Document ID: SEC-2008-0230-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2008-02-12T05:00Z

[Federal Register: February 12, 2008 (Volume 73, Number 29)]
[Notices]               
[Page 8089-8092]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12fe08-72]                         

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SECURITIES AND EXCHANGE COMMISSION

Release No. 34-57279; File No. SR-FINRA-2007-011]

 
Self-Regulatory Organizations: Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Amendment No. 1 and Order Granting 
Accelerated Approval of Proposed Rule Change as Modified by Amendment 
No. 1 To Amend NASD Rule 2711 (Research Analysts and Research Reports) 
and NYSE Rule 472 (Communications With the Public) Regarding a Member's 
Disclosure and Supervisory Review Obligations When It Distributes or 
Makes Available Third-Party Research Reports

February 6, 2008.

I. Introduction

    On September 12, 2007, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') a proposed rule change pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 
19b-4 thereunder.\2\ Notice of the proposal was published for comment 
in the Federal Register on September 26, 2007.\3\ The Commission 
received five comment letters to the proposed rule change.\4\ On 
January 16, 2008, FINRA filed Amendment No. 1 to the proposed rule 
change to make certain modifications to the original rule filing. This 
order provides notice of the proposed rule change, as modified by 
Amendment No. 1, and approves the proposed rule change as amended on an 
accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 56480 (September 20, 
2007), 72 FR 54698 (September 26, 2007).
    \4\ See letters to Nancy M. Morris, Secretary, Commission, from 
Morris N. Simkin, Esq., Katten Muchin Rosenman LLP (``Katten''), 
dated October 12, 2007; Stephen R. Biggar, Global Director of Equity 
Research, Standard & Poor's Equity Research Services (``S&P''), 
dated October 16, 2007; Jill Ostergaard and Christopher J. Mahon, 
Co-Chairs, Self Regulation and Supervisory Practices Committee, 
Securities Industry and Financial Markets Association (``SIFMA''), 
dated October 17, 2007; Stephanie R. Nicholas, WilmerHale 
(``WilmerHale''), dated October 19, 2007; and William D. Lyons and 
Arkadiy Neyman, Westminster Securities Corporation (``Westminster'') 
dated January 30, 2008.
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II. Description

    On September 12, 2007, FINRA filed with the Commission a proposed 
rule change to amend NASD Rule 2711 (``Research Analysts and Research 
Reports'') and NYSE Rule 472 (``Communications With the Public'') 
regarding a member's disclosure and supervisory review obligations when 
it distributes or makes available third-party research reports.\5\ The 
Commission received four comment letters to the proposed rule change 
during the comment period.\6\ FINRA responded to those comments in a 
letter dated January 16, 2008.\7\ In accordance with that response to 
comments, FINRA amended the proposed rule change. The Commission then 
received a fifth comment letter on January 30, 2008.\8\
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    \5\ See supra note 3.
    \6\ Katten, S&P, SIFMA, and WilmerHale.
    \7\ The comments and responses thereto are discussed in greater 
detail in FINRA's Response to Comments. See letter from Philip 
Shaikun to Nancy M. Morris dated January 16, 2008.
    \8\ Westminster. FINRA had already produced a response to 
comments dated January 16, 2008 by the time that the Commission 
received this letter. Per discussion with FINRA, FINRA does not 
believe that this letter changes its analysis.
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A. Current Rules

    NASD Rule 2711(h)(13) and NYSE Rule 472(k)(4) set forth a member's 
disclosure and supervisory review obligations when the member 
distributes--i.e., ``pushes out''--or makes available a research report 
produced by a third party. A member that distributes a third-party 
research report must accompany the report with certain current 
applicable disclosures (``third-party disclosures''), as they pertain 
to the member. The third-party disclosure requirements do not apply if 
a member makes available to its customers non-affiliate research either 
upon request or through a member-maintained Web site.
    NASD Rule 2711(h)(13) further requires that a registered principal 
(or

[[Page 8090]]

supervisory analyst approved pursuant to Rule 344 of the New York Stock 
Exchange) review and approve by signature or initial any third-party 
research distributed by a member. Consistent with NASD Rule 
2210(d)(1)(B), the member must review such research to ensure that the 
applicable disclosures discussed above are complete and accurate 
(``disclosure review'') and the content of the research reports 
contains no untrue statement of material fact or is otherwise not false 
or misleading (``content review''). Similarly, NYSE Rule 472(k)(4) 
requires a supervisory analyst approved pursuant to New York Stock 
Exchange Rule 344 to approve by signature or initial any third-party 
research distributed by a member organization. Additionally, NYSE Rule 
472(k)(4) requires a supervisory analyst or qualified person, 
designated pursuant to NYSE Rule 342(b)(1), to conduct the same 
disclosure and content review as NASD Rule 2711(h)(13).
    FINRA has interpreted that content review requirement to mean that 
a member's supervisory obligation for review of third-party research 
extends to any untrue statement of material fact or any false or 
misleading information that (1) should be known from a reading of the 
report or (2) is known based on information otherwise possessed by the 
member.\9\ No supervisory review is required under either rule when a 
member makes available non-affiliate research either upon request or 
through a member-maintained Web site.
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    \9\ See Notice to Members 07-04. NYSE Information Memo 07-11, 
which has been incorporated by FINRA, sets out the same standard for 
NYSE Rule 472(k)(4).
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B. Amended Proposal

    The proposed rule change would define a ``third-party research 
report'' for the purposes of the rules as a research report that is 
produced by a person or entity other than a member. The proposal 
further would create the subcategory of ``independent third-party 
research'' and eliminate the content review requirement when a member 
distributes or makes available such research. The proposal, as amended, 
would define ``independent third-party research'' for the purposes of 
the rules to mean a third-party research report, in respect of which 
the person or entity producing the report: (1) Has no affiliation or 
business or contractual relationship with the distributing member or 
that member's affiliates that is reasonably likely to inform the 
content of its research reports; and (2) makes content determinations 
without any input from the distributing member or that member's 
affiliates.
    The proposed rule change would create an exception from the 
disclosure review requirement for independent third-party research 
reports made available by a member either (1) upon request, (2) through 
a member-maintained Web site, or (3) where such report is made 
available by a member to a customer in connection with a solicited 
order in which the registered representative has informed the customer, 
during the course of the solicitation, of the availability of 
independent research on the solicited equity security and the customer 
requests such independent research.
    The proposed rule change would require that current applicable 
third-party disclosures accompany any third-party research report that 
does not meet the definition of ``independent third-party research 
report,'' irrespective of whether it is distributed or made available 
upon request, on a member-maintained web site or in connection with a 
solicitation, as described above. However, the proposed rule change 
would amend NASD Rule 2711(h)(13) and NYSE 472(k)(4) to allow a member 
to direct a customer to a web address where such applicable third-party 
disclosures could be found. As amended, the proposal would allow 
members to meet the disclosure review requirement for non-independent 
or pushed out independent third-party research if the member 
establishes written supervisory polices and procedures reasonably 
designed to ensure the completeness and accuracy of all applicable 
disclosures.
    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be the date of publication 
of the Regulatory Notice announcing Commission approval.

III. Comment Letters

    The Commission received five comment letters to the proposed rule 
change.\10\ The commenters generally expressed support for the 
proposal,\11\ but requested that FINRA consider certain modifications 
to it. As originally proposed, this rule change would define 
``independent third-party research'' to mean a research report, in 
respect of which the person or entity producing the report: (1) Has no 
affiliation or business or contractual relationship with the 
distributing member or that member's affiliates that is reasonably 
likely to inform the content of its research reports; and (2) makes 
both coverage and content determinations without any input from the 
distributing member or that member's affiliates.
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    \10\ See supra note 4.
    \11\ Westminster did not specifically express general support 
for the proposal and suggested changes. See infra.
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    One commenter \12\ asserted that the prohibition on input into 
coverage determinations could significantly diminish a firm's ability 
to rely on the exception. The commenter noted that firms typically 
request coverage from independent research providers of particular 
sectors or market capitalization companies to supplement their own 
research or offer a second opinion of companies they cover. The 
commenter argued that a distributing firm's inability to control the 
content of a research report should suffice to establish independence 
and therefore the second prong of the definition is superfluous and 
should be eliminated.
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    \12\ WilmerHale.
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    FINRA agreed that input into coverage decisions does not 
necessarily compromise the independence of a third-party research 
report and thus amended the original proposed rule change to delete the 
prohibition on coverage determinations in Amendment No. 1. However, 
FINRA believed the remainder of the second prong of the definition (the 
requirement that the member have no input on the content of the report) 
went beyond the prohibition of a contractual or affiliate relationship 
prohibited by the first prong and therefore should remain. Therefore, 
FINRA will construe the amended second prong to mean that a 
distributing firm cannot have any input into the outcome of the 
research report. Thus, input into coverage determinations would be 
permissible, so long as the agreement to cover a company or sector does 
not carry with it an implicit understanding as to any particular 
conclusions or recommendations of the resultant research reports.
    FINRA also received comments regarding the proposed disclosure 
review requirement. NASD and NYSE rules currently require a member that 
distributes any third-party research report to accompany the report 
with certain current applicable disclosures as they pertain to the 
member. These rules further require that a registered principal or 
supervisory analyst review and approve by signature or initial any 
third-party research distributed by a member. That review must ensure 
that the applicable disclosures are complete and accurate. No 
disclosures or review is required when the third-party

[[Page 8091]]

research report is made available upon request or through a member-
maintained web site.
    The rule change, as originally proposed, would maintain the 
disclosure review requirements when a member distributes independent 
third-party research reports, but would expand the exception to the 
requirement where independent third-party research is made available by 
a member to a customer in connection with a solicited order in which 
the registered representative has informed the customer, during the 
course of the solicitation, of the availability of such research and 
the customer requests it. The disclosure review requirement would still 
pertain where a member ``pushes out'' independent third-party research.
    One commenter \13\ suggested that the disclosure review requirement 
be more principles-based, such that firms can discharge their 
obligations with policies and procedures reasonably designed to ensure 
that the disclosures are complete and accurate. The commenter asserted 
that many firms have systems to populate the disclosures, where 
applicable, and that those disclosures are updated frequently through 
automated processes that derive their information from areas outside of 
the research department. The commenter further noted that many firms 
distribute thousands of third-party research reports, making it 
difficult or impractical to review and approve each one.
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    \13\ SIFMA.
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    In view of the volume of third-party research reports distributed 
by many firms, FINRA agreed that the disclosure review requirement 
should be satisfied with written supervisory policies and procedures 
reasonably designed to ensure the completeness and accuracy of all 
applicable disclosures and amended its proposal accordingly in 
Amendment No. 1.
    One commenter \14\ wanted clarification that the disclosure review 
requirement does not apply where no disclosures are required, such as 
when independent third-party research is made available to a customer 
upon their request. FINRA agreed that no disclosure review is required 
under such circumstances but noted that members must have policies and 
procedures in place to verify that disclosures are not required in the 
first instance.
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    \14\ S&P.
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    One commenter \15\ suggested that FINRA create an exception from 
the disclosure requirements altogether for independent third-party 
research that is distributed to institutional investors. FINRA 
responded that it is considering providing exceptions for the 
application of certain of the rules under its jurisdiction for 
institutional investors in its efforts in developing a single 
consolidated NASD and NYSE rulebook.
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    \15\ Katten.
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    One commenter \16\ suggested that the proposal be amended to 
``include language that reflects the fact that a principal or 
supervisory analyst assigned by a member firm to carry out the review 
of third party research may not be aware of all information his or her 
member firm employer possesses regarding a specific company, industry, 
etc.'' The commenter also requested that the rule text be amended to 
``refer to such reviews being performed based on information that can 
reasonably be expected to be in the possession of the reviewer (rather 
than the corporate knowledge of the reviewer's entire firm).'' Per 
discussion with FINRA, this comment did not change their analysis.
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    \16\ Westminster.
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IV. Discussion

    The Commission has carefully reviewed the proposed rule change and 
finds that it is consistent with the requirements of the Act and the 
rules and regulations thereunder applicable to a national securities 
association.\17\ In particular, the Commission finds that the proposed 
rule change is consistent with section 15A(b)(6) of the Act,\18\ which 
requires, among other things, that FINRA 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. The Commission believes that the proposed rule 
change will promote the availability of independent third party 
research reports, thereby resulting in more fully informed decisions by 
investors.
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    \17\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \18\ 15 U.S.C. 78o-3(b)(6).
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    The Commission also finds good cause to approve Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing of the amendment in the Federal 
Register. The proposed rule change was published in the Federal 
Register on September 26, 2007.\19\ FINRA submitted Amendment No. 1 in 
response to the four comments received on the proposed rule change 
prior to FINRA's response to those comments.\20\ The Commission 
believes that Amendment No. 1 simplifies the obligations of FINRA 
member firms but not at the expense of investor protection. Amendment 
No. 1 does not contain major modifications that are more restrictive 
than the scope of the proposed rule change as published in the Federal 
Register. The Commission believes that approving Amendment No. 1 will 
simplify compliance and is consistent with the public interest and the 
investor protection goals of the Act. Finally, the Commission finds 
that it is in the public interest to approve the proposed rule change 
as soon as possible to expedite its implementation.
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    \19\ See supra note 3.
    \20\ As discussed above, FINRA believes that no change is 
necessary based on the fifth comment (Westminster) because that 
comment did not change their analysis.
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    Accordingly, the Commission believes good cause exists, consistent 
with sections 15A(b)(6) and 19(b) of the Act,\21\ to approve Amendment 
No. 1 to the proposed rule change on an accelerated basis.
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    \21\ 15 U.S.C. 78o-3(b)(6), and 78s(b).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
changes are consistent with the Act. Comments may be submitted by any 
of the following methods:

Electronic Comments

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

File Number SR-FINRA-2007-011 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-FINRA-2007-011. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments, 

all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the

[[Page 8092]]

proposed rule change between the Commission and any person, other than 
those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-FINRA-2007-011 and should be 
submitted on or before March 4, 2008.

VI. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular section 15A of the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\22\ that the proposed rule change (File No. SR-FINRA-2007-011), as 
modified by Amendment No. 1, be, and hereby is, approved on an 
accelerated basis.
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    \22\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-2518 Filed 2-11-08; 8:45 am]

BILLING CODE 8011-01-P