not easily recognizable as research as opposed to an advertising
prospectus or supplemental sales literature. Although there are
multiple provisions in proposed rule 139b that aim to limit the risk
that broker-dealers could use the proposed safe harbor to circumvent
the prospectus requirements of the Securities Act,\167\ there could be
circumstances where, under rule 139b, broker-dealers publish or
distribute communications that historically have been viewed as
registered investment company advertisements or selling materials.
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    \165\ See section 2(a)(10)(a) of the Securities Act; rule
139b(a). See also rule 34b-1 under the Investment Company Act [17
CFR 270.34b-1]. Rule 34b-1 provides that any advertisement,
pamphlet, circular, form letter, or other sales literature addressed
to or intended for distribution to prospective investors that is
required to be filed with the Commission by section 24(b) of the
Investment Company Act will have omitted to state a fact necessary
in order to make the statements made therein not materially
misleading unless it includes certain specified information.
    \166\ See rule 34b-1(b)(1)-(2) [17 CFR 270.34b-1(b)(1)-(2)].
    \167\ See, e.g., supra sections II.A.1 (affiliate exclusion) and
II.B.1.c and II.B.2.b (regular-course-of-business requirements).
Certain covered investment fund research reports that meet the
definition of ``research report'' in Regulation AC would be subject
to the requirements of Regulation AC. Similarly, covered investment
fund research reports that meet the definition of ``research
report'' in FINRA rule 2241 or the definition of ``debt research
report'' in FINRA rule 2242 would be subject to the content
requirements in those rules as applicable. See infra section II.D.1.
---------------------------------------------------------------------------

    We received two comment letters addressing this issue.\168\ One
commenter suggested that the presentation of performance information in
research reports about registered investment companies should not be
subject to the standardized performance requirements of rule 482.\169\
This commenter stated that because rule 482 is intended to apply to
advertisements, such presentation requirements might undermine analysis
or insights that a

research analyst may seek to convey about one or more covered
investment funds by highlighting a particular aspect of performance
information. This commenter also stated that SRO rules would address
the investor confusion concern raised by the Commission. We disagree
that applying standardized performance presentation requirements would
undermine a research analyst's analysis or insights because rule 482
does not preclude non-standardized performance information. Rather, it
requires standardized performance information to be presented if non-
standardized performance information is presented. We believe SRO rules
may address some investor confusion concerns, but we believe requiring
presentation performance requirements would more fully address these
concerns.
---------------------------------------------------------------------------

    \168\ See SIFMA Comment Letter I; ICI Comment Letter; see also
BlackRock Comment Letter.
    \169\ SIFMA Comment Letter I.
---------------------------------------------------------------------------

    Another commenter stated that the Commission should require that
fund-specific performance information in covered investment fund
research reports be presented in accordance with the applicable
standardization requirements.\170\ This commenter stated that investors
tend to consider fund performance a significant factor in evaluating or
comparing funds and that standardized fund performance reporting
requirements have served investors well. Furthermore, this commenter
noted that discrepancies in performance between a broker-dealer's
research report and what a fund may report or disclose in regulatory
filings or advertisements would risk confusing investors. We agree with
both of the commenter's points. This commenter also noted that if the
final rule does not require standardized presentation requirements for
fund performance information, the Commission should require a clear and
prominent disclosure whenever fund-specific performance is not in
accordance with these standards.
---------------------------------------------------------------------------

    \170\ ICI Comment Letter. This commenter also suggested the
disclosure of Form N-2 performance data for closed-end funds. See
also BlackRock Comment Letter.
---------------------------------------------------------------------------

    The final rule thus requires that a research report that includes
open-end fund performance information must present this information in
accordance with rule 482 presentment and timeliness requirements. A
research report must present closed-end fund performance information in
accordance with the instructions to item 4.1(g) set forth in Form N-2
(although other historical measures of performance may also be included
if the other measurement is set out with no greater prominence than the
measurement that is in accordance with the instructions to item 4.1(g)
of Form N-2).
    Rule 139b(a)(3) requirements would not preclude research report
analysts from presenting performance information in their preferred
manner; rather, it requires that standardized performance information
also be included if non-standardized performance information is
presented. To satisfy this requirement, analysts may choose to present
non-standardized performance information in a way they believe
highlights a particular insight or analysis, so long as it is presented
alongside the standardized performance information consistent with rule
482 requirements or Form N-2, if applicable.\171\
---------------------------------------------------------------------------

    \171\ See rule 139b(a)(3).
---------------------------------------------------------------------------

    As noted in the proposal, covered investment fund research reports
relying on the rule 139b safe harbor are subject to the antifraud
provisions of the federal securities laws.\172\ The Commission has
previously articulated guidance on factors to be weighed in considering
whether statements involving a material fact in registered investment
company advertisements and sales literature, which are also subject to
the antifraud provisions of the federal securities laws, could be
misleading.\173\ This guidance provided factors to be weighed when
determining whether fund performance in sales literature is adequately
disclosed. The guidance factors in rule 156 \174\ are informative in
evaluating whether any presentations of registered investment company
performance in these research reports could be misleading because they
reflect principles that would help guide this analysis (such as
providing information to investors that is informative and that does
not create unrealistic investor expectations \175\). We believe that
incorporating these rule 482 and Form N-2 presentation standards in
rule 139b reduces the potential for confusion between (i) registered
open-end management investment company advertisements and selling
materials covered by rule 482 and registered closed-end investment
company selling materials covered by Form N-2 and (ii) rule 139b
research reports. Moreover, we believe it would reduce the potential
for investor confusion resulting from divergent standards in the
presentation of performance data.
---------------------------------------------------------------------------

    \172\ See section 2(c)(1) of the FAIR Act (stating that nothing
in the FAIR Act shall be construed as in any way limiting the
applicability of the antifraud or anti-manipulation provisions of
the federal securities laws and rules adopted thereunder to a
covered investment fund research report, including section 17 of the
Securities Act, section 34(b) of the Investment Company Act, and
sections 9 and 10 of the Exchange Act).
    \173\ See Amendments to Investment Company Advertising Rules,
Securities Act Release No. 8294 (Sept. 29, 2003) [68 FR 57759 (Oct.
6, 2003)]; see also rule 156 under the Securities Act [17 CFR
230.156].
    \174\ Rule 156(b) under the Securities Act provides guidance
factors concerning misleading statements in investment company sales
literature including: (i) Statements and omissions generally
(including in light of general economic or financial conditions or
circumstances), (ii) representations about past or future investment
performance, and (iii) statements involving a material fact about an
investment company's characteristics or attributes.
    \175\ See Amendments to Investment Company Advertising Rules,
Securities Act Release No. 8101 (May 17, 2002) [67 FR 36712 (May 24,
2002)].
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D. Role of Self-Regulatory Organizations

1. SRO Content Standards and Filing Requirements for Covered Investment
Fund Research Reports
SRO Content Standards
    The FAIR Act contemplates that SRO content standards applicable to
research reports would apply to covered investment fund research
reports.\176\ Specifically, the FAIR Act provides that, unless covered
investment fund research reports are subject to the content standards
in the rules of any SRO related to research reports, these research
reports may still be subject to the filing requirements of section
24(b) of the Investment Company Act for the review of investment
company sales literature.\177\ As discussed in more detail below, we
are adopting rule 24b-4 to implement this provision of the FAIR Act.
New rule 24b-4 provides that a covered investment fund research report
about a registered investment company will not be subject to section
24(b) of the Investment Company Act (or the rules and regulations
thereunder), except to the extent the

research report is otherwise not subject to the content standards in
SRO rules related to research reports, including those contained in the
rules governing communications with the public regarding investment
companies or substantially similar standards.\178\
---------------------------------------------------------------------------

    \176\ See section 2(b)(4) of the FAIR Act (A covered investment
fund research report shall not be subject to section 24(b) of the
Investment Company Act or the rules and regulations thereunder,
except that such report may still be subject to such section and the
rules and regulations thereunder to the extent that it is otherwise
not subject to the content standards in the rules of any self-
regulatory organization related to research reports, including those
contained in the rules governing communications with the public
regarding investment companies or substantially similar standards.).
This provision is relevant only to research reports on covered
investment funds that are investment companies subject to section
24(b) of the Investment Company Act. For example, registered closed-
end investment companies, BDCs, and commodity- or currency-based
trusts or funds are covered investment funds that are not subject to
section 24(b) of the Investment Company Act. A covered investment
fund research report that is not subject to section 24(b) of the
Investment Company Act would not be subject to filing requirements
under that section even if research reports concerning the covered
investment fund were not subject to the content standards in the
rules of any self-regulatory organization related to research
reports.
    \177\ See id.
    \178\ See rule 24b-4.
---------------------------------------------------------------------------

    Currently, the SRO content standards relevant to communications
that would be considered covered investment fund research reports under
rule 139b include the applicable content standards of FINRA rules 2210,
2241, and 2242.\179\ FINRA's rule governing communications with the
public (FINRA rule 2210) contains general content standards that apply
broadly to member communications,\180\ including broker-dealer research
reports. These general content standards require, among other things,
that all member communications ``must be based on principles of fair
dealing and good faith, must be fair and balanced, and must provide a
sound basis for evaluating the facts in regard to any particular
security or type of security, industry or service.'' \181\
---------------------------------------------------------------------------

    \179\ See infra note 183 (discussing the scope of these rules in
more detail, including noting that the scope of certain provisions
of FINRA rule 2210, and the scope of FINRA rules 2241(c)(1) and
2242(c)(2) generally, apply only to a certain subset of
communications that would be considered covered investment fund
research reports under rule 139b).
    \180\ See FINRA rule 2210(d)(1).
    \181\ See FINRA rule 2210(d)(1)(A). FINRA rule 2210's general
content standards also provide, among other things, that FINRA
members may not ``make any false, exaggerated, unwarranted,
promissory or misleading statement or claim in any communication''
nor ``publish, circulate or distribute any communication that the
member knows or has reason to know contains any untrue statement of
a material fact or is otherwise false or misleading.'' See FINRA
rule 2210(d)(1)(B).
---------------------------------------------------------------------------

    The FAIR Act does not explicitly refer to specific content
standards in SRO rules. It refers more generally to ``the content
standards in the rules of any self-regulatory organization related to
research reports, including those contained in the rules governing
communications with the public regarding investment companies or
substantially similar standards.'' \182\ In order to provide clarity
and facilitate consistent and predictable application of rule 24b-4, we
interpret section 2(b)(4) of the FAIR Act as excluding covered
investment fund research reports from section 24(b) of the Investment
Company Act so long as they continue to be subject to the general
content standards in FINRA rule 2210(d)(1) (or substantially similar
SRO rules). Accordingly, by operation of rule 24b-4, covered investment
fund research reports under rule 139b that otherwise would be subject
to section 24(b) of the Investment Company Act would not be subject to
that section so long as they remain subject to the general content
standards of FINRA rule 2210(d)(1).\183\ This interpretation is
consistent with our belief that it is important for SRO content
standards to continue to apply to covered investment fund research
reports, especially if, as discussed below, research reports about
registered investment companies would no longer be required to be filed
pursuant to section 24(b) of the Investment Company Act or rule 497
under the Securities Act,\184\ and therefore would no longer be subject
to routine review.\185\ We received no comments on SRO content
standards specifically, but some commenters suggested that FINRA rules
(particularly with respect to definitions and filing requirements
thereunder) be modified or harmonized with rule 139b, which we discuss
below.\186\
---------------------------------------------------------------------------

    \182\ Section 2(b)(4) of the FAIR Act.
    \183\ A subset of communications that would fall within the
definition of ``covered investment fund research report'' under rule
139b also would be subject to additional content-related
requirements under FINRA rules that are applicable to certain
research reports, but that are more narrowly applicable than the
general content standards of FINRA rule 2210(d)(1). However, under
our interpretation, whether or not these additional content
standards apply to any given covered investment fund research report
would not determine the applicability of section 24(b) to that
research report under proposed rule 24b-4. A different
interpretation could lead to results that we believe could be
inconsistent with section 2(b)(4) of the FAIR Act (i.e., if only
communications that are subject to additional FINRA content
standards discussed in this footnote (e.g., those applicable to
retail communications) were excluded from section 24(b) filing
requirements).
     Additional FINRA content-related requirements include the
content standards of FINRA rule 2210 that apply only to retail
communications (or retail communications and correspondence, as
those terms are defined in FINRA rule 2210(a)). See, e.g., FINRA
rules 2210(d)(2) (Comparisons), 2210(d)(3) (Disclosure of Member's
Name). Accordingly, covered investment fund research reports that
would meet the definition of institutional communications would not
be subject to some of the content standards of FINRA rule 2210.
     These additional requirements also include the content
standards incorporated in FINRA rules 2241 and 2242, which apply to
certain research reports defined in these FINRA rules. The scope of
FINRA rules 2241 and 2242 only includes research reports or debt
research reports as defined in these rules, and the definitions of
``research report'' and ``debt research report'' in these rules are
different than the definitions of ``research report'' set forth in
rule 139 and new rule 139b. Under FINRA rule 2241, ``research
report'' is defined as any written (including electronic)
communication that includes an analysis of equity securities of
individual companies or industries (other than an open-end
registered investment company that is not listed or traded on an
exchange) and that provides information reasonably sufficient upon
which to base an investment decision; similarly, under FINRA rule
2242, ``debt research report'' is defined as any written (including
electronic) communication that includes an analysis of a debt
security or an issuer of a debt security and that provides
information reasonably sufficient upon which to base an investment
decision, excluding communications that solely constitute an equity
research report as defined in FINRA rule 2241(a)(11). See FINRA
rules 2241(a)(11), 2242(a)(3).
    \184\ See infra notes 187-189 and accompanying text.
    \185\ Broker-dealer communications that are excluded from, or
otherwise not subject to FINRA's filing requirements may still be
reviewed by FINRA, for example, through examinations, targeted
sweeps or spot-checks. FAIR Act section 2(c)(2) provides that
nothing in the Act shall be construed as in any way limiting ``the
authority of any self-regulatory organization to examine or
supervise a member's practices in connection with such member's
publication or distribution of a covered investment fund research
report for compliance with applicable provisions of the Federal
securities laws or self-regulatory organization rules related to
research reports, including those contained in rules governing
communications with the public.'' See also, e.g., FINRA rule
2210(c)(6) (``In addition to the foregoing requirements, each
member's written (including electronic) communications may be
subject to a spot-check procedure. Upon written request from
[FINRA's Advertising Regulation] Department, each member must submit
the material requested in a spot-check procedure within the time
frame specified by the Department.'').
    \186\ See, e.g., Fidelity Comment Letter; SIFMA Comment Letter
I.
---------------------------------------------------------------------------

Filing Requirements for Covered Investment Fund Research Reports
    Rule 24b-4, as adopted, modifies the filing requirements that
currently apply to certain broker-dealer communications regarding
registered investment companies. Today, registered investment company
sales literature, including rule 482 omitting prospectus
advertisements, are required to be filed with the Commission under
section 24(b) of the Investment Company Act \187\ and rule 497 under
the Securities Act.\188\ Rule 24b-3 under the Investment Company Act
and rule 497(i) deem these materials to have been filed with the
Commission if filed with FINRA.\189\
---------------------------------------------------------------------------

    \187\ See supra note 144.
    \188\ See rule 497 of the Securities Act [17 CFR 230.497]. Rule
497, which generally requires investment company prospectuses,
including investment company advertisements deemed to be a section
10(b) prospectus pursuant to rule 482, to be filed with the
Commission.
    \189\ See supra note 144; see also 17 CFR 230.497(i).
---------------------------------------------------------------------------

    As discussed in the Economic Analysis below, we anticipate that
certain communications that historically have been treated as
investment company sales literature, including rule 482 ``omitting
prospectus'' advertisements, would be published or distributed by a
broker-dealer as covered investment fund research reports pursuant to
the rule 139b safe harbor.\190\ Such communications styled

as ``research reports'' that previously had been subject to the filing
requirements of section 24(b) of the Investment Company Act no longer
would be subject to these requirements by operation of rule 24b-4, as
adopted, because they would be subject to the general content standards
of FINRA rule 2210(d)(1).\191\
---------------------------------------------------------------------------

    \190\ See infra section III.C.3.
    \191\ A communication that previously had been subject to the
filing requirements of rule 497 also would no longer be subject to
the rule 497 filing requirements if it were published or distributed
by a broker-dealer as a covered investment fund research report,
because it would no longer be considered to be a section 10(b)
prospectus. See supra paragraph accompanying notes 165-167.
---------------------------------------------------------------------------

    FINRA rule 2210 requires the filing of certain communications,
including retail communications that promote or recommend a specific
registered investment company or family of registered investment
companies.\192\ However, FINRA provides a number of exclusions from the
filing requirements.\193\ For example, with respect to research reports
(as that term is defined in FINRA rule 2241), FINRA currently excludes
from filing those that concern only securities that are listed on a
national securities exchange, other than research reports required to
be filed with the Commission pursuant to section 24(b) of the
Investment Company Act.\194\ Because covered investment fund research
reports are not required to be filed with the Commission pursuant to
section 24(b), as directed by the FAIR Act, rule 24b-4 could have the
effect of narrowing the types of communications that would be filed
with FINRA (under current FINRA rule 2210) regarding registered
investment companies.
---------------------------------------------------------------------------

    \192\ See FINRA rule 2210(c)(3) (broker-dealers must file,
within 10 business days of first use or publication, retail
communications that promote or recommend a specific registered
investment company or family of registered investment companies).
See generally FINRA rule 2210(c)(1)-(3). In addition to these FINRA
filing requirements, as discussed above, such communications would
be required to be filed with the Commission (and are deemed to have
been filed with the Commission if filed with FINRA). See supra notes
187-189 and accompanying text.
    \193\ See generally FINRA rule 2210(c)(7).
    \194\ See FINRA rule 2210(c)(7)(O).
---------------------------------------------------------------------------

    However, the FAIR Act's rules of construction provide that the Act
shall not be construed as limiting the authority of an SRO to require
the filing of communications with the public if the purpose of such
communications ``is not to provide research and analysis of covered
investment funds.'' \195\ Therefore, even if the exclusion of covered
investment fund research reports from the provisions of section 24(b)
affects the applicability of the filing requirements or exclusions
under FINRA rule 2210 with respect to covered investment fund research
reports, it would not affect FINRA's authority to require the filing of
a communication that is included in the FAIR Act's definition of
``covered investment fund research report'' but whose purpose is not to
provide research and analysis.\196\ In addition, a covered investment
fund research report would continue to be subject to FINRA
recordkeeping requirements applicable to communications with the
public, even if the broker-dealer would not be required to file the
research report with FINRA or the Commission.\197\
---------------------------------------------------------------------------

    \195\ See section 2(c)(2) of the FAIR Act.
    \196\ Id. See also 15 U.S.C. 80a-24(b); FINRA rule 2210.
    \197\ See FINRA rule 2210(b)(4)(A) (requiring members to
maintain all retail communications and institutional communications
for the retention period required by Exchange Act rule 17a-4(b) and
in a format and media that comply with Exchange Act rule 17a-4).
---------------------------------------------------------------------------

    Two commenters requested that FINRA's filing requirements be
modified in light of the FAIR Act.\198\ One commenter recommended that
the Commission work with FINRA to harmonize FINRA's research rules with
rule 139b and that broker-dealers relying on rule 139b be exempted from
FINRA's filing requirements with respect to covered investment fund
research reports.\199\ Another commenter suggested that the relevant
statutory language of the FAIR Act \200\ should be interpreted to be
limited to covered investment fund research reports made in reliance of
the 139b safe harbor that only provide ``information'' that a user
would not be able to use for research and analysis.\201\ This commenter
asserted that only covered investment fund research reports that solely
provide information would fall within the scope of what an SRO could
require to be filed under its authority. Moreover, one commenter argued
that because the definition of ``research report'' under the FAIR Act
was broader than FINRA's definition of research report, that this may
cause confusion and conflicting interpretive views on what
communications are deemed research for purposes of the safe harbor and
filing exclusion.\202\
---------------------------------------------------------------------------

    \198\ See SIFMA Comment Letter I; Fidelity Comment Letter.
    \199\ See Fidelity Comment Letter.
    \200\ The FAIR Act provides that the Act does not limit the
authority of any self-regulatory organization to require the filing
of communications with the public the purpose of which is not to
provide research and analysis of covered investment funds. See
section 2(c)(2) of the FAIR Act.
    \201\ SIFMA Comment Letter I.
    \202\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

    As we discussed above, section 2(c)(2) of the FAIR Act states that
nothing in the FAIR Act shall be construed as in any way limiting the
authority of an SRO, which includes FINRA, to require the filing of
communications with the public, including covered investment fund
research reports, the purpose of which is not to provide research and
analysis of covered investment funds. To the extent FINRA would seek to
amend its rules, any such proposed rule changes would be filed with the
Commission pursuant to section 19(b)(1) of the Exchange Act and rule
19b-4 thereunder.
2. SRO Limitations
    The FAIR Act also directs us to provide that SROs may not maintain
or enforce any rule that would (i) prohibit the ability of a member to
publish or distribute a covered investment fund research report solely
because the member is also participating in a registered offering or
other distribution of any securities of such covered investment fund;
or (ii) prohibit the ability of a member to participate in a registered
offering or other distribution of securities of a covered investment
fund solely because the member has published or distributed a covered
investment fund research report about such covered investment fund or
its securities.\203\ Proposed rule 139b incorporated this provision of
the FAIR Act, and we received no comments on this aspect of the
proposal. We note that these limitations on an SRO and any rules
relating to research reports that an SRO might adopt would not affect
the safe harbor provided by rule 139b. To provide additional context
for the safe harbor, however, and in light of Congress's direction that
we provide these limitations in implementing the rulemaking required by
the FAIR Act, we have set forth these SRO limitations in rule 139b as
proposed.\204\
---------------------------------------------------------------------------

    \203\ Section 2(b)(3) of the FAIR Act.
    \204\ See rule 139b(b).
---------------------------------------------------------------------------

E. Conforming and Technical Amendments

    Rule 101 of Regulation M under the Exchange Act \205\ prohibits any
person who participates in a distribution from attempting to induce
others to purchase securities covered by the rule during a specified
period. It provides an exception for certain research activities--
namely, the publication or dissemination of any information, opinion,
or recommendation--if the conditions of Securities Act rule 138 or rule
139 are satisfied. We proposed, in connection with our adoption of
Securities Act rule 139b, a conforming

change to the exception contained within rule 101(b)(1) of Regulation M
to permit the publication or dissemination of any information, opinion,
or recommendation so long as the conditions of rule 139b are satisfied.
---------------------------------------------------------------------------

    \205\ 17 CFR 242.101(a).
---------------------------------------------------------------------------

    The conforming amendment is intended to align the treatment of
research under rule 139b with the treatment of research under rules 138
and 139 for purposes of Regulation M. In the absence of the conforming
amendment, rule 101 could prevent the publication or dissemination of a
covered investment fund research report under the rule 139b safe harbor
by a broker-dealer that is participating in a distribution that is
covered by Regulation M. We believe that such a result would be
contrary to the mandate of the FAIR Act. The conforming amendment is
intended to harmonize treatment of research under the Securities Act
and Exchange Act rules. We received no comments on this aspect of the
proposal. We are adopting the conforming amendment as proposed.
    In October 2016, the Commission adopted new rules and forms and
amended other rules and forms under the Investment Company Act to
modernize the reporting and disclosure of information by registered
investment companies.\206\ The Commission, among other things, adopted
Form N-CEN, a new form for registered investment companies to report
census-type information to the Commission, and rescinded Form N-SAR, a
form on which the Commission had previously collected census-type
information on management investment companies and unit investment
trusts. To implement these changes, the Commission revised references
to rules and forms to remove references to Form N-SAR and replace them
with references to Form N-CEN, but inadvertently did not revise Form
12b-25. We are making a technical amendment to Form 12b-25 to replace
references to Form N-SAR with references to Form N-CEN and to remove
the checkbox and accompanying text related to transition reports on
Form N-SAR.\207\
---------------------------------------------------------------------------

    \206\ See Reporting Modernization Release, supra note 53.
    \207\ Transition reports on Form N-SAR were covered by rule
30b1-3 under the Investment Company Act, which was rescinded by the
Reporting Modernization Adopting Release. See Reporting
Modernization Adopting Release, supra note 53, at 81929 n.781 and
accompanying and following text.
---------------------------------------------------------------------------

III. Economic Analysis

A. Introduction

    We are mindful of the costs and benefits of our rules. Section 2(b)
of the Securities Act, section 3(f) of the Exchange Act, and section
2(c) of the Investment Company Act state that when the Commission is
engaging in rulemaking under such titles and is required to consider or
determine whether an action is necessary or appropriate in (or, with
respect to the Investment Company Act, consistent with) the public
interest, the Commission shall consider, in addition to the protection
of investors, whether the action will promote efficiency, competition,
and capital formation.\208\ Additionally, Exchange Act section 23(a)(2)
requires us, when making rules or regulations under the Exchange Act,
to consider, among other matters, the impact that any such rule or
regulation would have on competition and states that the Commission
shall not adopt any such rule or regulation which would impose a burden
on competition that is not necessary or appropriate in furtherance of
the Exchange Act.\209\
---------------------------------------------------------------------------

    \208\ 15 U.S.C. 77b(b); 15 U.S.C. 78c(f); 15 U.S.C. 80a-2(c); 15
U.S.C. 80b-2(c).
    \209\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The economic analysis proceeds as follows. We begin with a
discussion of the baseline used in the analysis. We then discuss the
costs and benefits of the rules we are adopting, as well as the effects
of these rules on efficiency, competition, and capital formation
compared to the baseline. Where possible, we attempt to quantify the
economic effects we discuss, although in many cases we are unable to do
so and instead rely on qualitative characterizations. In the Proposing
Release, we requested comment on our analysis of these effects.\210\ We
did not receive comments that provided any additional quantification of
these effects, nor did commenters provide data that could facilitate a
more quantitative analysis. We therefore continue to be unable to
produce reasonable quantitative estimates for most of the economic
effects, and--as in the Proposing Release--rely on qualitative economic
assessments instead.\211\
---------------------------------------------------------------------------

    \210\ See Proposing Release, supra note 2.
    \211\ See id.
---------------------------------------------------------------------------

B. Baseline

    The Commission's economic analysis evaluates the costs and benefits
of the rules being adopted relative to a baseline that represents the
best assessment of relevant markets and market participants in the
absence of these rules. In this section, we begin by characterizing the
relevant market structure and participants.\212\ We then proceed to
describe the relevant regulatory structure.
---------------------------------------------------------------------------

    \212\ To characterize the baseline, we rely on data from year-
end 2017 where possible; however, in some cases, timing issues
related to data availability require us to rely on data from prior
periods.
---------------------------------------------------------------------------

1. Market Structure and Market Participants
    The rules we are adopting directly affect broker-dealers, but their
indirect effects extend to covered investment funds, other producers of
research on covered investment funds, and consumers of information
about covered investment funds.\213\
---------------------------------------------------------------------------

    \213\ The rules we are adopting, through their effects on
capital formation, may also affect securities issuers more broadly.
See infra section III.C.5.
---------------------------------------------------------------------------

a. Covered Investment Funds
    The ``covered investment fund'' definition in the FAIR Act and rule
139b has the effect of capturing five common types of investment
vehicles: Mutual funds, ETFs, certain currency and commodity exchanged
traded products (``ETPs''), \214\ closed-end funds, and BDCs.\215\ As
shown in Figure 1, the universe of covered investment funds is large.
At the end of 2017, there were 11,924 such entities, including 9,564
mutual funds, 1,629 ETFs and ETPs, 596 closed-end funds, and 135
BDCs.\216\ The total public market value of covered investment funds
exceeds $20 trillion. Of this total, $17 trillion is held through
shares issued by open-end mutual funds, $3 trillion through shares of
ETFs and ETPs, $317 billion through shares of closed-end funds, and $27
billion through shares of BDCs.\217\
---------------------------------------------------------------------------

    \214\ Exchange-traded trusts with assets consisting primarily of
commodities, currencies, or derivative instruments that reference
commodities or currencies (commonly referred to as currency ETPs and
commodity ETPs) and which are not registered under the Investment
Company Act; see rule 139b(c)(2)(ii).
    \215\ See supra section II.A.3.
    \216\ Mutual fund, ETF, and ETP statistics are based on data
from CRSP mutual fund database (2017Q4). Closed-end fund statistics
are based on data from CRSP monthly stock file (Dec. 2017). BDC
statistics are based on the Commission's listing of registered BDCs.
Securities and Exchange Commission, Business Development Company
Report: January 2012-July 2018 (Sept. 28, 2018), available at
https://www.sec.gov/open/datasets-bdc.html.
    \217\ See supra note 216. Market value of BDC shares are based
on information obtained from CRSP, Compustat, and Audit Analytics.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

[GRAPHIC] [TIFF OMITTED] TR13DE18.000

[GRAPHIC] [TIFF OMITTED] TR13DE18.001

    Covered investment fund shares represent a significant fraction of
investment assets held by U.S. residents. Approximately one-third of
U.S. corporate equity issues, one-quarter of U.S. municipal securities,
one-fifth of corporate debt, one-fifth of U.S. commercial paper, and
one-tenth of U.S. treasury and agency securities are held through
covered investment funds.\218\ Mutual funds comprise the bulk (84%) of
covered investment funds.\219\ Nearly half of U.S. households hold
mutual fund shares \220\ and the vast majority (89%) of mutual fund
shares are held through retail accounts (i.e., accounts of retail
investors, or households).\221\ Consequently, at least 75% of the
public market value of all covered investment funds is held through
retail accounts. By analyzing institutional holdings from year-end 2017
Form 13F filings we estimate that across ETF and ETPs, the mean
institutional holding \222\ was 45%.\223\ For BDCs, we estimate the
mean institutional holding was 30%, while for closed-end funds, we
estimate the mean institutional holding was 21%. Based on these
figures, we further estimate that shares representing 86% of the public
market value of all covered investment funds are held through retail
accounts.\224\
---------------------------------------------------------------------------

    \218\ See Investment Company Institute, 2017 Investment Company
Fact Book (2017), available at http://www.icifactbook.org/ (``ICI
Fact Book'').
    \219\ See supra note 217.
    \220\ See Investment Company Institute, Ownership of Mutual
Funds, Shareholder Sentiment, and Use of the internet (2017),
available at https://www.ici.org/pdf/per23-07.pdf.
    \221\ Percentage by value. See ICI Fact Book, supra note 218, at
30. Excluding money market funds (``MMF''), mutual fund shares held
in retail accounts make up an even larger fraction (95%) of mutual
fund shares.
    \222\ We calculated ``institutional holding'' as the sum of
shares held by institutions (as reported on Form 13F filings)
divided by shares outstanding (as reported in CRSP).
    \223\ Year-end 2017 Form 13F filings were used to estimate
institutional ownership. Closed-end funds were matched to reported
holdings based on CUSIP. We note that there are long-standing
questions around the reliability of data obtained from 13F filings.
See Anne M. Anderson & Paul Brockman, Form 13F (Mis)Filings, SSRN
Scholarly Paper. Rochester, NY: Social Science Research Network
(Oct. 15, 2016), available at https://papers.ssrn.com/abstract=2809128. See also Securities and Exchange Commission,
Office of Inspector General, Office of Audits, Review of the SEC's
Section 13(f) Reporting Requirements (Sept. 27, 2010), available at
https://www.sec.gov/files/480.pdf.
    \224\ Staff calculated the percentage of net asset value held by
institutions reported on Form 13F for ETFs, ETPs and BDCs as public
market value of shares held by institutions divided by public market
value of all shares. Mutual funds shares are generally not required
to be reported on Form 13F. We estimate institutional ownership of
non-MMF mutual funds using ICI Fact Book estimate (95%). See supra
note 221 and accompanying text.

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

    As depicted in Figure 3, the covered investment fund market is
dynamic. In 2017, 638 covered investment funds were created, while 853
were closed or merged into other covered investment funds.\225\
[GRAPHIC] [TIFF OMITTED] TR13DE18.002

b. Broker-Dealers
---------------------------------------------------------------------------

    \225\ See supra note 216.
---------------------------------------------------------------------------

    The broker-dealers directly affected by the rules we are adopting
are those who participate in registered offerings of covered investment
funds while at the same time publishing or distributing information
about those funds. The Commission does not have comprehensive data on
the number or characteristics of broker-dealers currently publishing
and distributing communications about covered investment funds, the
extent of their communications, and their distribution arrangements
with covered investment funds. Therefore we rely on inferences based on
the data that are available \226\ and make certain assumptions when
characterizing the baseline.
---------------------------------------------------------------------------

    \226\ We rely here primarily on broker-dealers' quarterly FOCUS
reports.
---------------------------------------------------------------------------

    We believe that broker-dealers that do not derive revenues from the
distribution of covered investment funds are less likely to be directly
affected by the rules we are adopting.\227\ As discussed above,
registered investment companies represent the vast majority of covered
investment funds.\228\ Broker-dealers report revenues from the
distribution of investment company shares in regulatory filings,\229\
and we use this to estimate broker-dealers' revenues from distribution
of covered investment funds. We estimate that for the 3,882 broker-
dealers active in 2017, revenues related to distribution of covered
investment funds exceeded $28 billion, or 9% of total broker-dealers'
revenues. Of these 3,882 broker-dealers, 1,417 reported revenues from
the distribution of investment company shares. These 1,417 ``affected''
broker-dealers accounted for 74% of total broker-dealer revenues and
59% of total broker-dealer assets.\230\ As shown in

Figure 4, among the affected broker-dealers, the importance of revenues
from the distribution of covered investment funds varies widely.\231\
However, in aggregate, these revenues accounted for 13% of affected
broker-dealers' total revenues.\232\ For comparison, among the affected
broker-dealers, revenues from brokerage trading commissions and account
management accounted for 9%, and 20% of total revenues, respectively,
while revenues from propriatery trading and underwriting accounted for
4% and 8% of total revenues, respectively.
---------------------------------------------------------------------------

    \227\ We believe that broker-dealers that do not participate in
the distribution of covered investment funds are less likely to
publish or distribute research reports about such funds and--to the
extent that they do--may not derive significant benefits from the
safe harbor of rule 139b.
    \228\ See supra section III.B.1.a.
    \229\ The sum of FOCUS Supplemental Statement of Income items:
13970 (``revenues from sales of investment company shares''), 11094
(``12b-1 fees''), and 11095 (``mutual fund revenue other than
concessions or 12b-1 fees'').
    \230\ We describe these dealers as ``affected,'' but the degree
to which they are affected will vary based on individual
characteristics. Other things being equal, we expect broker-dealers
that are currently more active in the marketing of covered
investment funds would be more affected.
    \231\ This suggests that the degree to which the ``affected''
broker-dealers are affected by the rule will also vary widely.
    \232\ Estimates are based on staff analysis of FOCUS filings.
    [GRAPHIC] [TIFF OMITTED] TR13DE18.003

BILLING CODE 8011-01-C
c. Research on Covered Investment Funds
    The Commission does not have comprehensive data on broker-dealers
that publish or distribute research reports on entities that are
included within the definition of ``covered investment fund'' under
rule 139b.\233\ The Commission estimates that in 2017, there were 1,417
broker-dealers that reported revenues from the distribution of covered
investment funds.\234\ We assume that these broker-dealers will have
incentives to publish or distribute research reports about covered
investment funds. However, due to the large number of covered
investment funds, we do not expect that many broker-dealers' in-house
research departments (if they have such departments) are currently
capable of providing research on a large percentage of covered
investment funds. Most covered investment funds are not followed by
dedicated research analysts akin to the analyst coverage that the
Commission has previously identified as being one indicator of market
interest and following for operating companies.
---------------------------------------------------------------------------

    \233\ See supra section III.B.1.b.
    \234\ See id.
---------------------------------------------------------------------------

    Existing Commission and SRO rules do not delineate a category of
``research reports'' pertaining to covered investment funds.
Consequently, it is not possible to identify with precision broker-
dealer communications under the baseline that would be considered
``research reports'' as defined in rule 139b. However, we understand
that some broker-dealers have published and distributed communications
styled as ``research reports'' in compliance with rule 482 under the
Securities Act.\235\ FINRA member firms--the vast majority \236\ of
broker-dealers--file these communications with FINRA.\237\ The number
of communications filed with FINRA help to provide an estimate of the
number of communications currently published or distributed by broker-
dealers that could potentially be considered ``research reports'' under
rule 139b. FINRA staff has reported reviewing 47,707 filings subject to
rule 482 in 2017. FINRA staff reviewed an additional 8,528
communications that are subject to Investment Company Act

rule 34b-1, for a total of 56,235 communications.\238\ There are
several factors that limit our ability to extrapolate from these
estimates the number of communications that broker-dealers currently
publish or distribute that would satisfy the definition of ``covered
investment fund research report'' under rule 139b. First, these data do
not reflect the affiliate exclusion incorporated in the rule 139b
definition of ``covered investment fund research report,'' which has
the effect of excluding from the safe harbor research reports that are
published or distributed by persons covered by the affiliate
exclusion.\239\ Second, the data do not include communications about
entities that would be considered ``covered investment funds,'' but
that do not need to comply with the requirements of rule 482 (e.g.,
commodity- or currency-based trusts or funds). Third, for those
communications that are currently filed as rule 482 advertising
prospectuses or rule 34b-1 supplemental sales literature, we are
uncertain what percentage of these communications broker-dealers would
continue to structure as rule 482 advertising prospectuses or rule 34b-
1 supplemental sales literature, as opposed to publishing or
distributing them as covered investment fund research reports under the
rule 139b safe harbor.
---------------------------------------------------------------------------

    \235\ See supra note 162 and accompanying text.
    \236\ Based on staff analysis of FOCUS filings, we estimate that
as of year-end 2017, there were 3,882 registered broker-dealers,
3,755 of which were members of FINRA.
    \237\ See supra note 189 and accompanying text.
    \238\ Under rule 34b-1, ``sales literature'' required to be
filed by section 24(b) shall have omitted to state a fact necessary
in order to make the statements made therein not materially
misleading unless the sales literature includes certain specified
information. See rule 34b-1 [17 CFR 270.34b-1]; see also supra note
165.
    Of the 47,707 filings subject to rule 482, 229 were also subject
to rule 34b-1. These 229 are not included in the 8,528 figure.
Statistics provided by FINRA.
    \239\ See supra notes 18-21 and accompanying text.
---------------------------------------------------------------------------

    We have also analyzed the number of ``research reports'' as defined
under FINRA rules 2241 and 2242 that FINRA staff reviewed in 2017.
However, for reasons discussed below, we also believe that these data
have limited value in assessing the number of covered investment fund
research reports whose publication or distribution could be eligible
for the safe harbor under rule 139b. FINRA reviewed 354 filings in 2017
that were identified as ``research reports'' as defined in FINRA rules
2241 and 2242. However, the definitions of ``research report'' and
``debt research report'' under FINRA rules 2241 and 2242, respectively,
do not correspond in every respect to the term ``research report'' as
defined in the FAIR Act and rule 139b.
    Under FINRA rule 2241, the term ``research report'' includes any
written communication that includes an analysis of equity securities
(other than mutual fund securities) and that provides information
reasonably sufficient upon which to base an investment decision.\240\
Under FINRA rule 2242, the term ``debt research report'' includes any
written communication that includes an analysis of a debt security or
an issuer of a debt security and that provides information reasonably
sufficient upon which to base an investment decision.\241\ As discussed
above, the FAIR Act and the rule 139b definition of ``research report''
do not require a communication to provide information reasonably
sufficient upon which to base an investment decision.\242\ Also, unlike
the definition of ``research report'' in FINRA rule 2241, the FAIR Act
and the rule 139b definitions of ``research report'' include
communications about mutual funds. Thus, while the number of ``research
reports'' as defined in FINRA rules 2241 and 2242 that FINRA staff has
historically reviewed provides an estimate of a subset of
communications currently being styled as ``research reports'' whose
publication or distribution could be eligible for the rule 139b safe
harbor, this number would represent only a small portion of the
complete universe of research reports whose publication or distribution
could be eligible for this safe harbor. We also understand that the
reported number of ``research reports'' as defined in FINRA rules 2241
and 2242 that FINRA staff has historically reviewed also could relate
to research reports for securities products other than entities that
would be considered ``covered investment funds'' (e.g., certain stocks,
bonds, or master limited partnership interests).
---------------------------------------------------------------------------

    \240\ See FINRA rule 2241(a)(11).
    \241\ See FINRA rule 2242(a)(3).
    \242\ See supra note 40 and accompanying text.
---------------------------------------------------------------------------

    In addition to broker-dealers, various firms that are independent
of the offering process currently provide data and analysis on
different subsets of the covered investment fund universe (e.g.,
through subscription services or through licensing agreements with
broker-dealers). Data aggregators provide various forms of information
and analysis about covered investment funds, ranging from automated
fund rankings, to analyst research reports.\243\ Because data and
analysis provided by these firms play an important role in investors'
information environment under the baseline, these firms will be
affected by changes to the competitive environment resulting from the
rules we are adopting.\244\ We understand that communications styled as
``research reports'' on covered investment funds distributed by broker-
dealers may rely on information obtained from these independent
sources. In particular, we understand that information that is commonly
provided by these independent firms may include: (1) Information
obtained from regulatory filings, such as narrative descriptions of
fund objectives, information about key personnel, performance history,
fees, and top holdings; (2) statistics and other information derived
from public, proprietary, and licensed data sources, such as risk
exposures (e.g., geographic, sectoral), quantitative characteristics
(e.g., beta, correlations, tracking error), and peer group; and (3)
fund ratings. The fund ratings that independent firms may provide are
generally based on methodologies proprietary to each firm.\245\
---------------------------------------------------------------------------

    \243\ While various firms provide automated fund rankings for
much of the covered investment fund universe, true ``analyst
coverage'' is considerably more limited. Morningstar provides
``analyst ratings'' for certain open-end funds, closed-end funds,
and ETFs. Based on queries of the Morningstar database, as of
October 2018, only 1,562 open-end funds, no closed-end funds, and
200 ETFs had a Morningstar analyst rating. We calculated that in
total, as of December 2017, there were 9,564 mutual funds, 596
closed-end funds, and 1,629 ETFs and ETPs. See supra note 216.
    \244\ See infra section III.C.5.
    \245\ See, e.g., Zacks Investment Research, ETF Rank Guide (Mar.
12, 2013), available at https://www.zacks.com/stock/news/94561/zacks-etf-rank-guide; Morningstar, Morningstar's Two Rating for
Assessing a Fund (2014), available at http://corporate1.morningstar.com/Documents/UK/Landing/Morningstars-Two-Ratings-For-Assessing-A-Fund.
---------------------------------------------------------------------------

2. Regulatory Structure
    The objective of this analysis is to consider the effects of
regulations being adopted pursuant to the FAIR Act's statutory mandate.
Thus, for the purposes of the baseline, we take into account the
regulatory structure in place immediately prior to the enactment of the
FAIR Act. We also note that on July 3, 2018, the interim effectiveness
provision of the FAIR Act came into effect.\246\ This provision allows
broker-dealers to rely on the rule 139 safe harbor when publishing or
distributing covered investment fund research reports. In addition,
under this provision, covered investment funds are deemed to be
securities that are listed on a national securities exchange and are
not subject to section 24(b) of the Investment Company Act. While the
effectiveness of this provision is now part of the regulatory
framework, in light of its recent effectiveness and the

limited time duration until it will be replaced by rule 139b, as a
practical matter, it is unclear to what extent broker-dealers will rely
on the interim provision to publish or distribute research reports
about covered investment funds.
---------------------------------------------------------------------------

    \246\ See section 2(d) of the FAIR Act.
---------------------------------------------------------------------------

a. Legal and Regulatory Framework Applicable to Statements Included in
Covered Investment Fund Research Reports
    A broker-dealer's publication or distribution of a covered
investment fund research report could be deemed to constitute an offer
that otherwise could be a non-conforming prospectus whose use in the
offering may violate section 5 of the Securities Act.\247\ We
understand that some broker-dealers currently publish and distribute
communications styled as ``research reports'' regarding covered
investment funds in compliance with rule 482 under the Securities
Act.\248\ Unlike research reports covered under the rule 139 safe
harbor, broker-dealers' publication or distribution of rule 482
advertisements could subject the broker-dealer to liability under
section 12(a)(2) of the Securities Act.\249\ In addition, rule 482
advertisements regarding open-end investment companies, trust accounts,
and money markets funds are subject to requirements on the standardized
presentation of performance information.\250\
---------------------------------------------------------------------------

    \247\ See supra note 5 and accompanying text.
    \248\ Research reports regarding covered investment funds could
also be distributed today as ``supplemental sales literature'' under
rule 34b-1 under the Investment Company Act. However, research
reports distributed under rule 34b-1 would need to be preceded or
accompanied by a statutory prospectus. See supra note 167 and
accompanying text.
    \249\ Section 12(a)(2) provides express remedies to the person
purchasing the security (i.e., a private right of action) for
material misstatements and omissions made by any seller of the
security. It also provides a different standard for claims for
damages than under Exchange Act rule 10b-5, which requires proof of
scienter in the representations made. See 15 U.S.C. 77l(a)(2); see
also rule 10b-5 [17 CFR 240.10b-5].
    \250\ Research reports that are published or distributed as rule
34b-1 supplemental sales literature also would be subject to
requirements relating to the standardized presentation of
performance information, because rule 34b-1 incorporates many of the
rule 482 requirements relating to performance disclosure. See supra
notes 166, 248.
---------------------------------------------------------------------------

    Additionally, certain SRO rules governing content standards may
apply to advertisements styled as ``research reports'' under rule 482
or to communications that would be covered investment fund research
reports under rule. These include FINRA rule 2210, which contains
general content standards that apply broadly to member
communications.\251\ In addition, covered investment fund research
reports pertaining to funds other than open-end registered investment
companies that are not listed or traded on an exchange (i.e., ETFs,
ETPs, closed-end funds, and BDCs) may be subject to FINRA rules 2241
and 2242 governing content standards of ``research reports'' as defined
by FINRA.\252\
---------------------------------------------------------------------------

    \251\ See FINRA rule 2210(d)(1).
    \252\ See supra note 183 (discussing the scope of these rules in
more detail, including noting that the scope of FINRA rules
2241(c)(1) and 2242(c)(2) generally apply only to a subset of
communications that would be considered covered investment fund
research reports under rule 139b).
---------------------------------------------------------------------------

    Exposure to liability under section 12(a)(2) of the Securities Act,
rule 482 requirements on the standardized presentation of performance
information, and the various aforementioned FINRA rules impose costs on
broker-dealers. These include conduct costs resulting from additional
liability (e.g., foregoing publication of certain reports), and
compliance costs associated with the relevant content standards. We are
not able to quantify these costs.\253\
---------------------------------------------------------------------------

    \253\ In the Proposing Release, we asked commenters to supply
data that could aid us in quantifying these costs. No such data was
provided in the comment letters received. See Proposing Release,
supra note 2, at 26812.
---------------------------------------------------------------------------

b. Filing Requirements
    Under the baseline, a research report or other communication about
a covered investment fund that is a registered investment company would
have to comply with the requirements of Securities Act rule 482 \254\
and registered investment company sales material, including rule 482
``omitting prospectus'' advertisements as well as supplemental sales
literature,\255\ are required to be filed with the Commission under
section 24(b) of the Investment Company Act.\256\ Broker-dealers that
are FINRA members are also subject to certain additional filing
requirements under current FINRA rule 2210.\257\
---------------------------------------------------------------------------

    \254\ See FINRA rule 2210(d)(5) (providing that non-money market
fund open-end management company performance data as permitted by
rule 482 in retail communications and correspondence must disclose
standardized performance information and, to the extent applicable,
certain sales charge and expense ratio information); see also supra
note 161.
    \255\ See supra note 248.
    \256\ Rule 24b-3 under the Investment Company Act deems these
materials to have been filed with the Commission if filed with
FINRA. See supra notes 144, 189 and accompanying text.
    \257\ FINRA rule 2210's filing requirements include a number of
exclusions, including an exclusion for certain research reports,
except that broker-dealers are required to file research reports
with FINRA if they are also required to be filed with the Commission
pursuant to section 24(b) of the Investment Company Act. See supra
notes 176-178, and accompanying text.
---------------------------------------------------------------------------

C. Costs and Benefits

    In this section, we first consider the overarching costs and
benefits associated with the FAIR Act's statutory mandates. Second, we
evaluate the costs and benefits of the specific provisions of the rules
we are adopting and their relation to the overarching considerations
resulting from the statutory mandate. Next, we discuss the effects on
efficiency, competition, and capital formation of the new rules. We
conclude with a discussion of alternatives considered.
1. FAIR Act Statutory Mandate
a. Benefits
    We believe that the expansion of the rule 139 safe harbor (as
mandated by the FAIR Act) will generally reduce broker-dealers' costs
of publishing and distributing research reports about covered
investment funds. These cost reductions are expected because under the
new rules a broker-dealer could publish or distribute covered
investment fund research reports without reliance on rule 482 or rule
34b-1 and without being required to file these reports under section
24(b) of the Investment Company Act and the rules and regulations
thereunder.\258\ Broker-dealers publishing or distributing covered
investment fund research reports in reliance on the expanded safe
harbor will not be subject to the liability provisions of section
12(a)(2) of the Securities Act,\259\ rule 34b-1, or the filing
requirements of section 24(b) of the Investment Company Act.\260\ Thus,
they will be expected to incur lower costs associated with liability
under section 12(a)(2), lower conduct costs, and lower compliance costs
(including fewer content and filing requirements).\261\ Because of
these cost reductions, we expect publication and distribution of such
reports to increase. First, we expect that certain broker-dealers that
had previously published and distributed communications under rule 482
that could be styled as ``research reports'' will aim to meet the
conditions of the expanded safe harbor and increase their supply of
covered investment fund research as a result. Second, we expect some
broker-dealers that have previously not published or distributed such
reports (due to the

activity being deemed too costly or subject to too many restrictions),
to begin doing so. We believe that the aforementioned effects will
generally benefit broker-dealers and advisers to covered investment
funds if, as we expect, they increase broker-dealers' sales of covered
investment funds.
---------------------------------------------------------------------------

    \258\ See supra section II.D.1.
    \259\ See supra note 249.
    \260\ See supra section II.D.1.
    \261\ However, we would not expect any lower costs of compliance
for any research reports that currently are structured as rule 34b-1
supplemental sales literature (and are not rule 482 advertising
prospectuses), because supplemental sales literature is not an
``offer'' to which prospectus liability under section 12(a)(2) of
the Securities Act would attach.
---------------------------------------------------------------------------

    Because there is limited historical experience dealing specifically
with broker-dealers' research reports on covered investment funds,
there is little in the way of direct empirical evidence on the value of
such reports to investors. Prior research on the informativeness of
broker-dealers' research on operating companies suggests that broker-
dealers can produce research that positively contributes to the
information content of market prices,\262\ and--perhaps more
importantly--that broker-dealers may enjoy a comparative advantage in
its production.\263\ However, other studies have questioned the
investment value of such research to investors \264\ or its continued
relevance.\265\
---------------------------------------------------------------------------

    \262\ See, e.g., Brad M. Barber, Reuven Lehavy, & Brett Trueman,
Ratings changes, ratings levels, and the predictive value of
analysts' recommendations, 39 Financial Management 2, 533-553 (2010)
(broker-dealers' research analysts' upgrades (downgrades) elicit
positive (negative) price reactions, respectively). See also Scott
E. Stickel, The Anatomy of the Performance of Buy and Sell
Recommendations, 51 Financial Analysts Journal 5, 25-39 (Sept. 1,
1995) (broker-dealers' research provides new information,
particularly for smaller firms, where information is less generally
available). See also Kent L. Womack, Do Brokerage Analysts'
Recommendations Have Investment Value?, 51 The Journal of Finance 1,
137-167 (1996) (price reactions are permanent and exhibit post-
announcement drift).
    \263\ See, Boris Groysberg, Paul Healy & Craig Chapman, Buy-Side
vs. Sell-Side Analysts' Earnings Forecasts, 64 Financial Analysts
Journal 4, 25-39 (July 1, 2008) (informativeness of broker-dealers'
sell-side research is superior to that of buy-side firms).
    \264\ See Brad Barber, Reuven Lehavy, Maureen McNichols & Brett
Trueman, Can Investors Profit from the Prophets? Security Analyst
Recommendations and Stock Returns, 56 The Journal of Finance 2, 531-
563 (Apr. 1, 2001) (investors hoping to exploit research analysts'
recommendations must trade frequently and these transaction costs
often exceed the gains from trading); see also Xi Li, The
persistence of relative performance in stock recommendations of
sell-side financial analysts, 40.1 Journal of Accounting and
Economics 3, 129-152 (2005). See also Narasimhan Jegadeesh,
Joonghyuk Kim, Susan D. Krische & Charles M. C. Lee, Analyzing the
Analysts: When Do Recommendations Add Value?, 59 The Journal of
Finance 3, 1083-1124 (2004) (significant portion of investment value
may be attributable to previously documented trading signals, with
little incremental value attributable to the broker-dealer
research). See also Yongtae Kim & Minsup Song, Management Earnings
Forecasts and Value of Analyst Forecast Revisions, 61 Management
Science 7, 1663-1683 (2015) (past estimates of the informativeness
of analyst recommendations may be confounded by the impact of
forecasts issued by management).
    \265\ See Oya Alt[inodot]nk[inodot]l[inodot][ccedil], Robert S.
Hansen & Liyu Ye, Can analysts pick stocks for the long-run?, 119
Journal of Financial Economics 2, 371-398 (Feb. 2016) (reductions in
transactions costs and increases in computational speed reduced the
amount of new information available for analysts to discover).
---------------------------------------------------------------------------

    We are cautious in drawing implications from these findings to
broker-dealers' research on covered investment funds. While analysts
researching operating companies generally endeavor to identify
mispricing--to forecast the idiosyncratic component of firms' future
returns--covered investment funds represent portfolios of securities,
and many covered investment funds are priced at net asset value
(``NAV'').\266\ Although individual securities within a covered
investment fund's portfolio may be viewed as ``mispriced'' by a
research analyst, diversification effects will tend to drown out such
effects at the fund level and minimize idiosyncratic variation in
investors' return on their investment in the fund. Therefore, any
``investment value'' \267\ of research on covered investment funds
would likely be rooted in analysts' ability to predict broader market
movements. Such ability is generally believed to be rather rare.\268\
We therefore believe that the value to investors of information in
broker-dealers' research reports will largely be limited to the
synthesis or discovery of factual information about fund
characteristics, fees, or other transactions costs. For example,
investors may find analysts' views of a fund's management, objectives,
risk exposures, tracking error, volatility, tax efficiency, fees, or
other fund characteristics to be valuable. Such analysis could be a
valuable source of information for investors evaluating relative fund
performance.\269\
---------------------------------------------------------------------------

    \266\ Closed-end funds, for example, are not priced on a NAV
basis and their (mis-) pricing has long served as a puzzle in the
finance literature. See, e.g., Charles M.C. Lee, Andrei Schleifer, &
Richard H. Thaler, Investor Sentiment and the Closed-End Fund
Puzzle, 46 The Journal of Finance 1 (Mar. 1991). Similar pricing
issues may arise in BDCs.
    \267\ We mean this in the sense of providing a signal about
future investment performance.
    \268\ See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman, &
Russ Wermers, Measuring Mutual Fund Performance with Characteristic-
Based Benchmarks, 52 The Journal of Finance 3, 1035-1058 (July
1997).
    \269\ See, e.g., W. J. Armstrong, Egemen Genc & Marno Verbeek,
Going for Gold: An Analysis of Morningstar Analyst Ratings,
Management Science (Aug. 2017).
---------------------------------------------------------------------------

    We believe that the quantity of information available to potential
investors of covered investment funds will increase as a result of
broker-dealers' increased publication and distribution of covered
investment fund research reports. The rules we are adopting will also
allow for greater flexibility in the type of information that broker-
dealers may communicate to customers.\270\ To the extent that this new
information is valuable, it will benefit investors by providing them
with additional information to help shape investment decisions.
Finally, we believe that important negative information about a covered
investment fund, such as high fees, high risk exposure, or an
inefficient portfolio strategy will be more likely to be publicized as
a result of increased competition among information providers, with
attendant benefits to investors.\271\
---------------------------------------------------------------------------

    \270\ Currently such communications would be subject to rule 482
requirements, including standards on the presentation of performance
information. See supra section II.C.
    \271\ See Matthew Gentzkow & Jesse M. Shapiro, Media Bias and
Reputation, 114 Journal of Political Economy 2, 280-316 (Apr. 1,
2006).
---------------------------------------------------------------------------

b. Costs
    Prior experience and academic research suggests that, unchecked,
broker-dealers' conflicts of interest can lead to bias in research
reports,\272\ and that such bias has the potential to adversely affect
investor welfare.\273\

Broker-dealers' financial incentives to sell covered investment funds
could undermine the objectivity of the information they produce about
such funds, and the existence of the rule 139b safe harbor could
increase opportunities for broker-dealers to promote funds from which
they derive the most financial benefits.\274\ If such conflicts are
unrecognized by or unknown to investors, they could negatively affect
investor welfare. Although market mechanisms \275\ as well as existing
regulation \276\ may limit the extent of such actions, there is the
potential that they could nonetheless impose costs on investors--
particularly retail investors.\277\
---------------------------------------------------------------------------

    \272\ See Amitabh Dugar & Siva Nathan, The Effect of Investment
Banking Relationships on Financial Analysts' Earnings Forecasts and
Investment Recommendations*, 12 Contemporary Accounting Research 1,
131-160 (Sept. 1, 1995) (``Dugar and Nathan Article'') (affiliated
analysts issue more optimistic earnings forecasts and investment
recommendations about companies with which their firms had an
investment banking relationship). See also Hsiou-wei Lin & Maureen
F. McNichols, Underwriting Relationships, Analysts' Earnings
Forecasts and Investment Recommendations, 25 Journal of Accounting
and Economics 1, 101-127 (Feb. 26, 1998) (``Lin and McNichols
Article'') (affiliated analysts are more optimistic in their long-
term growth forecasts and investment recommendations).
    \273\ See Roni Michaely & Kent L. Womack, Conflict of Interest
and the Credibility of Underwriter Analyst Recommendations, 12 The
Review of Financial Studies 4, 653-686 (July 2, 1999) (``Michaely
and Womack Article'') (stock recommendations of affiliated analysts
perform worse prior to, at the time of, and subsequent to the
recommendation); see also Patricia M. Dechow, Amy P. Hutton &
Richard G. Sloan, The Relation between Analysts' Forecasts of Long-
Term Earnings Growth and Stock Price Performance Following Equity
Offerings*, 17 Contemporary Accounting Research 1, 1-32 (Mar. 1,
2000). See also Global Research Analyst Settlement, Litigation
Release No. 18438 (Oct. 31, 2003) (The court issued an Order
approving a $1.4 billion global settlement of the SEC enforcement
actions against several investment firms and certain individuals
alleging undue influence of investment banking interests on
securities research); see also Deutsche Bank Securities Inc. and
Thomas Weisel Partners LLC Settle Enforcement Actions Involving
Conflicts of Interest Between Research and Investment Banking, SEC
Press Release 2004-120 (Aug. 26, 2004). The settlement was an action
in response to conflicts of interest that certain broker-dealers
were found to have failed to manage in an adequate or appropriate
manner and was modified in 2010 to remove certain requirements where
FINRA and NYSE rules addressed the same concerns. See 2010
Modifications to Global Research Analyst Settlement, Litigation
Release No. 21457 (Mar. 19, 2010).
    \274\ Such concerns were also noted by one commenter. See
Morningstar Comment Letter.
    \275\ See infra section III.C.1.b(2).
    \276\ See infra section III.C.1.b(1).
    \277\ See infra section III.C.1.b(2).
---------------------------------------------------------------------------

    The potential for conflicts of interest to lead to actions that
impose costs on investors depends in large part on the strength of the
underlying incentives. In the context of broker-dealers' research on
covered investment funds, the greatest conflicts of interest are faced
by broker-dealers serving as investment advisers to covered investment
funds, who--due to asset-based management fees--have strong incentives
to increase demand for the funds that they advise. Because the FAIR Act
by its terms,\278\ and also rule 139b,\279\ will not extend the safe
harbor to a broker-dealer that is publishing or distributing a research
report about a covered investment fund for which the broker-dealer
serves as an investment adviser (or where the broker-dealer is an
affiliated person of the investment adviser), we believe that there
will be limited potential for the greatest conflicts of interest to
impose costs on investors.
---------------------------------------------------------------------------

    \278\ See section 2(f)(3) of the FAIR Act.
    \279\ See rule 139b(a).
---------------------------------------------------------------------------

    Other conflicts of interest may nevertheless arise from incentives
in fund distribution arrangements.\280\ Distributing broker-dealers may
receive compensation from sales loads, 12b-1 fees,\281\ shelf space
fees, or other revenue sharing agreements, all of which create
financial incentives for broker-dealers to promote and sell funds and
potentially to promote and sell particular funds or share classes.\282\
Associated persons of broker-dealers (i.e., analysts) may face similar
conflicts of interests arising from incentives in their compensation
agreements.\283\ Finally, broker-dealers may have fewer direct or non-
pecuniary incentives.\284\ However, in all of these cases, the risk
that such conflicts of interest could result in actions that negatively
impact information communicated to investors is mitigated by the fact
that a broker-dealer will bear the costs of such actions, but generally
may be unable to fully appropriate the benefits.\285\
---------------------------------------------------------------------------

    \280\ See Susan E. K. Christoffersen, Richard Evans & David K.
Musto, What Do Consumers' Fund Flows Maximize? Evidence from Their
Brokers' Incentives, 68 The Journal of Finance 1, 201-235 (Feb. 1,
2013) (where brokers' compensation arrangements with funds are found
to drive their customers' fund flows).
    \281\ See rule 12b-1 under the Investment Company Act [17 CFR
270.12b-1].
    \282\ See infra note 298 (noting that the Commission has
historically found broker-dealers to have violated sections 17(a)(2)
and (3) of the Securities Act by making recommendations of more
expensive mutual fund share classes while omitting material facts).
    \283\ Such conflicts of interest arising from incentives in
compensation agreements involving research analysts issuing research
reports covered by FINRA Rule 2241 are mitigated by FINRA rules
2241(b)(2)(C), (E), (F), and (K). Additionally, section 501(a)(2) of
Regulation AC (17 CFR 242.501(a)(2)) requires specific disclosure
regarding research analyst compensation in order to mitigate the
conflicts of interest that can arise based on analyst compensation
arrangements.
    \284\ For example, although it is prohibited conduct, a broker-
dealer may have a financial incentive to provide coverage for, or to
promote, a fund based on an understanding that the fund will
participate in offerings underwritten by the broker-dealer. See,
e.g., FINRA rule 2241(b)(2) (requiring that a member's written
policies and procedures must be reasonably designed to, among other
things, ``prevent the use of research reports or research analysts
to manipulate or condition the market or favor the interests of the
member''); see also NASD Fines U.S. Bancorp Piper Jaffray and
Managing Director $300,000, FINRA News Release (June 25, 2002)
available at http://www.finra.org/newsroom/2002/nasd-fines-us-bancorp-piper-jaffray-and-managing-director-300000 (announcing
settlement with U.S. Bancorp Piper Jaffray and one of its managing
directors in which the NASD found that the firm violated a NASD (now
FINRA) rule requiring all firms and associated persons to adhere to
high standards of commercial honor and just and equitable principles
of trade when it threatened to discontinue research coverage of a
company if the company did not select it as lead underwriter for an
upcoming offering). But see also note 183.
     Rule 12b-1(h)(1) prohibits funds from compensating a broker-
dealer for promoting or selling funds shares by directing brokerage
transactions to that broker. See rule 12b-1(h)(1) under the
Investment Company Act [17 CFR 270.12b-1(h)(1)]; see also
Prohibition on the Use of Brokerage Commissions to Finance
Distribution, Investment Company Act Release No. 26591 (Sept. 2,
2004) [69 FR 54727 (Sept. 9, 2004)].
    \285\ For example, if a broker-dealer firm publishes biased
research about a fund, some of the gains (i.e., compensation from
sales of that fund) may accrue to other broker-dealer firms (i.e.,
other broker-dealer firms that distribute the same fund) while the
costs of the action (i.e., reputation costs, litigation risk, and
risk of regulatory action) will be borne entirely by the broker-
dealer firm that published the biased research.
---------------------------------------------------------------------------

    It is difficult for us to quantify the aforementioned costs in the
context of this rulemaking. We are not aware of any studies directly
examining the role that conflicts of interest play in broker-dealers'
research reports on covered investment funds in U.S. markets, or of any
data that would support a quantitative analysis of an expanded safe
harbor in this context.\286\ Although one commenter registered similar
concerns,\287\ no commenters provided any data that would facilitate
such a quantitative analysis.\288\ As with the potential benefits
discussed above, we are limited to characterizing the potential costs
qualitatively. While we believe that expanding the rule 139 safe harbor
to broker-dealers' publication or distribution of covered investment
fund research reports has the potential to impose costs on retail
investors, existing regulations, specific provisions of the rules that
we are adopting,\289\ and certain market mechanisms will reduce these
costs.
---------------------------------------------------------------------------

    \286\ Authors have examined the impact of conflicts of interest
on mutual fund research in China, providing evidence consistent with
bias arising from conflicts of interest in that market, though
differences between Chinese and U.S. markets and corresponding
regulatory frameworks make it difficult to apply inferences drawn
from experience in Chinese markets to U.S. markets. See Y. Zeng, Q.
Yuan & J. Zhang, Blurred stars: Mutual fund ratings in the shadow of
conflicts of interest, 60 Journal of Banking & Finance 1, 284-295
(2015).
    \287\ See Morningstar Comment Letter.
    \288\ In the Proposing Release, we requested comment on our
characterization of these costs. See Proposing Release, supra note
2, at 26816.
    \289\ See infra section III.C.2.
---------------------------------------------------------------------------

(1) Existing Regulation
    Rules and regulations have been implemented to address potential
conflicts of interest that may arise with broker-dealers specifically
in the context of research reports.\290\ As discussed in detail
above,\291\ the definition of ``research report'' for purposes of
Regulation AC and FINRA rules 2241 and 2242 is narrower than the
definition of ``research report'' for purposes of the FAIR Act and rule
139b. However, to the extent a research report meets both the
definition of a research report under rule 139b and the definition of
research report as defined in Regulation AC, Regulation AC will be
applicable to that research report (and, if it meets the definition of
``research report'' in FINRA rule 2241, FINRA rule 2241 also will apply
if the research report otherwise were within the scope of rule 2241
\292\). These rules may help promote objective and reliable
research.\293\
---------------------------------------------------------------------------

    \290\ See supra note 35; see also Proposing Release, supra note
2, at 26791 n.37.
    \291\ See supra note 183.
    \292\ See id.
    \293\ See section 501 of the Sarbanes-Oxley Act; Regulation
Analyst Certification, Securities Act Release No. 8193 (Feb. 20,
2003) [68 FR 9481 (Feb. 27, 2003)]. Several studies have analyzed
bias in broker-dealers' research following the Global Settlement and
subsequent regulatory changes, in particular at sanctioned banks.
See O. Kadan, L. Madureira, R. Wang, & T. Zach, Conflicts of
interest and stock recommendations: The effects of the global
settlement and related regulations 22 The Review of Financial
Studies 10, 4189-4217 (2009). See also, S. A. Corwin, S. A. Larocque
& M. A. Stegemoller, Investment banking relationships and analyst
affiliation bias: The impact of the global settlement on sanctioned
and non-sanctioned banks, 124 Journal of Financial Economics 3, 614-
631 (2017).

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

    Additionally, as described above, FINRA rule 2210 contains general
content standards that apply broadly to member communications,
including broker-dealer research reports. These general content
standards require, among other things, that all member communications
``must be based on principles of fair dealing and good faith, must be
fair and balanced, and must provide a sound basis for evaluating the
facts in regard to any particular security or type of security,
industry or service.'' \294\
---------------------------------------------------------------------------

    \294\ See supra section II.D.1.
---------------------------------------------------------------------------

    If a broker-dealer recommends \295\ a covered investment fund to
its customers, additional obligations under the federal securities laws
and FINRA rules will apply. As a general matter, broker-dealers must
deal with their customers fairly \296\--and, as part of that
obligation, have a reasonable basis for any recommendation.\297\
Furthermore, when making recommendations, broker-dealers may be
generally liable under the antifraud provisions if they do not give
``honest and complete information'' or disclose any material adverse
facts or conflicts of interest, including any economic self-
interest.\298\
---------------------------------------------------------------------------

    \295\ See, e.g., Additional Guidance on FINRA's New Suitability
Rule, FINRA Regulatory Notice 12-25 (May 2012), at Q.2, (regarding
the scope of ``recommendation''), n.25.
    \296\ See, e.g., Duker & Duker, Exchange Act Release No. 2350
(Dec. 19, 1939), at 2 (Commission opinion) (``Inherent in the
relationship between a dealer and his customer is the vital
representation that the customer be dealt with fairly, and in
accordance with the standards of the profession.'').
    \297\ See Mac Robbins & Co., Exchange Act Release No. 6846 (July
11, 1962), at 3 (``[T]he making of representations to prospective
purchasers without a reasonable basis, couched in terms of either
opinion or fact and designed to induce purchases, is contrary to the
basic obligation of fair dealing borne by those who engage in the
sale of securities to the public.''), aff'd sub nom., Berko v. SEC,
316 F.2d 137 (2d Cir. 1963). A broker-dealer's recommendation must
also be suitable for the customer. See, e.g., J. Stephen Stout,
Exchange Act Release No. 43410 (Oct. 4, 2000), at 11 (Commission
opinion) (``As part of a broker's basic obligation to deal fairly
with customers, a broker's recommendation must be suitable for the
client in light of the client's investment objectives, as determined
by the client's financial situation and needs.''); see also FINRA
Rule 2111.05(b) (``The customer-specific obligation requires that a
member or associated person have a reasonable basis to believe that
the recommendation is suitable for a particular customer based on
that customer's investment profile, as delineated in Rule
2111(a).'').
    \298\ See, e.g., De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d
1293, 1302 (2d Cir. 2002); Chasins v. Smith, Barney & Co., 438 F.2d
1167, 1172 (2d Cir. 1970). Generally, under the antifraud
provisions, whether a broker-dealer has a duty to disclose material
information to its customer is based upon the scope of the
relationship with the customer, which is fact intensive. See, e.g.,
Conway v. Icahn & Co., Inc., 16 F.3d 504, 510 (2d Cir. 1994) (``A
broker, as agent, has a duty to use reasonable efforts to give its
principal information relevant to the affairs that have been
entrusted to it.''). For example, where a broker-dealer processes
its customers' orders, but does not recommend securities or solicit
customers, then the material information that the broker-dealer is
required to disclose is generally narrow, encompassing only the
information related to the consummation of the transaction. See,
e.g., Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 536 (2d
Cir. 1999). The Commission has historically charged broker-dealers
with violating sections 17(a)(2) and (3) of the Securities Act for
making recommendations of more expensive mutual fund share classes
while omitting material facts. See, e.g., In re IFG Network Sec.,
Inc., Exchange Act Release No. 54127 (July 11, 2006), at 15
(Commission opinion) (registered representative violated 17(a)(2)
and (3) by omitting to disclose to his customers material
information concerning his compensation and its effect upon returns
that made his recommendation that they purchase Class B shares
misleading; ``The rate of return of an investment is important to a
reasonable investor. In the context of multiple-share-class mutual
funds, in which the only bases for the differences in rate of return
between classes are the cost structures of investments in the two
classes, information about this cost structure would accordingly be
important to a reasonable investor.'').
---------------------------------------------------------------------------

(2) Market Mechanisms
    We believe that by facilitating production of information on
covered investment funds, the FAIR Act's mandates will contribute to
competition among information providers,\299\ which we believe can
mitigate the effects of conflicts of interest on research reports.\300\
With respect to broker-dealers' research on operating companies,
analysts' career concerns \301\ have also been found to have similar
effects, and, in principle, broker-dealers' reputations could as
well.\302\ However, we believe it is unlikely that analyst career
concerns or broker-dealer reputation will play as significant a role in
the context of covered investment fund research reports which we expect
to be aimed primarily at retail investors. Research reports about
operating companies have traditionally been provided to institutional
customers as part of a bundle of services provided by full-service
brokerages.\303\ In this setting, broker-dealers benefit from
institutional investors' willingness to pay for broker-dealers'
additional bundled services (e.g., research).\304\ Such institutional
customers are generally capable of producing similar reports, and so
can evaluate the quality of broker-dealers' research.\305\ Thus, they
can provide market discipline: Broker-dealers' provision of low-quality
or misleading information could plausibly be discovered and lead to the
loss of valuable customer relationships. We do not believe that similar
mechanisms would be as effective in the covered investment fund
context. We expect broker-dealers to publish and distribute covered
investment fund research reports on funds that they distribute to their
customers.\306\ With retail investors, information asymmetries are
greater: Retail investors do not generally possess the capabilities to
replicate an analyst report or evaluate its quality.\307\ Moreover, the
problem of evaluating the performance of analysts is harder in the
context of covered

investment funds.\308\ Because institutional investors are not major
investors in covered investment funds,\309\ we believe they are
unlikely to provide market discipline in this context.\310\
---------------------------------------------------------------------------

    \299\ See infra section III.C.5.
    \300\ See Harrison Hong & Marcin Kacperczyk, Competition and
Bias, 125 The Quarterly Journal of Economics 4, 1683-1725 (Nov. 1,
2010) (reduction in (analyst) competition resulting from mergers
reduces analyst coverage and increases bias in the remaining
coverage).
    \301\ See Harrison Hong & Jeffrey D. Kubik, Analyzing the
Analysts: Career Concerns and Biased Earnings Forecasts, 58 The
Journal of Finance 1, 313-351 (2003) (analysts' reputation plays a
role in the analyst's career outcome); see also Andrew R. Jackson,
Trade Generation, Reputation, and Sell-Side Analysts, 60 The Journal
of Finance 2, 673-717 (Apr. 1, 2005) see also Lily Fang & Ayako
Yasuda, The Effectiveness of Reputation as a Disciplinary Mechanism
in Sell-Side Research, 22 The Review of Financial Studies 9, 3735-
3777 (Sept. 1, 2009) (``Fang and Yasuda Article'')
    \302\ For a discussion of the role of reputation in financial
intermediation, see Thomas J. Chemmanur & Paolo Fulghieri,
Investment Bank Reputation, Information Production, and Financial
Intermediation, 49 The Journal of Finance 1, 57-79 (1994)
(``Chemmanur and Fulghieri Article''). See also Fang and Yasuda
Article, supra note 301 (analyst reputation mitigates bias, but
institutional reputation does not).
    \303\ See Mehran, Hamid, and Ren[eacute] M. Stulz, The Economics
of Conflicts of Interest in Financial Institutions, 85 Journal of
Financial Economics 2, 267-296 (Aug. 1, 2007) (``Mehran and Stulz
Article''). We note however, that this model has been disrupted by
the European MiFID II regulations that took effect in 2018. See e.g.
CFA Institute, MiFID II: A New Paradigm for Investment Research,
available at https://www.cfainstitute.org/-/media/documents/support/advocacy/mifid_ii_new-paradigm-for-research-report.ashx
    \304\ Institutional customers are valuable in that they are
willing to pay for brokers-dealers' additional services (e.g.,
research). Payments for such services need not be direct and may be
reflected in (relatively) higher brokerage commissions. See Michael
A. Goldstein, Paul Irvine, Eugene Kandel & Zvi Wiener, Brokerage
Commissions and Institutional Trading Patterns, 22 The Review of
Financial Studies 12, 5175-5212 (Dec. 1, 2009).
    \305\ See id. See also Ulrike Malmendier & Devin Shanthikumar,
Are Small Investors Naive about Incentives?, 85 Journal of Financial
Economics 2, 457-489 (Aug. 1, 2007) (``Malmendier and Shanthikumar
Article'') (institutions account for bias in analysts'
recommendations while retail investors do not).
    \306\ See supra section III.B.1.c.
    \307\ See Mehran and Stulz Article, supra note 303.
    \308\ Traditional analyst research reports on operating
companies largely focus on firm-specific factors, and thus are more
akin to ``stock picking'' than ``market timing'': They attempt to
forecast the idiosyncratic component of firms' future returns.
Covered investment funds represent portfolios of securities and
diversification effects reduce the amount of idiosyncratic variation
in their returns. Thus, abstracting from fees, ``fund picking'' is
more akin to ``market timing'' than ``stock picking.'' Market timing
is a skill that is relatively rare and econometrically difficult to
detect. See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman &
Russ Wermers, Measuring Mutual Fund Performance with Characteristic-
Based Benchmarks, 52 The Journal of Finance 3, 1035-1058 (July
1997).
    \309\ See supra section III.B.1.a.
    \310\ See Alexander Ljungqvist, Felicia Marston, et al.,
Conflicts of Interest in Sell-Side Research and the Moderating Role
of Institutional Investors, 85 Journal of Financial Economics 2,
420-456 (Aug. 1, 2007) (securities of interest to institutional
investor receive coverage that is less biased).
---------------------------------------------------------------------------

    We also acknowledge that biases resulting from conflicts of
interest need not adversely impact investors if investors
disregard,\311\ discount,\312\ or de-bias \313\ the recommendations of
conflicted analysts.\314\ We believe however, that retail investors who
are primary clientele for covered investment funds are less likely to
be aware of potential bias in analysts' recommendations,\315\ may fail
to de-bias or otherwise condition their trades based on the credibility
of the recommendation,\316\ and could thus be led to invest in
underperforming securities.\317\
---------------------------------------------------------------------------

    \311\ See Dugar and Nathan Article, supra note 272.
    \312\ See Michaely and Womack Article, supra note 273.
    \313\ See Lin and McNichols Article, supra note 272.
    \314\ Institutional market participants generally attribute bias
in sell-side analysts' research reports to conflicts of interest.
See Michaely and Womack Article, supra note 273.
    \315\ See Michael B. Mikhail, Beverly R. Walther & Richard H.
Willis, When Security Analysts Talk, Who Listens?, 82 The Accounting
Review 5, 1227-1253 (2007) (``Mikhail Walther and Willis Article'').
See also Diane Del Guercio & Paula A. Tkac, Star Power: The Effect
of Morningstar Ratings on Mutual Fund Flow, 43 Journal of Financial
and Quantitative Analysis 4, 907-936 (Dec. 2008) (retail investors
in mutual funds are very sensitive to fund rankings). See
Christopher R. Blake & Matthew R. Morey, Morningstar Ratings and
Mutual Fund Performance, 35 The Journal of Financial and
Quantitative Analysis 3, 451-483 (2000) (mutual fund ranking have
little predictive power for future performance).
    \316\ See id.; Malmendier and Shanthikumar Article, supra note
305.
    \317\ See Mikhail Walther and Willis Article, supra note 315.
See also Malmendier and Shanthikumar Article, supra note 305. See
also Amanda Cowen, Boris Groysberg & Paul Healy, Which Types of
Analyst Firms Are More Optimistic?, 41 Journal of Accounting and
Economics 1, 119-146 (Apr. 1, 2006) (finding that analysts at retail
brokerage firms are more optimistic than those serving only
institutional investors). See Xuanjuan Chen, Tong Yao & Tong Yu,
Prudent Man or Agency Problem? On the Performance of Insurance
Mutual Funds, 16 Journal of Financial Intermediation 2, 175-203
(Apr. 1, 2007) (underperformance of mutual funds sponsored by
insurance companies is attributed to inadequate monitoring by less
sophisticated retail customers who are subject to cross-selling
efforts by their insurer). See also Daniel Bergstresser, John M. R.
Chalmers, and Peter Tufano, Assessing the Costs and Benefits of
Brokers in the Mutual Fund Industry, 22 Review of Financial Studies
10, 4129-4156 (Oct. 2009) (broker-sold mutual funds deliver lower
risk-adjusted returns (even before subtracting distribution fees)
than direct-sold funds). See also Diane Del Guercio & Jonathan
Reuter, Mutual Fund Performance and the Incentive to Generate Alpha,
69 The Journal of Finance 4, 1673-1704 (Aug. 1, 2014)
(underperformance of actively managed mutual funds is attributed to
the underperformance of funds sold by brokers; the authors find
little evidence for underperformance in the subset of funds that are
sold directly to investors).
---------------------------------------------------------------------------

2. Rule 139b
    As discussed above, rule 139b conditions eligibility for the safe
harbor on satisfaction of several conditions.\318\ These conditions are
generally modeled on and resemble similar provisions in rule 139 (with
differences from rule 139 that the FAIR Act specifically directs, or
that tailor the provisions of rule 139 more directly or specifically to
the context of covered investment fund research reports).\319\ We
believe that modeling rule 139b on rule 139 will benefit market
participants through regulatory consistency. We address these
conditions in turn in the sections that follow.
---------------------------------------------------------------------------

    \318\ See supra section II.B.
    \319\ See supra paragraph accompanying notes 12-15.
---------------------------------------------------------------------------

a. Affiliate Exclusion
    Under the affiliate exclusion of rule 139b,\320\ a broker-dealer
who is an affiliate of a covered investment fund (or is an investment
adviser or an affiliated person of the investment adviser to a covered
investment fund), would not be eligible for the safe harbor of rule
139b when publishing or distributing a research report about that
covered investment fund. The economic benefit of the affiliate
exclusion is that it reduces the potential for retail investors to
receive research reports containing information that was published,
distributed, authorized, or approved by persons whose financial
incentives create the greatest conflicts of interest.\321\ The primary
cost of the affiliate exclusion will be borne by broker-dealers that
both distribute covered investment funds and act as investment advisers
to such funds (or do so through affiliated persons). These broker-
dealers will be unable to provide research reports to their customers
on funds that they (or their affiliated persons) advise.\322\ In
addition, we believe that smaller broker-dealers, and broker-dealers
without significant research departments and who would want to rely on
pre-publication materials distributed by a covered investment fund, its
adviser, or affiliated persons, would also be significantly affected by
the new rules.
---------------------------------------------------------------------------

    \320\ See section 2(f)(3) of the FAIR Act. See supra section
II.A.1.
    \321\ See supra section III.C.1.b.
    \322\ See supra notes 18-21 and accompanying text.
---------------------------------------------------------------------------

    We expect covered investment funds and their investment advisers to
engage in a broad range of marketing activities to support the
distribution of fund shares (particularly in the case of redeemable
securities such as those issued by mutual funds), and that funds and
their advisers prepare and distribute materials to distributing broker-
dealers intended to increase sales. The affiliate exclusion and
associated guidance \323\ will reduce the potential for retail
investors to receive research reports containing materials from persons
whose financial incentives create the greatest conflicts of
interest.\324\
---------------------------------------------------------------------------

    \323\ See supra section II.A.1.
    \324\ Persons covered by the affiliate exclusion may have strong
financial interests to increase sales of associated covered
investment funds. See supra paragraph accompanying note 278.
---------------------------------------------------------------------------

    The affiliate exclusion is also likely to limit the benefits of the
rule for certain broker-dealers. Many broker-dealers distributing
covered investment fund securities do not have sizeable research
departments, and we understand that very few broker-dealers operate at
a scale that would allow for comprehensive coverage of the covered
investment funds that they distribute. We believe that under the
affiliate exclusion, it would be inappropriate for such broker-dealers
to publish or distribute research report provided by a covered
investment fund or the fund's affiliates.\325\ Thus, the affiliate
exclusion could have the effect of limiting broker-dealers' ability and
willingness to publish and distribute research reports about the funds
they distribute: In order to rely on the rule to publish or distribute
a covered investment fund research report, these broker-dealers would
need to conduct their own research in-house or to rely on independent
third-party service providers for their information.
---------------------------------------------------------------------------

    \325\ Among other things, we believe it would be inappropriate
for any person covered by the affiliate exclusion, or for any person
acting on its behalf, to publish or distribute a research report
indirectly that the person could not publish or distribute directly
under the rule. See supra paragraph accompanying note 30.

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b. Regular-Course-of-Business Requirement
    Under rule 139b, research reports (both issuer-specific research
reports and industry research reports) need to be published or
distributed by the broker-dealer in the ``regular course of its
business'' in order to rely on the safe harbor.\326\ For issuers that
do not have a class of securities in ``substantially continuous
distribution,'' issuer-specific research reports that represent the
initiation of publication of research reports about the issuer or its
securities or reinitiation following discontinuation of publication of
such research reports would be deemed to not satisfy the regular-
course-of-business requirement.\327\ The regular-course-of-business
requirement of rule 139b is similar to that of rule 139, except that,
as directed by the FAIR Act, rule 139b specifies that the ``initiation
or reinitiation requirement'' only applies to research reports
regarding a covered investment fund that does not have a class of
securities in substantially continuous distribution.\328\
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    \326\ See supra sections II.B.1.c and II.B.2.b.
    \327\ See supra notes 112-114 and accompanying text.
    \328\ See section 2(b)(1) of the FAIR Act; see also supra note
101 and accompanying text.
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    Given the breadth of the definition of ``research report'' under
the FAIR Act (and the definition of ``research report'' that we are
adopting under rule 139b), certain communications that are currently
treated as covered investment fund advertisements under Securities Act
rule 482 could fall under the rule 139b definition of ``research
report.'' \329\ Investors, particularly retail investors, may be
unaware of the differences in regulatory status and purpose among the
various types of communications regarding registered investment
companies and BDCs. This may result in investors not being able to
readily discern what constitutes a research report and what constitutes
an advertisement about these issuers. We continue to believe that
broker-dealers that publish or distribute research reports in the
regular course of business are more likely to publish analysis that
investors recognize as research.\330\ Therefore, in principle we expect
this requirement to benefit investors by reducing opportunities for
communications published or distributed under the safe harbor to cause
confusion about their intended purpose. However we also believe that
establishing whether a research report is published in the ``regular
course of business'' could, in practice, prove uniquely challenging in
the covered investment funds context.\331\
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    \329\ See supra note 162 and accompanying text.
    \330\ See Proposing Release, supra note 2, at 26797.
    \331\ See Proposing Release, supra note 2, at 26797-98
(requesting comment on the application of the regular-course-of-
business requirement in the context of broker-dealers' publication
or distribution of covered investment fund research reports and
unique concerns relevant to this context (e.g., whether the
requirement should be modified to address broker-dealers that have
not previously published or distributed covered investment fund
research reports)).
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    First, in the context of covered investment funds, the distinction
between communications intended as sales materials and those intended
as research could be difficult to discern. Research reports about debt
and equity securities have traditionally been provided to institutional
customers as part of the broker-dealer's collection of services.\332\
Institutional customers are generally capable of producing similar
reports, and so can more readily evaluate the quality of broker-
dealers' research.\333\ In these circumstances, broker-dealers have a
compelling business rationale for producing high-quality research as
distinct from sales materials.
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    \332\ See Mehran and Stulz Article, supra note 303.
    \333\ See id; see also Malmendier and Shanthikumar Article,
supra note 305.
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    In contrast, we expect covered investment fund research reports to
be produced by broker-dealers that distribute covered investment funds
to retail investors.\334\ Thus, we believe that cultivating a
reputation for high-quality research is less likely to serve as the
primary business rationale for broker-dealers' publication and
distribution of research reports on covered investment funds. Rather,
we expect that facilitating the marketing of covered investment funds
to customers (so as to increase revenues derived from distribution
arrangements) will motivate these activities. In this setting, the
distinction between different types of communications will not be as
clear.
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    \334\ See supra section III.B.1.c.
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    Second, the information environment surrounding covered investment
funds further complicates establishing whether publishing research
reports about covered investment funds is undertaken in the regular
course of business. In the context of research reports about operating
companies, a research analyst ``following'' an operating company
continually monitors that company so as to provide timely forecasts and
recommendations. Because of differences in the nature of covered
investment funds and operating companies, we believe that the same is
less likely to hold for a research analyst ``following'' a covered
investment fund.\335\ We believe that the opportunities for acquiring
idiosyncratic information relevant to future returns of covered
investment funds are generally more limited: Covered investment funds
represent portfolios of securities and diversification effects reduce
the value of idiosyncratic (i.e., firm-specific) information.\336\
Consequently, we expect research analysts ``following'' covered
investment funds to focus instead on information related to fund
characteristics (e.g., fees, portfolio composition, or index tracking
strategy) and on developments at the sector- or macro-level. Because we
do not expect the arrival of such information to be as frequent, we
expect that the inclusion of new analysis in research reports about
covered investment funds could be more rare than in the context of
operating company research reports. Consequently, the publication or
distribution of covered investment fund research reports could occur
relatively infrequently, or could be driven largely by market-wide
factors. This could make it more difficult to establish whether a
covered investment fund research report is published in the regular
course of business.
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    \335\ The regular-course-of-business requirement generically
requires ``research reports'' to be published or distributed in the
regular course of a broker-dealer's business and is not limited to
covered investment fund research reports. See Proposing Release,
supra note 2, at 26797.
    \336\ See supra notes 267-268 and accompanying text.
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    We noted in the Proposing Release that due to the aforementioned
distinctions in the information environment and business rationale, we
believed that the regular-course-of-business requirement in the context
of rule 139b may be more challenging to apply in practice than the
regular-course-of-business requirement in the context of rule 139 and
that the potential benefits of this requirement in rule 139b may be
more limited. We also noted that the effects of the regular-course-of-
business requirement would be clearer in cases where, in the case of
issuer-specific research reports, the bright-line ``initiation or
reinitiation'' requirement applies (i.e., where the covered investment
fund does not have a class of securities in substantially continuous
distribution). For such cases, the regular-course-of-business
requirement would condition the availability of the safe harbor on the
research report not representing the initiation or reinitiation of
coverage by the broker-dealer publishing or distributing said research
report. However, because the universe of covered investment funds is
dominated

by funds with a class of securities that could be considered to be in
substantially continuous distribution,\337\ the bright-line test of the
regular-course-of-business requirement would impact only a small subset
of funds.
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    \337\ See supra section III.B.1.a.
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    Related concerns were voiced by several commenters who questioned
the feasibility of satisfying the regular-course-of-business
requirement under the proposed rules.\338\ As discussed above, we have
included additional guidance to mitigate concerns about the
interpretation of the regular-course-of-business requirement.\339\
While we believe that this guidance should address commenters' concerns
about the feasibility of satisfying the regular-course-of-business
requirement, we acknowledge that--due to the reasons discussed above--
broker-dealers evaluating whether their research activities satisfy the
regular-course-of-business requirement are likely to face more
uncertainty when those activities relate to covered investment funds
than when those activities relate to operating companies. However, we
believe that broker-dealers would only issue covered investment fund
research reports if the benefits are likely to outweigh the costs,
including uncertainty.
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    \338\ See supra sections II.B.1.c, II.B.2.b.
    \339\ See supra paragraph accompanying note 118.
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c. Reporting History and Minimum Market Value Requirements for Issuers
Appearing in Issuer-Specific Research Reports
    Under rule 139b, a broker-dealer's publication or distribution of
issuer-specific research reports does not qualify for the safe harbor
unless the covered investment fund included in the report satisfies a
minimum public market value threshold of $75 million.\340\ Issuers are
also required to have been subject to the reporting requirements of the
Investment Company Act (for covered investment funds that are
registered investment companies) or the reporting requirements under
section 13 or section 15(d) of the Exchange Act (for covered investment
funds that are not registered investment companies) for a period of at
least 12 calendar months prior to reliance on the rule as well as to
have timely filed all required reports during the preceding 12 calendar
months.\341\
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    \340\ See rule 139b(a)(1)(i)(B).
    \341\ Including Forms N-CSR, N-Q, N-PORT, N-MFP, and N-CEN as
applicable for registered investment companies, and Forms 10-K, 10-
Q, and 20-F as applicable for covered investment funds that are not
registered investment companies. See rule 139b(a)(1)(i)(A).
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    The covered investment funds market is dynamic.\342\ In 2017, more
than six hundred covered investment funds entered the market, while
more than eight hundred exited. The entry and exit of covered
investment funds creates a situation in which a younger covered
investment fund may not be widely followed by market participants.\343\
Thus, for covered investment funds, the universe of young--and
potentially less-followed--issuers is large.\344\ Moreover, securities
issued by covered investment funds may not be subject to significant
levels of market scrutiny. Unlike securities issued by operating
companies (that generally have diverse groups of investors, including
institutional investors, money managers, arbitrageurs, activist
investors, and short sellers), covered investment funds are primarily
held by retail investors.\345\ As covered investment fund shares are
not a major component of institutional investors' portfolios, we
believe that they are less likely to garner wide-spread attention from
the types of sophisticated institutional investors most capable of
subjecting them to scrutiny.\346\
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    \342\ See supra section III.B.1.a.
    \343\ In contrast, there were fewer than one hundred U.S. IPOs
for operating companies in 2016. See Jay Ritter, Initial Public
Offerings: Updated Statistics (Aug. 8, 2017), available at https://site.warrington.ufl.edu/ritter/files/2017/08/IPOs2016Statistics.pdf.
    \344\ For example, Morningstar notes that funds with short track
records are unlikely to be provided coverage. See Morningstar,
Morningstar Manager Research Coverage Decision-Making (June 2018),
available at https://morningstardirect.morningstar.com/clientcomm/Morningstar_Manager_Research_Coverage_Decision_Making.pdf.
    \345\ See supra section III.B.1.a.
    \346\ See supra note 310 and accompanying text.
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    We believe that in the context of covered investment funds, where
we expect limited market discipline from institutional investors and
where large numbers of new funds are created each year, the information
available to investors could be sparse. In such an environment, a
single research report about a covered investment fund could have a
disproportionate effect on retail investors' beliefs about the fund
and--in the case of a biased research report--have a negative effect on
investor welfare. We believe that conditioning the availability of the
safe harbor on the aforementioned reporting history and market
valuation requirements would help restrict the availability of the safe
harbor in situations where we expect the information environment to be
most limited: For new funds and for funds with limited trading or
interest.\347\
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    \347\ For example, while Morningstar provides analyst ratings
for 200 ETFs and 1,562 open-end funds, among ETFs and open-end funds
falling below the $75 million minimum public market value threshold,
only 27 received an analyst rating. See supra notes 243 and 344.
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    As noted by several commenters, because young and small covered
investment funds are relatively common, the costs associated with these
conditions on the availability of a safe harbor could be
significant.\348\ In particular, as shown in Table 1, the $75 million
minimum public market valuation condition will limit the availability
of the safe harbor with respect to broker-dealers' publication or
distribution of research reports for approximately one-third of all
covered investment funds.\349\ Research reports about nearly half of
extant ETFs, ETPs will not qualify for the safe harbor.\350\
Availability of the safe harbor would be least impacted for research
reports about BDCs and closed-end funds.\351\
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    \348\ See SIFMA Comment Letter I; ICI Comment Letter; Fidelity
Comment Letter; see also BlackRock Comment Letter.
    \349\ 30% of all covered investment funds have public market
valuations less than $75 million. See Table 1.
    \350\ 41% of ETF and ETPs have public market valuations less
than $75 million. See Table 1.
    \351\ 12% of closed-end funds and 7% of BDCs have public market
valuations less than $75 million. See Table 1.
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    Although small funds represent a very small fraction of covered
investment fund assets, they are relatively large in number.\352\
Because nearly one-third of covered investment funds will not satisfy
the eligibility criteria for the safe harbor, we believe that those
funds will be less likely to receive coverage by broker-dealers insofar
as the inability to rely on the safe harbor reduces broker-dealers'
willingness to publish and distribute research reports.
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    \352\ See Table 1.

  Table 1--Covered Investment Funds With Public Market Value Less Than $75 Million, and the Fraction of Covered
                                   Investment Fund Assets Held by These Funds
   [For each covered investment fund type, we report the percentage of funds of that type with a public market
  value below $75 million and the percentage of covered investment fund assets held in funds with public market
 values below $75 million. Mutual fund, ETF, and ETP statistics are based on data from CRSP mutual fund database
 (2017Q3). Close-end fund statistics are based on data from CRSP monthly stock file (Dec. 2017). BDC statistics
  are based on Commission's listing of registered BDCs, and regulatory filings (2017) compiled by Compustat and
                                                Audit Analytics]
----------------------------------------------------------------------------------------------------------------
                                                                                Funds with public market value
                                                                                <$75 million
                        Covered investment fund type                         -----------------------------------
                                                                               Number of funds
                                                                                (%)         Fund assets (%)
----------------------------------------------------------------------------------------------------------------
Open-end....................................................................                30                <1
Closed-end..................................................................                12                <1
ETF/ETP.....................................................................                41                <1
BDC.........................................................................                 7                <1
                                                                             -----------------------------------
    Total...................................................................                30                <1
----------------------------------------------------------------------------------------------------------------

    Several commenters raised concerns that--in addition to the
aforementioned costs--compliance with the reporting history and minimum
market value requirements as proposed could be operationally
challenging for broker-dealers.\353\ In general, we do not believe that
verifying covered investment funds' reporting history and public market
valuation represents a significant additional burden for broker-dealers
in this position.\354\
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    \353\ See SIFMA Comment Letter I; see also Fidelity Comment
Letter.
    \354\ For example, much of this information is currently
accessible through the publicly available EDGAR system and/or third-
party data providers.
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    Another commenter noted that some broker-dealers provide investors
research about large numbers of funds on a largely automated basis, and
that ensuring compliance with the reporting history and minimum public
market value requirements would create ``operational hurdles'' for
these broker-dealers.\355\ We believe that broker-dealers that choose
to automate publication of research reports will make significant
investments in technology to implement this automation, and that
broker-dealers with infrastructure capable of automating publication of
research reports should have little difficulty implementing the
procedures required for similarly automating the verification of these