ 15 U.S.C. 78o-6(b)(3) and proposed FINRA Rule 
2241(c)(4)(E).
    \174\ 15 U.S.C. 78o-6(b)(4) and proposed FINRA Rule 
2241(c)(4)(B).
---------------------------------------------------------------------------

L. The Proposal Is Not Inconsistent With the JOBS Act

    The JOBS Act prohibits certain rules by national securities 
associations with regards to research reports regarding EGCs. 
Specifically, section 105(b) of the JOBS Act amended section 15D of the 
Act to prohibit the Commission or a national securities association 
registered under section 15A of the Act from adopting or maintaining 
any rule or regulation in connection with an IPO of the common equity 
of an EGC that either (1) restricts, based on functional role, which 
associated persons of a broker, dealer, or member of a national 
securities association, may arrange for communications between an 
analyst and a potential investor; \175\ or (2) restricts an analyst 
from participating in any communications with the management of an EGC 
that is also attended by any other associated person of a broker, 
dealer, or member of a national securities association whose functional 
role is other than as an analyst.\176\ Section 105(d) further prohibits 
the Commission or any national securities association registered under 
section 15A of the Act from adopting or maintaining any rule or 
regulation that prohibits any broker, dealer, or member of a national 
securities association from publishing or distributing any research 
report or making a public appearance, with respect to the securities of 
an EGC, either within any prescribed period of time following the IPO 
date of the EGC, or within any prescribed period of time prior to the 
expiration date of any agreement between the broker, dealer, or member 
of a national securities association and the EGC or its shareholders 
that restricts or prohibits the sale of securities held by the EGC or 
its shareholders after the IPO date. The proposal is not inconsistent 
with these requirements.
---------------------------------------------------------------------------

    \175\ 15 U.S.C. 78o-6(c)(1).
    \176\ 15 U.S.C. 78o-6(c)(2).
---------------------------------------------------------------------------

    One commenter noted that, because joint meetings are permitted by 
the JOBS Act, the provision in the proposal prohibiting joint due 
diligence conferences should be clarified.\177\ As explained above in 
the description of the joint due diligence provision, FINRA clarified 
that it ``would interpret the provision to apply only to the extent it 
is not contrary to the JOBS Act'' and ``[t]hus, for example, would not 
interpret the joint due diligence prohibition to apply where the joint 
due diligence activities involve a communication with the management of 
an EGC that is attended by both the research analyst and an investment 
banker.'' \178\ We believe that, as a result, the joint due diligence 
provision in the proposal cannot be seen as contrary to section 
15D(c)(2) of the Act.\179\
---------------------------------------------------------------------------

    \177\ JMP.
    \178\ FINRA Response.
    \179\ The staff notes that the proposal is consistent with FAQs 
issued by the staff concerning the analyst conflicts of interest 
provisions of the JOBS Act. Specifically, in FAQ 4, the staff 
provided three examples of purely ministerial statements that an 
analyst might provide at a pitch meeting for an ECG before the firm 
is formally retained to underwrite an offering and three examples of 
purely ministerial statements that an analyst might provide after 
the firm is formally retained to underwrite an offering, provided 
such statements are also in compliance with FINRA rules prohibiting 
promises of favorable research and solicitation. Thus, for instance, 
the FAQs suggest that an analyst may ask follow up questions in 
order to understand factual matters being presented provided such 
questions do not imply that the analyst is soliciting investment 
banking business or otherwise promising favorable research. The FAQs 
also suggest that firms should institute and enforce appropriate 
controls with regards to such pitch meetings to prevent violations 
of FINRA rules prohibiting solicitations or promises of favorable 
research, including analysts that may try to imbed such 
solicitations or promises in follow-up questions, during their 
introductions, or in outlining their research program and factors 
the analyst would consider in analyzing the company. Therefore, when 
taken in context with the entirety of the FAQ, the staff notes that 
the examples provided in the FAQs did not and were not intended to 
permit otherwise impermissible activities solely because they are 
conducted via the ministerial examples given in the FAQ.
---------------------------------------------------------------------------

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.\180\ 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 practices, to promote just and 
equitable principles of trade, and, in general, to protect investors 
and the public interest.\181\ Further, the Commission finds that the 
proposed rule change, as amended by Amendment No. 1, is consistent with 
Section 15D of the Act which requires, among other things, that the 
Commission, or upon the authorization and direction of the Commission, 
a registered securities association or national securities exchange, 
adopt rules reasonably designed to address conflicts of interest that 
can arise when securities analysts recommend equity securities in 
research reports and public appearances, in order to improve the 
objectivity of research and provide investors with more useful and 
reliable information.\182\
---------------------------------------------------------------------------

    \180\ 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).
    \181\ 15 U.S.C. 78o-3(b)(6).
    \182\ 15 U.S.C. 78o-6.
---------------------------------------------------------------------------

    FINRA stated in their proposal that it ``believes the proposed rule 
change protects investors and the public interest by maintaining, and 
in some cases expanding, structural safeguards to insulate research 
analysts from influences and pressures that could compromise the 
objectivity of research reports and public appearances on which 
investors rely to make investment decisions'' and ``that the proposed 
rule change prevents fraudulent and manipulative acts and practices by 
requiring firms to identify and manage, often with extensive 
disclosure, conflicts of interest related to the preparation, content 
and distribution of research.'' \183\ FINRA also noted that ``[a]t the 
same time, the proposal furthers the public interest by increasing 
information flow to investors in select circumstances--e.g., before and 
after the expiration of lock up provisions--where FINRA believes the 
integrity of research will not be compromised.'' \184\
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    \183\ Notice.
    \184\ Id.
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    The Commission generally agrees with these assertions. The 
Commission

[[Page 43496]]

found NASD Rule 2711 (and NYSE Rule 472) to meet the standards of 
sections 15A(b)(6) and 15D of the Act when adopted and as they have 
been amended since their original adoption.\185\ While the proposed 
rule change, as amended, is not an exact copy of these earlier 
provisions, it retains the vast majority of these rules as minimum 
standards required of members. The Commission believes that the vital 
elements of NASD Rule 2711 designed to address research analyst 
conflicts of interest--prohibitions on pre-publication review,\186\ 
institutional separations between investment banking and research,\187\ 
prohibitions on research analyst compensation based on investment 
banking results,\188\ prohibitions on research analysts participating 
in investment banking efforts,\189\ prohibitions on promises of 
favorable research coverage,\190\ and important disclosures,\191\ to 
name a few examples--are carried over to new FINRA Rule 2241.
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    \185\ See, e.g., Exchange Act Release No. 48252 (Jul. 29, 2003); 
68 FR 45875 (Aug. 4, 2003).
    \186\ NASD Rule 2711(b)(2) and proposed FINRA Rule 
2241(b)(2)(A).
    \187\ E.g., NASD Rule 2711(b)(1) and proposed FINRA Rule 
2241(b)(2)(C).
    \188\ NASD Rule 2711(d) and proposed FINRA Rule 2241(b)(2)(E)-
(F).
    \189\ E.g., NASD Rule 2711(c)(5)-(6) and proposed FINRA Rule 
2241(b)(2)(L)-(M).
    \190\ NASD Rule 2711(e) and proposed FINRA Rule 2241(b)(2)(K).
    \191\ NASD Rule 2711(h) and proposed FINRA Rule 2241(c) and (d).
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    Further, the proposed rule change includes new provisions that help 
ensure investor protection. For example, the proposed rule would 
require research management make independent decisions regarding 
research coverage,\192\ 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,\193\ and 
ensure that purported facts in research reports are based on reliable 
information.\194\ Also, where provisions have been altered, FINRA has 
generally kept the important element of the provision but required 
members to establish reasonable policies and procedures tailored to a 
member's business. For example, NASD Rule 2711(g)(2) prohibits 
``research analyst accounts'' from purchasing or selling securities 
issued by a company that the analyst covers for a period beginning 
thirty calendar days before and ending five calendar days after the 
publication of a research report, subject to certain exceptions. Under 
proposed FINRA Rule 2241(b)(2)(J), the same general principal applies 
(analysts and accounts they control should not trade in a security in 
such a way that the analyst benefits from knowledge of the content or 
timing of a research report ahead of its intended audience) without 
setting strict numerical timelines that may or may not be appropriate 
in every circumstance. Members may set periods that are longer or 
shorter than the current thirty/five day paradigm, but could be subject 
to liability if they are not reasonably designed to prevent the 
unwanted conduct.
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    \192\ Proposed FINRA Rule 2241(b)(2)(B).
    \193\ Proposed FINRA Rule 2241(b)(2)(G) and Notice (``Among the 
structural safeguards, FINRA believes separation between investment 
banking and research is of particular importance. As such, while the 
proposed rule change does not mandate physical separation between 
the research and investment banking departments (or other person who 
might seek to influence research analysts), FINRA would expect such 
physical separation except in extraordinary circumstances where the 
costs are unreasonable due to a firm's size and resource 
limitations. In those instances, a firm must implement written 
policies and procedures, including information barriers, to 
effectively achieve and monitor separation between research and 
investment banking personnel.'')
    \194\ Proposed FINRA Rule 2241(c)(1)(A).
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    Regarding concerns raised by commenters regarding the principles-
based structure of the proposal, we note the proposed rule change 
retains the key provisions of NASD Rule 2711 and includes a number of 
new protections for investors including the requirement that research 
management make independent decisions regarding research coverage,\195\ 
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,\196\ and ensure 
that purported facts in research reports are based on reliable 
information.\197\ Further, FINRA's responses to interpretive questions 
posed by the commenters to the original proposal in the Amendment 
Notice seem to have helped reduce uncertainty or confusion regarding 
how the proposal will operate in light of the principles-based 
structure. For example, one commenter noted with approval the 
clarification regarding the ``at a minimum'' requirement, which seemed 
to be the source of the commenter's confusion.\198\ FINRA also provided 
guidance in response to comments on other issues in the FINRA Response. 
For example, FINRA responded to an assertion by a commenter,\199\ 
agreeing that, consistent with the current rule and subject to controls 
regarding evaluation based on improper or inappropriate reviews, sales 
and trading personnel can provide feedback for purposes of evaluating 
an analyst. With regards to the context provided by FINRA, we 
particularly support the clarification that physical separation is 
expected except in extraordinary situations where the costs are 
unreasonable due to a firm's size or resources and that, even then, 
that the firm must establish written policies and procedures, including 
information barriers, to effectively achieve and monitor separation 
between research and investment banking personnel.\200\
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    \195\ Proposed FINRA Rule 2241(b)(2)(B).
    \196\ Proposed FINRA Rule 2241(b)(2)(G) and Notice (``Among the 
structural safeguards, FINRA believes separation between investment 
banking and research is of particular importance. As such, while the 
proposed rule change does not mandate physical separation between 
the research and investment banking departments (or other person who 
might seek to influence research analysts), FINRA would expect such 
physical separation except in extraordinary circumstances where the 
costs are unreasonable due to a firm's size and resource 
limitations. In those instances, a firm must implement written 
policies and procedures, including information barriers, to 
effectively achieve and monitor separation between research and 
investment banking personnel.'')
    \197\ Proposed FINRA Rule 2241(c)(1)(A).
    \198\ WilmerHale Equity Two.
    \199\ Id.
    \200\ Notice.
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    In approving this proposal, however, we expect that FINRA will 
continue to monitor the effectiveness of the rule proposal and modify 
the rule, or issue further guidance as promised, should it prove to be 
unworkable or fail to provide the same level of protection to investors 
as provided NASD Rule 2711.\201\
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    \201\ We note that, as one commenter suggested, the 
interpretation of what constitutes ``reasonableness'' may prove 
difficult for FINRA and member alike. See JMP.
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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,\202\ that the proposed rule change (SR-FINRA-2014-047), as 
modified by Amendment No. 1 thereto, be, and it hereby is, approved.
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    \202\ 15 U.S.C. 78s(b)(2).

[[Page 43497]]

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    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\203\
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    \203\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2015-17971 Filed 7-21-15; 8:45 am]
BILLING CODE 8011-01-P