Document ID: SEC-2009-0093-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2009-01-23T05:00Z

[Federal Register: January 23, 2009 (Volume 74, Number 14)]
[Notices]               
[Page 4271-4272]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23ja09-111]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59254; File No. SR-FINRA-2008-054]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving Proposed Rule Change To Adopt FINRA 
Rule 5280 (Trading Ahead of Research Reports) in the Consolidated FINRA 
Rulebook

January 15, 2009.

I. Introduction

    On October 29, 2008, the Financial Regulatory Authority, Inc. 
(``FINRA'') (f/k/a National Association of Securities Dealers, Inc. 
(``NASD'')) 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 change to adopt NASD Interpretive Material 2110-4 
(Trading Ahead of Research Reports) as a FINRA rule, subject to certain 
amendments. The proposed rule change was published for comment in the 
Federal Register on November 6, 2008.\3\ The Commission received two 
comment letters in response to the proposed rule change. This order 
approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 58905 (November 6, 
2008), 73 FR 67237 (November 13, 2008) (SR-FINRA-2008-054) (notice).
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II. Description of the Proposed Rule Change

    As part of the process of developing the new consolidated rulebook 
(``Consolidated FINRA Rulebook''),\4\ FINRA proposed to adopt in the 
Consolidated FINRA Rulebook NASD Interpretive Material (``IM'') 2110-4 
(Trading Ahead of Research Reports) with certain modifications.
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    \4\ The current FINRA rulebook includes, in addition to FINRA 
Rules, (1) NASD Rules and (2) rules incorporated from NYSE 
(``Incorporated NYSE Rules'') (together, the NASD Rules and 
Incorporated NYSE Rules are referred to as the ``Transitional 
Rulebook''). While the NASD Rules generally apply to all FINRA 
members, the Incorporated NYSE Rules apply only to those members of 
FINRA that are also members of the NYSE (``Dual Members''). For more 
information about the rulebook consolidation process, see FINRA 
Information Notice, March 12, 2008 (Rulebook Consolidation Process).
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    IM-2110-4 states that it is conduct inconsistent with just and 
equitable principles of trade for a member to establish or adjust an 
inventory position in an exchange-listed security traded over-the-
counter or a derivative of such security in anticipation of the 
issuance of a research report on that security. The IM further 
recommends--but does not require--that firms establish policies and 
procedures to develop and implement effective internal controls to 
isolate specific information within research and other relevant 
departments so as to prevent the trading department from utilizing 
advance knowledge of the issuance of research reports. Those members 
that choose not to establish such procedures bear the burden to show 
that changes in inventory positions in advance of research reports were 
not purposeful.\5\
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    \5\ Incorporated NYSE Rule Interpretation 401/01 includes 
aspects similar to IM-2110-4. FINRA deleted that Interpretation as 
part of an earlier filing to transfer NASD Rule 2110 (Standards of 
Commercial Honor and Principles of Trade) and 2120 (Use of 
Manipulative, Deceptive or Other Fraudulent Devices) to the 
Consolidated FINRA Rulebook, as the conduct addressed in the 
Interpretation is subsumed by those rules. See Securities Exchange 
Act Release No. 58643 (September 24, 2008) 73 FR 57174 (October 1, 
2008) (Order Approving SR-FINRA-2008-028).
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    The proposed rule change would amend the IM in three respects. 
First, it would extend the application of the IM to cover inventory 
positions with respect to any security--including debt--or derivative 
thereof, irrespective of whether the security is exchange-listed. FINRA 
believes the purpose of the IM--to prevent the manipulation of the 
supply of a security for the benefit of a firm and to the detriment of 
investors--applies equally to inventory positions in non-exchange-
listed securities.
    Second, the proposed rule change would apply the rule only to 
circumstances where a member establishes or adjusts its inventory based 
on non-public advance knowledge of the content or timing of a research 
report in that security. As such, it would not be a violation of the 
rule for a member to increase or decrease inventory of a security based 
on publicly available information regarding the likely timing of a 
research report. By way of example, when a member's trading desk 
adjusts an inventory position in anticipation of a research report 
because of a publicly discernible trend that a member's report tends to 
follow an earnings announcement, the prohibitions of the rule would not 
be triggered. However, having knowledge of a publicly discernible trend 
is not a viable alternative basis for the member's trading desk to 
adjust its inventory position when the trading desk is also the 
recipient of non-public advance knowledge of the content or timing of a 
research report in that security.
    Finally, the proposal would eliminate the option to establish 
internal controls to manage the flow of information between the 
research and trading departments and instead mandate that firms 
establish policies and procedures reasonably designed to restrict or 
limit the information flow between research department personnel, or 
other persons with knowledge of the content or timing of a research 
report, and trading department personnel, so as to prevent trading 
department personnel from utilizing non-public advance knowledge of the 
issuance or content of a research report for the benefit of the member 
or any other person.
    FINRA believes that a member should have an affirmative obligation 
to manage conflicts of interest in its trading of securities. Moreover, 
this approach is more consistent with existing and proposed rules 
regarding supervision and the requirements of NASD Rule 2711 and NYSE 
Rule 472 to eliminate conflicts involving the publication and 
distribution of research reports.

III. Comments

    The SEC received two comment letters.\6\ The commenters' concerns, 
as well as FINRA's responses are discussed below.
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    \6\ Letter from Amal Aly, Managing Director and Associate 
General Counsel, Securities Industry and Financial Markets 
Association (``SIFMA''), December 5, 2008; Letter from Peter C. 
Chepucavage, General Counsel, Plexus Consulting, LLC, January 12, 
2009.
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    The first comment letter expressed general support for the proposed 
rule change, but requested a few clarifications. First, the commenter 
sought clarification that the term ``research report'' in the proposed 
rule change has the same definition as that in NASD Rule 2711(a)(9). 
The latter defines research report as ``any written (including 
electronic) communication that includes an analysis of equity 
securities of individual companies or industries, and that provides 
information sufficient upon which to base an investment decision.'' 
Rule 2711(a) also includes several exceptions to the definition, among 
them communications limited to

[[Page 4272]]

commentaries on economic, political or market conditions.
    FINRA responded that the term ``research report'' in the proposed 
rule change is intended to be much broader than that in NASD Rule 
2711(a)(9) and is meant to cover adjustments to inventory positions 
based on non-public knowledge of the content or timing of both debt and 
equity research.\7\ The proposed rule change differs in objective from 
NASD Rule 2711(a)(9) and is intended to ``enhance investor protection 
and market integrity by deterring member firms from improperly 
accumulating or otherwise altering investor positions in securities'' 
based on non-public advance knowledge of the content or timing of a 
research report in those securities. FINRA interprets the term research 
report in proposed FINRA Rule 5280 to cover any written information 
from the research department that a reasonable person would expect to 
result in a transaction based on that information. Thus, to the extent 
a reasonable person would expect that a communication containing market 
commentary would result in a transaction in a particular security or 
securities, a member could not establish or adjust its inventory in 
those securities based on non-public advance knowledge of that 
communication or the timing of its public release. Based on these 
reasons, FINRA declined the commenter's additional request that the 
proposal be narrowed to cover only those actions taken by a member firm 
to adjust its inventory based upon advance non-public knowledge of 
material investment conclusions, such as ratings or price targets.
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    \7\ See Letter from Philip Shaikun, Associate Vice President and 
Associate General Counsel, FINRA, January 2, 2008.
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    Second, the commenter requested that FINRA confirm that the 
requirement in subparagraph (b) of the proposal to establish, maintain 
and enforce certain policies and procedures is not meant to (1) limit 
or restrict communications between sales and trading personnel and 
research personnel concerning an analyst's published views or (2) to 
require that such communications must be pre-cleared or monitored.
    FINRA responded that the proposed rule sets forth an unambiguous 
supervision standard that ``a member must establish, maintain and 
enforce policies and procedures reasonably designed to restrict or 
limit the information flow between research department personnel, or 
others with knowledge of the content or timing of a research report, 
and trading department personnel, so as to prevent trading department 
personnel from utilizing non-public advance knowledge of the issuance 
or content of a research report for the benefit of the member or any 
other person.'' FINRA views the supervisory standard in the proposal as 
purposefully flexible, to allow firms to tailor their policies and 
procedures to their size, structure, business model and compliance 
system. As such any number of specific policies and procedures may be 
appropriate to satisfy the standard. Thus, absent ambiguity in the 
standard, FINRA believes it inappropriate to opine on the adequacy of 
one or more elements of potentially many approaches that could satisfy 
the rule's supervision requirement.
    The second comment letter expressed concern that while the proposed 
rule addresses that a broker-dealer cannot trade ahead of its own 
research report, the broker-dealer's customers and potential customers 
should also be so prohibited and that all customers and potential 
customers should get the research report at the same time. Further, the 
commenter indicated that the issue of whether the public should 
simultaneously get such reports should be explored and addressed. Per 
discussion, FINRA noted that the commenter's concerns are more 
appropriate to and are addressed in FINRA's proposed ``Research 
Registration and Conflict of Interest Rules.'' \8\
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    \8\ See, FINRA NTM 08-55, October 2008.
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IV. Discussion and Findings

    After careful review of the proposed rule change, the comments and 
FINRA's response to the comments, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act, 
and the rules and regulations thereunder that are applicable to a 
national securities association.\9\ In particular, the Commission 
believes the proposed rule change is consistent with the provisions of 
Section 15A(b)(6) of the Act,\10\ which requires, among other things 
that FINRA rules must be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and questionable 
principles of trade, and, in general, to protect investors and the 
public interest. The Commission believes that the proposed rule change 
will protect the investing public by preventing firms from utilizing 
non-public advance knowledge of the timing or content of a research 
report to benefit its own trading to the detriment of its customers. 
Moreover, the Commission believes the proposed rule change further 
would clarify and streamline NASD IM-2110-4 for adoption as a FINRA 
Rule in the Consolidated FINRA Rulebook.\11\ NASD IM-2110-4 has 
previously been found to meet the statutory requirements, and FINRA 
believes the rule has since proven effective in achieving statutory 
mandates.
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    \9\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition and capital 
formation. See 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78o-3(b)(6).
    \11\ See supra note 4.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\12\ that the proposed rule change (SR-FINRA-2008-054) be, and 
hereby is, approved.
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    \12\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E9-1298 Filed 1-22-09; 8:45 am]

BILLING CODE 8011-01-P