[Federal Register Volume 79, Number 226 (Monday, November 24, 2014)]
[Notices]
[Pages 69939-69957]
[FR Doc No: 2014-27700]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73622; File No. SR-FINRA-2014-047]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt
FINRA Rule 2241 (Research Analysts and Research Reports) in the
Consolidated FINRA Rulebook

November 18, 2014.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on November 14, 2014, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission'') the proposed rule change as described in Items I,
II, and III below, which Items have been prepared by FINRA. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    FINRA is proposing to adopt NASD Rule 2711 (Research Analysts and
Research Reports) as a FINRA rule, with several modifications. The
proposed rule change also would amend NASD Rule 1050 (Registration of
Research Analysts) and Incorporated NYSE Rule 344 to create an
exception from the research analyst qualification requirement. The
proposed rule change would renumber NASD Rule 2711 as FINRA Rule 2241
in the consolidated FINRA rulebook.
    The text of the proposed rule change is available on FINRA's Web
site at http://www.finra.org, at the principal office of FINRA and at
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

1. Purpose
    As part of the process of developing a new consolidated rulebook
(``Consolidated FINRA Rulebook''),\3\ FINRA is proposing to adopt in
the Consolidated FINRA Rulebook NASD Rule 2711 (Research Analysts and
Research Reports) with several modifications as FINRA Rule 2241. The
proposed rule change also would amend NASD Rule 1050 (Registration of
Research Analysts) and Incorporated NYSE Rule 344 (Research Analysts
and Supervisory Analysts) to create an exception from the research
analyst qualification requirements.
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    \3\ The current FINRA rulebook includes, in addition to FINRA
Rules, (1) NASD Rules and (2) rules incorporated from NYSE
(``Incorporated NYSE Rules'') (together, the NASD Rules and
Incorporated NYSE Rules are referred to as the ``Transitional
Rulebook''). While the NASD Rules generally apply to all FINRA
members, the Incorporated NYSE Rules apply only to those members of
FINRA that are also members of the NYSE (``Dual Members''). For more
information about the rulebook consolidation process, see
Information Notice, March 12, 2008 (Rulebook Consolidation Process).
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Background
    NASD Rule 2711 and Incorporated NYSE Rule 472 (Communications with
the Public) (``the Rules'') set forth requirements to foster
objectivity and transparency in equity research and provide investors
with more reliable and useful information to make investment decisions.
The Rules were intended to restore public confidence in the objectivity
of research and the veracity of research analysts, who are expected to
function as unbiased intermediaries between issuers and the investors
who buy and sell those issuers' securities. The integrity of research
had eroded due to the pervasive influences of investment banking and
other conflicts that became apparent during the market boom of the late
1990s.
    The current NASD and Incorporated NYSE rules have no significant
differences.\4\ In general, the Rules require disclosure of conflicts
of interest in research reports and public appearances by research
analysts. The Rules further prohibit conflicted conduct--investment
banking personnel involvement in the content of research reports and
determination of analyst compensation, for example--where the conflicts
are too pronounced to be cured by disclosure. Several of the Rules'
provisions implement provisions of the Sarbanes-Oxley Act of 2002
(``Sarbanes-Oxley''), which mandates separation between research and
investment banking, proscribes conduct that could compromise a research
analyst's objectivity and requires specific disclosures in research
reports and public appearances.\5\
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    \4\ The one substantive difference between the rules involves
the recordkeeping obligations when a research analyst makes a public
appearance. Incorporated NYSE Rule 472(k)(2) requires a record of
the public appearance to be made within 48 hours and include
specific information about the nature of the appearance and
applicable disclosures. NASD Rule 2711(h)(12) provides that members
must maintain records of public appearances sufficient to
demonstrate compliance with the applicable disclosure requirements.
    \5\ 15 U.S.C. 78o-6.
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    NASD Rule 1050 (Registration of Research Analysts) and Incorporated
NYSE Rule 344 (Research Analysts and Supervisory Analysts) require any
person associated with a member and who functions as a research analyst
to be registered as such and pass the Series 86 and 87 exams, unless an
exemption applies. NASD Rule 1050 defines ``research analyst'' as ``an
associated person who is primarily responsible for the preparation of
the substance of a research report or whose name appears on a research
report.'' Incorporated NYSE Rule 344 has a substantially similar
definition.
    In December 2005, in response to a Commission Order, FINRA and the
NYSE submitted to the Commission a joint report on the operation and
effectiveness of the research analyst conflict of interest rules
(``Joint Report'').\6\ Among other things, the Joint Report analyzed
the impact of the Rules based on academic studies, media reports and
commentary. The Joint Report concluded that the Rules have been
effective in helping to restore integrity to research by minimizing the
influence of investment banking and promoting transparency of other
potential conflicts of interest. Evidence from academic studies, among
other sources, further suggested that investors are benefiting from
more balanced and accurate research to aid their investment decisions.
A January 2012 GAO report on securities research (``GAO Report'') also
concluded that empirical results suggest the Rules have resulted in
increased analyst independence and weakened the influence of conflicts
of interest on analyst recommendations.\7\
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    \6\ Joint Report by NASD and the NYSE on the Operation and
Effectiveness of the Research Analyst Conflict of Interest Rules
(December 2005), available at http://www.finra.org/web/groups/industry/@ip/<EMAIL_ADDRESS>    \7\ United States Government Accountability Office, Securities
Research, Additional Actions Could Improve Regulatory Oversight of
Analyst Conflicts of Interest, January 2012.
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    The Joint Report also recommended changes to the Rules to strike an
even better balance between ensuring objective and reliable research on
the one hand, and permitting the flow of information to investors and
minimizing costs and burdens to members on the other.\8\ The
recommendations resulted from a comprehensive review of the Rules. In
evaluating the Rules, FINRA staff considered several analytical
touchstones: whether a provision was accomplishing its intended
purpose; findings from examinations, sweeps and enforcement actions;
interpretive requests and member questions; a comparison of provisions
of the ``Global Settlement''; \9\ potential gaps or overbreadth in the
provisions; and input from members and industry groups. The proposed
rule change maintains those aforementioned objectives and therefore
incorporates many of the recommendations in the Joint Report not
already incorporated into the current rules.\10\
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    \8\ FINRA previously filed two proposed rule changes to
implement recommendations from the Joint Report. On October 17,
2006, FINRA filed for immediate effectiveness a proposed rule change
to codify previously issued interpretive guidance. See Securities
Exchange Act Release No. 54616 (October 17, 2006), 71 FR 62331
(October 24, 2006) (Notice of Filing File Nos. SR-NYSE-2006-77; SR-
NASD-2006-112). However, FINRA withdrew the second proposal in
anticipation of filing this more comprehensive consolidated proposed
rule change. See Securities Exchange Act Release No. 55072 (January
9, 2007), 72 FR 2058 (January 17, 2007) (Notice of Filing File Nos.
SR-NYSE-2006-78; SR-NASD-2006-113) (Withdrawn October 25, 2012).
    \9\ In 2003, federal and state authorities and self-regulatory
organizations reached a settlement with 10 of the nation's largest
broker-dealers to resolve allegations of misconduct involving
conflicts of interest between their research analysts and investment
bankers. In 2004, two additional firms settled substantively under
the same terms, which included provisions to effectively separate
research from investment banking.
    \10\ FINRA has not incorporated all of the Joint Report
recommendations in the proposed rule change. As discussed infra at
72, FINRA is not incorporating the recommendation to exclude direct
participation programs from the definition of ``research report.''
FINRA previously addressed a recommendation to provide guidance with
respect to the road show prohibition. FINRA set forth guidance in
Regulatory Notice 07-04 that it is permissible for research analysts
to listen to or view a live webcast of a road show or other widely
attended presentation to investors or the sales force from a remote
location. That guidance remains applicable to the proposed rule
change. As discussed infra at 21, FINRA is not incorporating the
recommendation to completely eliminate the quiet period after
secondary offerings. FINRA also is not incorporating the
recommendation to expand the exceptions to the personal trading
restrictions because, as discussed infra at 27, FINRA is proposing
to replace the prescriptive restrictions with a requirement to
establish, maintain and enforce policies and procedures that obviate
the need to set out specific exceptions to those provisions. In
addition, as discussed infra at 34-35, FINRA is not proposing to
replace the current disclosure requirements with a prominent warning
on the cover of a research report that conflicts of interest exist,
together with information on how the reader may obtain more detail
about the conflicts on the member's Web site.

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    The proposed rule change would retain the core provisions of the
current rules, broaden the obligations on members to identify and
manage research-related conflicts of interest, restructure the rules to
provide some flexibility in compliance without diminishing investor
protection, extend protections where gaps have been identified, and
provide clarity to the applicability of existing rules. Where
consistent with protection of users of research, the proposed rule
change reduces burdens: For example, it would modify or eliminate
requirements (e.g., quiet periods and the annual attestation), expand
the exemption for firms with limited investment banking activity, and
create a new limited exemption from the registration requirements for
``research reports'' produced by persons whose primary job function is
something other than producing research. Taken together, FINRA believes
the proposed amendments will result in rules that more effectively and
efficiently achieve their intended goals of objective, transparent and
useful research for investors. The proposed rule change reflects input
from FINRA advisory committees and market participants and includes
changes made in response to comments received to an earlier
consolidated rule proposal set forth in Regulatory Notice 08-55. The
substantive proposed changes to the existing research rules are
described below.\11\
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    \11\ For economy, the discussion generally refers only to NASD
Rules; however, those references apply equally to the corresponding
Incorporated NYSE Rules.
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Definitions
    The proposed rule change mostly maintains the definitions in
current NASD Rule 2711, with the following modifications:
     Minor changes to the definition of ``investment banking
services'' to clarify that such services include all acts in
furtherance of a public or private offering on behalf of an issuer.\12\
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    \12\ See proposed FINRA Rule 2241(a)(5). The current definition
includes, without limitation, many common types of investment
banking services. FINRA is proposing to add the language ``or
otherwise acting in furtherance of'' either a public or private
offering to further emphasize that the term ``investment banking
services'' is meant to be construed broadly.
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     clarification in the definition of ``research analyst
account'' that the definition does not apply to a registered investment
company over which a research analyst has discretion or control,
provided that the research analyst or a member of that research
analyst's household has no financial interest in the investment
company, other than a performance or management fee.\13\
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    \13\ See proposed FINRA Rule 2241(a)(9).
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     exclusion from the definition of ``research report'' of
communications concerning open-end registered investment companies that
are not listed or traded on an exchange (``mutual funds'').\14\
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    \14\ See proposed FINRA Rule 2241(a)(11).
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     move into the definitional section the definitions of
``third-party research report'' and ``independent third-party research
report'' that are now in a separate provision of the rules.\15\
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    \15\ See proposed FINRA Rules 2241(a)(3) and (13). FINRA
believes it creates a more streamlined and user friendly rule to
combine defined terms in a single definitional section.
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    The current rules define ``research analyst account'' to include
any account over which a research analyst or member of the research
analyst's household has a financial interest, or over which such person
has discretion or control, other than an investment company registered
under the Investment Company Act of 1940. The purpose of the exception
is to accommodate circumstances where a research analyst also manages a
registered investment company; otherwise, every transaction in the
investment company's fund would be subject to personal trading
restrictions, including any blackout periods a firm may establish,
creating substantial logistical difficulties in operating the fund. The
proposed change is intended to clarify that the exception does not
apply where the research analyst account has a financial interest in
the fund, other than a performance or management fee. In those
circumstances, FINRA believes the conflict is too serious because the
research analyst account could benefit more directly by taking
positions in advance of publishing research or making a public
appearance that could affect the price of the holdings.
    ``Research report'' currently is defined in Rule 2711(a)(9) as a
``written (including electronic) communication that includes an
analysis of equity securities of individual companies or industries,
and that provides information reasonably sufficient upon which to base
an investment decision.'' Since shares of mutual funds are ``equity
securities'' as defined in Section 3(a)(11) of the Exchange Act, a
written communication that contains an analysis of mutual fund
securities and information sufficient upon which to base an investment
decision technically is covered by the definition.
    However, FINRA believes that communications concerning mutual funds
should be excluded from the definition of ``research report.'' Sales
material regarding mutual funds is already subject to a separate
regulatory regime, including FINRA Rule 2210 and Securities Act of 1933
(``Securities Act'') Rule 482, and, subject to certain exceptions,
retail communications regarding registered investment companies must be
filed with FINRA within 10 business days of first use.\16\ The
extensive content standards of these rules, combined with the filing
and review of mutual fund sales material by FINRA staff, substantially
reduce the likelihood that such material will include materially
misleading information about the funds. Moreover, FINRA does not
believe that the conflicts underpinning the research rules are manifest
to the same extent with respect to reports on mutual funds. For
example, a mutual fund's share price is determined by the fund's net
asset value (``NAV''), which is based on the total value of the fund's
portfolio. Because most mutual funds hold a large

number of individual securities, it is much less likely that a report
on a mutual fund would affect the fund's NAV to the same extent that a
research report on a single stock might impact its share price.
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    \16\ See FINRA Rule 2210(c)(3)(A). A retail communication
concerning a registered investment company that includes a
performance ranking or performance comparison of the investment
company with other investment companies that is not generally
published or is created by the fund or its affiliates must be filed
with FINRA at least 10 business days prior to first use or
publication. FINRA Rule 2210(c)(7) lists categories of member
communications that are excluded from the rule's filing
requirements, including certain retail communications concerning
investment companies. For example, FINRA Rule 2210(c)(7)(I) excludes
from the rule's filing requirements certain independently prepared
reprints or excerpts of articles or reports concerning investment
companies. However, this filing exclusion only applies to articles
or reports where the publisher is not an affiliate of the member
using the reprint or any underwriter or issuer of a security
mentioned in the reprint, and neither the member using the reprint
nor any underwriter or issuer of a security mentioned in the reprint
has commissioned the reprinted article or report.
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Identifying and Managing Conflicts of Interest
    The proposal creates a new section entitled ``Identifying and
Managing Conflicts of Interest.'' This section contains an overarching
provision that requires members to establish, maintain and enforce
written policies and procedures reasonably designed to identify and
effectively manage conflicts of interest related to the preparation,
content and distribution of research reports and public appearances by
research analysts and the interaction between research analysts and
persons outside of the research department, including investment
banking and sales and trading personnel, the subject companies and
customers.\17\ A second provision sets forth more specifically what
those written policies and procedures must address. They must promote
objective and reliable research that reflects the truly held opinions
of research analysts and prevent the use of research or research
analysts to manipulate or condition the market or favor the interests
of the member or a current or prospective customer or class of
customers.\18\ These provisions, therefore, set out the fundamental
obligation for a member to establish and maintain a system to identify
and mitigate conflicts to foster integrity and fairness in its research
products and services. The provisions are also intended to require
firms to be more proactive in identifying and managing conflicts as new
research products, affiliations and distribution methods emerge.
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    \17\ See proposed FINRA Rule 2241(b)(1).
    \18\ See proposed FINRA Rule 2241(b)(2).
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    The proposed rule change then sets forth minimum requirements for
those written policies and procedures. This approach allows for some
flexibility to manage identified conflicts, with some specified
prohibitions and restrictions where disclosure does not adequately
mitigate them. Most of the minimum requirements have been experience
tested and found effective.
    Sarbanes-Oxley mandates specific rules to prohibit or restrict
conduct related to the preparation, approval and distribution of
research reports and the determination of research analyst
compensation. Thus, the proposal requires members to establish,
maintain and enforce written policies and procedures reasonably
designed specifically to achieve compliance with those Sarbanes-Oxley
requirements. This approach provides firms with more flexibility to
adopt policies and procedures to effectuate those mandates in a manner
consistent with the member's size and organizational structure. The
proposed rule changes also goes beyond Sarbanes-Oxley to require
additional written policies and procedures that further the separation
between research and not only investment banking, but also other non-
research personnel, such as sales and trading, that may have interests
that conflict with independent, unbiased research.
    Thus, the proposed rule change mostly retains or slightly modifies
the current structural safeguards that the Joint Report found effective
to promote analyst independence and objective research, but in the form
of mandated written policies and procedures with some baseline
proscriptions.\19\ FINRA believes this approach will provide the same
investor protections as the current rules, but impose less cost than a
pure prescriptive approach by requiring firms to adopt a compliance
system that aligns with their particular structure, business model and
philosophy. FINRA notes that the approach is consistent with FINRA's
general supervision rule, which similarly provides firms flexibility to
establish and maintain supervisory programs best suited to their
business models, reasonably designed to achieve compliance with
applicable federal securities law and regulations and FINRA rules.\20\
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    \19\ Among the structural safeguards, FINRA believes separation
between investment banking and research is of particular importance.
As such, while the proposed rule change does not mandate physical
separation between the research and investment banking departments
(or other person who might seek to influence research analysts),
FINRA would expect such physical separation except in extraordinary
circumstances where the costs are unreasonable due to a firm's size
and resource limitations. In those instances, a firm must implement
written policies and procedures, including information barriers, to
effectively achieve and monitor separation between research and
investment banking personnel.
    \20\ See NASD Rule 3010, recently adopted with changes as a
consolidated FINRA rule by Securities Exchange Act Release No. 71179
(December 23, 2013), 78 FR 79542 (December 30, 2013) (Order
Approving File No. SR-FINRA-2013-025). The consolidated rule becomes
effective December 1, 2014. FINRA further notes that the policies
and procedures approach is consistent with the effective practices
highlighted by FINRA in its Report on Conflicts of Interest, among
them that firms should implement a robust conflicts management
framework that includes structures, processes and policies to
identify and manage conflicts of interest. See Report on Conflicts
of Interest, FINRA (October 2013) at 5, available at http://www.finra.org/web/groups/industry/@ip/<EMAIL_ADDRESS>The proposed changes also help to harmonize
with approaches in international jurisdictions, such as the rules of
the Financial Conduct Authority in the United Kingdom. See COBS
12.2.5 R, The Financial Conduct Authority Handbook, available at
http://fshandbook.info/FS/html/handbook/COBS/12/2.
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Prepublication Review
    The required policies and procedures must, at a minimum, be
reasonably designed to prohibit prepublication review, clearance or
approval of research reports by persons engaged in investment banking
services activities and restrict or prohibit such review, clearance or
approval by other persons not directly responsible for the preparation,
content and distribution of research reports, other than legal and
compliance personnel.\21\ Thus, this provision maintains the current
prohibition on prepublication review by investment banking personnel,
but eliminates the exception in paragraph (b)(3) of Rule 2711 that
permits pre-publication review of research by investment banking to
verify the factual accuracy of information in a research report. FINRA
believes that review of facts in a report by investment banking is
unnecessary in light of the numerous other sources available to verify
factual information, including the subject company, and only raises
concerns about the objectivity of the report. Such review may invite
pressure on a research analyst from such personnel that could be
difficult to monitor. Factual review by investment banking personnel is
not permitted under the terms of the Global Settlement, and FINRA staff
is not aware of any evidence that the factual accuracy of research
produced by Global Settlement firms has suffered. Moreover, legal and
compliance can adequately perform a conflict review without sharing
draft research reports with investment banking.
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    \21\ See proposed FINRA Rule 2241(b)(2)(A).
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    The proposal requires policies and procedures reasonably designed
to at least restrict prepublication review by other non-research
personnel, other than legal and compliance personnel. Thus, a firm must
specify in its policies and procedures the circumstances, if any, where
such review would be permitted as necessary and appropriate; for
example, where non-research personnel are best situated to verify
select facts or where administrative personnel review for formatting.
FINRA notes that members still would be subject to the overarching
requirement to have policies and procedures reasonably designed to
effectively manage conflicts of interest between

research analysts and those outside of the research department.
Coverage Decisions
    The required policies and procedures must be reasonably designed to
restrict or limit input by investment banking department into research
coverage decisions to ensure that research management independently
makes all final decisions regarding the research coverage plan.\22\
This provision makes express FINRA's interpretation that the separation
requirements in current Rule 2711(b)(1) prohibit investment banking
personnel from making any final coverage decisions. The proposed
provision does not preclude investment banking personnel from conveying
customer interests or providing input into coverage considerations, so
long as final decisions regarding the coverage plan are made by
research management.
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    \22\ See proposed FINRA Rule 2241(b)(2)(B).
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Supervision and Control of Research Analysts
    The required policies and procedures must be reasonably designed to
prohibit persons engaged in investment banking activities from
supervision or control of research analysts, including influence or
control over research analyst compensation evaluation and
determination.\23\ The provision is substantively the same as current
Rule 2711(b)(1), a core structural separation requirement that FINRA
believes is essential to safeguarding analyst objectivity.
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    \23\ See proposed FINRA Rule 2241(b)(2)(C).
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Research Budget Determinations
    The required policies and procedures must be reasonably designed to
limit determination of research department budget to senior management,
excluding senior management engaged in investment banking services
activities.\24\ This provision makes express FINRA's interpretation
that the separation requirements of current Rule 2711(b)(1) prohibit
investment banking personnel from making any determination of research
budget decisions.
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    \24\ See proposed FINRA Rule 2241(b)(2)(D).
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Compensation
    The required policies and procedures must be reasonably designed to
prohibit compensation based upon specific investment banking services
transactions or contributions to a member's investment banking services
activities.\25\ The policies and procedures further must require a
committee that reports to the member's board of directors--or if none
exists, a senior executive officer--to review and approve at least
annually the compensation of any research analyst who is primarily
responsible for preparation of the substance of a research report. The
committee may not have representation from a member's investment
banking department. The committee must consider, among other things,
the productivity of the research analyst and the quality of his or her
research and must document the basis for each research analyst's
compensation.\26\ These provisions are consistent with the requirements
in current Rule 2711(d).
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    \25\ See proposed FINRA Rule 2241(b)(2)(E).
    \26\ See proposed FINRA Rule 2241(b)(2)(F).
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Information Barriers
    The required policies and procedures must be reasonably designed to
establish information barriers or other institutional safeguards to
ensure that research analysts are insulated from the review, pressure
or oversight by persons engaged in investment banking services
activities or other persons, including sales and trading department
personnel, who might be biased in their judgment or supervision.\27\
FINRA believes the other policies and procedures required by the
proposed rule change to identify and manage research-related conflicts
of interest should effectively result in compliance with this Sarbanes-
Oxley-based provision. However, FINRA is including the provision to
emphasize that the conflicts management must extend to persons other
than investment banking personnel, including sales and trading
department personnel, who may be placed in a position to supervise or
influence the content of research reports or public appearances.
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    \27\ See proposed FINRA Rule 2241(b)(2)(G).
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Retaliation
    The required policies and procedures must be reasonably designed to
prohibit direct or indirect retaliation or threat of retaliation
against research analysts employed by the member or its affiliates by
persons engaged in investment banking services activities or other
employees as the result of an adverse, negative, or otherwise
unfavorable research report or public appearance written or made by the
research analyst that may adversely affect the member's present or
prospective business interests.\28\ This provision is consistent with
current Rule 2711(j), except that it extends the retaliation
prohibition to employees other than investment banking personnel. FINRA
believes it is essential to a research analyst's independence and
objectivity that no person employed by a member that is in a position
to retaliate or threaten to retaliate should be permitted to do so
based on the content of a research report or public appearance.
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    \28\ See proposed FINRA Rule 2241(b)(2)(H). This provision is
not intended to limit a member's authority to discipline or
terminate a research analyst, in accordance with the member's
written policies and procedures, for any cause other than writing an
adverse, negative, or otherwise unfavorable research report or for
making similar comments during a public appearance.
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Quiet Periods
    The required policies and procedures must be reasonably designed to
define quiet periods of a minimum of 10 days after an initial public
offering, and a minimum of three days after a secondary offering,
during which the member must not publish or otherwise distribute
research reports, and research analysts must not make public
appearances, relating to the issuer if the member has participated as
an underwriter or dealer in the initial public offering or, with
respect to the quiet periods after a secondary offering, as a manager
or co-manager of that offering.\29\ This provision represents a
significant change from the current rules, which impose a 40-day quiet
period on a member acting as manager or co-manager of an IPO, a 25-day
quiet period on a member participating as an underwriter or dealer
(other than manager or co-manager) in an IPO, and a 10-day quiet period
on a member acting as manager or co-manager of a secondary offering. As
mentioned above, the quiet periods do not apply to EGCs.
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    \29\ See proposed FINRA Rule 2241(b)(2)(I). Consistent with the
Jumpstart Our Business Startups Act (``JOBS Act''), those quiet
periods do not apply following the IPO or secondary offering of an
Emerging Growth Company (``EGC''), as that term is defined in
Section 3(a)(80) of the Exchange Act.
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    With respect to these quiet-period provisions, the proposed rule
change reduces the current 40-day quiet period for IPOs to a minimum of
10 days after the completion of the offering for any member that
participated as an underwriter or dealer, and reduces the 10-day
secondary offering quiet period to three days after the completion of
the offering for any member that participated as a manager or co-
manager in the secondary offering.
    The lengthier quiet period for managers and co-managers was
intended to allow other voices to publicly analyze and value a subject
company before members most vested in the success of the offering
expressed a view in their reports and public appearances. However, in
light of the objectivity safeguards in other

provisions of the research rules and the certification requirement of
SEC Regulation AC, FINRA believes it is no longer necessary to impose a
longer period on managers and co-managers. Both the Joint Report and
the GAO Report noted that analysts have been issuing less optimistic
recommendations since the regulatory reforms, particularly at firms
involved in underwriting subject company securities.\30\ FINRA believes
that the separation, disclosure and certification requirements in the
rules and Regulation AC have had greater impact on the objectivity of
research than maintaining quiet periods during which research may not
be distributed and research analysts may not make public appearances.
FINRA has observed--and media reports have documented--instances when a
manager or co-manager of an IPO has initiated coverage of the subject
company with a ``hold'' or even ``sell'' rating once the quiet period
ended.\31\ These examples buttress FINRA's belief that the other
provisions of the rules and Regulation AC have been effective in
deterring biased research. FINRA also notes that there is a cost to
investors when they are deprived of information and analysis during
quiet periods.
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    \30\ See Joint Report, supra note 6 at 17-20; see GAO Report,
supra note 7 at 12-15.
    \31\ See Facebook Shares No Lock for Pop After Quiet Period,
available at http://blogs.wsj.com/marketbeat/2012/06/27/facebook-shares-no-lock-for-pop-after-quiet-period/; see also Warburg Analyst
Advises Investors to Sell JetBlue, available at http://articles.latimes.com/2002/may/08/business/fi-wrap8.
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    Accordingly, FINRA is proposing to reduce all of the quiet periods
after IPOs and secondary offerings. By doing so, FINRA believes the
proposed rule change would promote more information flow to investors
without jeopardizing the objectivity of research. As reflected in the
Joint Report, FINRA was in favor of completely eliminating the quiet
periods around secondary offerings; however, SEC staff has since
indicated its view that the Sarbanes-Oxley reference to ``public
offering of securities'' \32\ encompasses both initial public offerings
and secondary offerings and therefore mandates a quiet period after
such public offerings, except for EGCs. FINRA will read with interest
comments with evidence that suggests that maintaining longer quiet
periods for manager and co-managers after the IPO of a non-EGC issuer
would provide a meaningful benefit to investors.
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 78o-6(a)(2).
---------------------------------------------------------------------------

    As recommended in the Joint Report, the proposed rule change also
eliminates the current quiet periods 15 days before and after the
expiration, waiver or termination of a lock-up agreement. FINRA
believes that research issued during such periods potentially offers
valuable market information, and the other provisions of the research
rules and SEC Regulation AC provide sufficient protection that such
research will reflect the analyst's honest beliefs and be free from
other conflicts that would undermine the value or integrity of research
issued during these periods. FINRA understands from some underwriters
that issuers will time release of negative news to occur during these
quiet periods, thereby depriving investors of timely analysis of the
impact of the news on their holdings. FINRA also notes that the change
will bring consistency to the application of the rules, irrespective of
the subject company, because, as noted above, recent amendments
implementing the JOBS Act exempt research regarding EGCs from the
current quiet periods.\33\
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    \33\ FINRA notes that the proposed changes to the quiet periods
do not affect any quiet periods that may be required under federal
law.
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Solicitation and Marketing
    In addition, the proposed rule change requires firms to adopt
written policies and procedures to restrict or limit activities by
research analysts that can reasonably be expected to compromise their
objectivity.\34\ This includes the existing prohibitions on
participation in pitches and other solicitations of investment banking
services transactions and road shows and other marketing on behalf of
issuers related to such transactions. FINRA notes that consistent with
existing guidance analysts may listen to or view a live webcast of a
transaction-related road show or other widely attended presentation by
investment banking to investors or the sales force from a remote
location, or another room if they are in the same location.\35\
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    \34\ See proposed FINRA Rule 2241(b)(2)(L).
    \35\ See NASD Notice to Members 07-04 (January 2007) and NYSE
Information Memo 07-11 (January 2007).
---------------------------------------------------------------------------

    Pursuant to the recent amendments implementing the JOBS Act, the
prohibition on participation in pitch meetings does not apply to a
research analyst that attends a pitch meeting in connection with an IPO
of an EGC that is also attended by investment banking personnel.
However, FINRA notes that research analysts still are prohibited from
soliciting an investment banking services transaction or promising
favorable research during permissible attendance at those pitch
meetings.\36\ The proposed rule change also adds Supplementary Material
.01, which codifies the existing interpretation that the pitch
provision prohibits members from including in pitch materials any
information about a member's research capacity in a manner that
suggests, directly or indirectly, that the member might provide
favorable research coverage.\37\ By way of example, the Supplementary
Material explains that FINRA would consider the publication in a pitch
book or related materials of an analyst's industry ranking to imply the
potential outcome of future research because of the manner in which
such rankings are compiled. The Supplementary Material further notes
that a member would be permitted to include in the pitch materials the
fact of coverage and the name of the research analyst, since that
information alone does not imply favorable coverage.
---------------------------------------------------------------------------

    \36\ See Jumpstart Our Business Startups Act, Frequently Asked
Questions About Research Analysts and Underwriters, available at
http://www.sec.gov/divisions/marketreg/tmjobsact-researchanalystsfaq.htm.
    \37\ See proposed FINRA Rule 2241.01 and Notice to Members 07-04
(January 2007).
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Joint Due Diligence and Other Interactions With Investment Banking
    The proposed rule establishes a new proscription with respect to
joint due diligence activities--i.e., due diligence by the research
analyst in the presence of investment banking department personnel--
during a specified time period. Specifically, proposed Supplementary
Material .02 states that FINRA interprets the overarching principle
requiring members to, among other things, establish, maintain and
enforce written policies and procedures that address the interaction
between research analysts, banking and subject companies, to prohibit
the performance of joint due diligence prior to the selection of
underwriters for the investment banking services transaction. FINRA
understands that in some instances, due diligence activities take place
even before an issuer has awarded the mandate to manage or co-manage an
offering. FINRA believes there is heightened risk in those
circumstances that investment bankers may pressure analysts to produce
favorable research that may bolster the firm's bid to become an
underwriter for the offering. Once the mandate has been awarded, FINRA
believes joint due diligence may take place in accordance with
appropriate policies and procedures to guard against interactions to
further the interests of the investment banking department. At that
time, FINRA believes that the efficiencies of joint due diligence
outweigh the risk of pressure

on research analysts by investment banking. Also, FINRA understands
that typically an analyst that is participating in due diligence
activities will not be publishing research at that time due to quiet
periods under the offering rules of the Securities Act or because the
analyst has been brought ``over the wall.'' FINRA notes that this
provision is consistent with restrictions in the Global Settlement.
    The proposed rule continues to prohibit investment banking
department personnel from directly or indirectly directing a research
analyst to engage in sales or marketing efforts related to an
investment banking services transaction, and directing a research
analyst to engage in any communication with a current or prospective
customer about an investment banking services transaction.\38\
Supplementary Material .03 clarifies that three-way meetings between
research analysts and a current or prospective customer in the presence
of investment banking department personnel or company management about
an investment banking services transaction are prohibited by this
provision.\39\ FINRA believes that the presence of investment bankers
or issuer management could compromise a research analyst's candor when
talking to a current or prospective customer about a deal.
Supplementary Material .03 also retains the current requirement that
any written or oral communication by a research analyst with a current
or prospective customer or internal personnel related to an investment
banking services transaction must be fair, balanced and not misleading,
taking into consideration the overall context in which the
communication is made.
---------------------------------------------------------------------------

    \38\ See proposed FINRA Rule 2241(b)(2)(M). FINRA notes that
this provision does not prohibit investment banking personnel from
forwarding to a research analyst the name of a prospective investor
in an investment banking transaction, provided that the research
analyst retains discretion whether to contact the investor and for
the content of any discussion that ensues. See Regulatory Notice 12-
49 (November 2012).
    \39\ See proposed FINRA Rule 2241.03.
---------------------------------------------------------------------------

Promises of Favorable Research and Prepublication Review by Subject
Company
    The proposal maintains the current prohibition against promises of
favorable research, a particular research recommendation, rating or
specific content as inducement for receipt of business or
compensation.\40\ It further prohibits prepublication review of a
research report by a subject company for purposes other than
verification of facts.\41\
---------------------------------------------------------------------------

    \40\ See proposed FINRA Rule 2241(b)(2)(K). FINRA provided
additional guidance on the current provision, NASD Rule 2711(e), in
Regulatory Notice 11-41 (September 2011).
    \41\ See proposed FINRA Rule 2241(b)(2)(N).
---------------------------------------------------------------------------

    Supplementary Material .05 maintains the current guidance
applicable to the prepublication submission of a research report to a
subject company. Specifically, sections of a draft research report may
be provided to non-investment banking personnel or the subject company
for factual review, provided: (1) That the draft section does not
contain the research summary, research rating or price target; (2) a
complete draft of the report is provided to legal or compliance
personnel before sections are submitted to non-investment banking
personnel or the subject company; and (3) any subsequent proposed
changes to the rating or price target are accompanied by a written
justification to legal or compliance and receive written authorization
for the change. The member also must retain copies of any draft and the
final version of the report for three years.\42\
---------------------------------------------------------------------------

    \42\ See proposed FINRA Rule 2241.05.
---------------------------------------------------------------------------

Personal Trading Restrictions
    The proposal provides for a more encompassing and flexible
supervisory approach with respect to research analyst account trading
in securities of companies the research analyst covers. The current
rules impose specific blackout periods during which a research analyst
account may not trade covered securities and require pre-approval by
legal and compliance of transactions in covered securities by persons
who oversee research analysts. The current rules also provide several
exceptions to the blackout periods, including where a report or change
in rating or price target results from ``significant news or a
significant event concerning the subject company.'' In addition, the
blackout periods do not apply to: (1) Transactions in the securities of
a registered diversified investment company as defined under Section
(5)(b)(1) of the Investment Company Act of 1940; or (2) purchases or
sales of securities in other investment funds over which neither the
research analyst nor a member of a research analyst's household has any
investment discretion or control, provided that the research analyst
account collectively owns interests representing no more than 1% of the
fund's assets and that the fund invests no more than 20% of its assets
in securities of issuers principally engaged in the same types of
businesses as companies in the research analyst's coverage universe.
The rules further prohibit a research analyst account from purchasing
or selling any security or any option or derivative of such security in
a manner inconsistent with the research analyst's recommendation as
reflected in the most recent research report published by the member.
Legal or compliance may authorize transactions otherwise prohibited by
the rules based on an unanticipated significant change in the personal
financial circumstances of the beneficial owner of the research analyst
account, provided that the authorization is in accordance with policies
and procedures reasonably designed to avoid a conflict between the
professional responsibilities of the research analyst and his or her
personal trading and that the member maintains for three years written
records documenting the justification for permitting the transaction.
    The proposal instead requires that firms establish written policies
and procedures that restrict or limit research analyst account trading
in securities, any derivatives of such securities and funds whose
performance is materially dependent upon the performance of securities
covered by the research analyst.\43\ Such policies and procedures must
ensure that research analyst accounts, supervisors of research analysts
and associated persons with the ability to influence the content of
research reports do not benefit in their trading from knowledge of the
content or timing of a research report before the intended recipients
of such research have had a reasonable opportunity to act on the
information in the research report.\44\ The proposal maintains, as
minimum standards, the current prohibitions on research analysts
receiving pre-IPO shares in the sector they cover and trading against
their most recent recommendations. However, members may define
financial hardship circumstances, if any, in which a research analyst
would be permitted to trade against his or her most recent
recommendation.\45\ While the proposed rule change does not include a
recordkeeping requirement, FINRA expects members to evidence compliance
with their policies and procedures and retain any related documentation
in accordance with FINRA Rule 4511. The proposed rule change includes
Supplementary Material .10, which provides that FINRA would not
consider a research analyst account to have traded in a manner
inconsistent with a research

analyst's recommendation where a member has instituted a policy that
prohibits any research analyst from holding securities, or options on
or derivatives of such securities, of the companies in the research
analyst's coverage universe, provided that the member establishes a
reasonable plan to liquidate such holdings consistent with the
principles in paragraph (b)(2)(J)(i) and such plan is approved by the
member's legal or compliance department.\46\ This provision is intended
to provide a mechanism by which a firm's analysts can divest their
holdings to comply with a more restrictive personal trading policy
without violating the trading against recommendation provision in
circumstances where an analyst has, for example, a ``buy'' rating on a
subject company.
---------------------------------------------------------------------------

    \43\ See proposed FINRA Rule 2241(b)(2)(J).
    \44\ See proposed FINRA Rule 2241(b)(2)(J)(i).
    \45\ See proposed FINRA Rule 2241(b)(2)(J)(ii).
    \46\ See proposed FINRA Rule 2241.10.
---------------------------------------------------------------------------

    FINRA believes these provisions will provide enhanced investor
protection, while allowing firms to tailor management of conflicts
related to personal trading of subject company securities to their
particular size and business model. The enhanced protection results
from expanding the scope of persons covered by the provisions to
include not only research analyst accounts, but also those of
supervisors and persons with an ability to influence the content of
research reports. The proposal also preserves the key protections of
the current rules by preventing research analysts from trading ahead of
their customers and by generally requiring consistency between personal
trading and recommendations to customers.
Content and Disclosure in Research Reports
    With a couple of modifications, the proposed rule change maintains
the current disclosure requirements. Thus, the proposed rule change
maintains the mandated Sarbanes-Oxley disclosure requirements,\47\ as
well as additional disclosure obligations--meanings and distribution of
ratings and price charts, for example--that are designed to provide
investors with useful information on which to base their investment
decisions. The proposed rule change also maintains the requirement that
disclosures be presented on the front page of the research report or
the front page must refer to the page on which the disclosures are
found. Electronic research reports may provide a hyperlink directly to
the required disclosures. All disclosures and references to required
disclosures must be clear, comprehensive and prominent.\48\
---------------------------------------------------------------------------

    \47\ See Section 501 Sarbanes-Oxley Act, Public Law 107-204, 116
Stat. 745 (2002).
    \48\ See proposed FINRA Rule 2241(c)(6).
---------------------------------------------------------------------------

    The proposed rule change adds a requirement that a member must
establish, maintain and enforce written policies and procedures
reasonably designed to ensure that purported facts in its research
reports are based on reliable information.\49\ FINRA has included this
provision because it believes members should have policies and
procedures to foster verification of facts and trustworthy research on
which investors may rely. The policies and procedures also must be
reasonably designed to ensure that any recommendation or rating has a
reasonable basis in fact and is accompanied by a clear explanation of
any valuation method used and a fair presentation of the risks that may
impede achievement of the recommendation or rating.\50\
---------------------------------------------------------------------------

    \49\ See proposed FINRA Rule 2241(c)(1)(A).
    \50\ See proposed FINRA Rule 2241(c)(1)(B). This is
substantively the same as NASD Rule 2711(h)(7) but in the form of
policies and procedures.
---------------------------------------------------------------------------

    In addition, the proposed rule change would require a member to
disclose in any research report at the time of publication or
distribution of the report: \51\
---------------------------------------------------------------------------

    \51\ See proposed FINRA Rule 2241(c)(4). In comparing the
proposed disclosure provisions to those in NASD Rule 2711, FINRA
notes that in some instances the proposed rule change makes minor
word or grammatical changes, uses streamlined language or has moved
some text to Supplementary Material, but does not intend to change
the substantive disclosure requirements. In those circumstances,
FINRA considers the proposed disclosure provisions to be
``substantively the same'' as the current provisions.
---------------------------------------------------------------------------

     If the research analyst or a member of the research
analyst's household has a financial interest in the debt or equity
securities of the subject company (including, without limitation,
whether it consists of any option, right, warrant, future, long or
short position), and the nature of such interest; \52\
---------------------------------------------------------------------------

    \52\ See proposed FINRA Rule 2241(c)(4)(A). This is
substantively the same as NASD Rule 2711(h)(1).
---------------------------------------------------------------------------

     if the research analyst has received compensation based
upon (among other factors) the member's investment banking revenues;
\53\
---------------------------------------------------------------------------

    \53\ See proposed FINRA Rule 2241(c)(4)(B). This is
substantively the same as NASD Rule 2711(h)(2)(A)(i)a.
---------------------------------------------------------------------------

     if the member or any of its affiliates: (i) Managed or co-
managed a public offering of securities for the subject company in the
past 12 months; (ii) received compensation for investment banking
services from the subject company in the past 12 months; or (iii)
expects to receive or intends to seek compensation for investment
banking services from the subject company in the next three months;
\54\
---------------------------------------------------------------------------

    \54\ See proposed FINRA Rule 2241(c)(4)(C). This is
substantively the same as NASD Rule 2711(h)(2)(A)(ii).
---------------------------------------------------------------------------

     if, as of the end of the month immediately preceding the
date of publication or distribution of a research report (or the end of
the second most recent month if the publication or distribution date is
less than 30 calendar days after the end of the most recent month), the
member or its affiliates have received from the subject company any
compensation for products or services other than investment banking
services in the previous 12 months; \55\
---------------------------------------------------------------------------

    \55\ See proposed FINRA Rule 2241(c)(4)(D). This provision,
together with proposed FINRA Rule 2241.04, is substantively the same
as NASD Rules 2711(h)(2)(A)(iii)a., (iv) and (v).
---------------------------------------------------------------------------

     if the subject company is, or over the 12-month period
preceding the date of publication or distribution of the research
report has been, a client of the member, and if so, the types of
services provided to the issuer. Such services, if applicable, must be
identified as either investment banking services, non-investment
banking services, non-investment banking securities-related services or
non-securities services; \56\
---------------------------------------------------------------------------

    \56\ See proposed FINRA Rule 2241(c)(4)(E). This is
substantively the same as NASD Rule 2711(h)(2)(A)(iii)b.
---------------------------------------------------------------------------

     if the member was making a market in the securities of the
subject company at the time of publication or distribution of the
research report; \57\ and
---------------------------------------------------------------------------

    \57\ See proposed FINRA Rule 2241(c)(4)(G). This is
substantively the same as NASD Rule 2711(h)(8).
---------------------------------------------------------------------------

     if the research analyst received any compensation from the
subject company in the previous 12 months.\58\
---------------------------------------------------------------------------

    \58\ See proposed FINRA Rule 2241(c)(4)(H). This is
substantively the same as NASD Rule 2711(h)(2)(A)(i)b.
---------------------------------------------------------------------------

    The proposal also expands upon the current ``catch all''
disclosure, which mandates disclosure of any other material conflict of
interest of the research analyst or member that the research analyst
knows or has reason to know of at the time of the publication or
distribution of a research report or public appearance.\59\ The
proposed rule change goes beyond the existing provision by requiring
disclosure of material conflicts known not only by the research
analyst, but also by any ``associated person of the member with the
ability to influence the content of a research report.'' \60\ In so
doing, the proposed rule change would capture

material conflicts of interest that, for example, only a supervisor or
the head of research may be aware of. The ``reason to know'' standard
would not impose a duty of inquiry on the research analyst or others
who can influence the content of a research report. Rather, it would
cover disclosure of those conflicts that should reasonably be
discovered by those persons in the ordinary course of discharging their
functions.
---------------------------------------------------------------------------

    \59\ For example, FINRA would consider it to be a material
conflict of interest if the research analyst or a member of the
research analyst's household serves as an officer, director or
advisory board member of the subject company.
    \60\ See proposed FINRA Rule 2241(c)(4)(I).
---------------------------------------------------------------------------

    The proposed rule change also modifies the requirement to disclose
when a member or its affiliates own securities of the subject company
to include any ``significant financial interest in the debt or equity
of the subject company,'' including, at a minimum, beneficial ownership
of 1% or more of any class of common equity securities of the subject
company.\61\ Thus, among other things, the proposal delineates the
obligation to disclose significant debt holdings as a material conflict
of interest that currently is captured by the ``other material conflict
of interest'' provision referenced above. FINRA believes that an equity
research report that analyzes the creditworthiness of the subject
company could impact the price of the company's debt securities, and
therefore a material conflict exists where the member or its affiliates
maintains significant debt holdings in the subject company. The
determination of beneficial ownership would continue to be based upon
the standards used to compute ownership for the purposes of the
reporting requirements under Section 13(d) of the Exchange Act.
---------------------------------------------------------------------------

    \61\ See proposed FINRA Rule 2241(c)(4)(F). The requirement to
disclose beneficial ownership of 1% or more of any class of common
equity securities of the subject company is the same as NASD Rule
2711(h)(1)(B).
---------------------------------------------------------------------------

    The proposal retains the general exception for disclosure that
would reveal material non-public information regarding specific
potential future investment banking transactions of the subject
company.\62\ The proposal also continues to permit a member that
distributes a research report covering six or more companies
(compendium report) to direct the reader in a clear manner as to where
the applicable disclosures can be found. An electronic compendium
research report may hyperlink to the disclosures. A paper compendium
report must include a toll-free number or a postal address where the
reader may request the disclosures. In addition, paper research reports
may include a web address where the disclosures can be found.\63\
---------------------------------------------------------------------------

    \62\ See proposed FINRA Rule 2241(c)(5).
    \63\ See proposed FINRA Rule 2241(c)(7). This is substantively
the same as Rule 2711(h)(11).
---------------------------------------------------------------------------

    As detailed in the Joint Report, FINRA believes that a web-based
disclosure approach would be at least as effective and a more efficient
means to inform investors of conflicts of interests. To that end, FINRA
recommended--and eventually proposed in SR-NASD-2006-113--to permit
members, in lieu of publication in the research report itself, to
disclose their conflicts of interest by including a prominent warning
on the cover of a research report that conflicts of interest exist,
together with information on how the reader may obtain more detail
about these conflicts on the member's Web site. However, FINRA has
subsequently been informed by SEC staff that it believes such a web-
based disclosure approach would not be consistent with the Sarbanes-
Oxley requirement ``to disclose [conflicts of interest] in each
report''; \64\ therefore, FINRA has not re-proposed it here.
---------------------------------------------------------------------------

    \64\ 15 U.S.C 78o-6(b).
---------------------------------------------------------------------------

Disclosures in Public Appearances
    The proposal groups in a separate provision the disclosures
required when a research analyst makes a public appearance.\65\ The
required disclosures remain substantively the same as under the current
rules,\66\ with one exception: Consistent with the modification
referenced above with respect to disclosure in research reports, a
research analyst is similarly required to disclose in a public
appearance if a member or its affiliates maintain a ``significant
financial interest in the debt or equity of the subject company,''
including, at a minimum, if the member or its affiliates beneficially
own 1% or more of any class of common equity securities of the subject
company, as computed in accordance with Section 13(d) of the Exchange
Act. Unlike in research reports, the ``catch all'' disclosure
requirement in public appearances applies only to a conflict of
interest of the research analyst or member that the research analyst
knows or has reason to know at the time of the public appearance and
does not extend to conflicts that an associated person with the ability
to influence the content of a research report or public appearance
knows or has reason to know. The proposed rule change defines a person
with the ``ability to influence the content of a research report'' as
an associated person who, in the ordinary course of that person's
duties, has the authority to review the research report and change that
research report prior to publication or distribution.\67\ FINRA
understands that supervisors typically do not have the opportunity to
review and insist on changes to public appearances, many of which are
extemporaneous in nature. The proposal also retains the current
requirement in NASD Rule 2711(h)(12) to maintain records of public
appearances sufficient to demonstrate compliance by research analysts
with the applicable disclosure requirements.\68\
---------------------------------------------------------------------------

    \65\ See proposed FINRA Rule 2241(d).
    \66\ See NASD Rules 2711(h)(1), (h)(2)(B) and (C), (h)(3) and
(h)(9).
    \67\ See proposed FINRA Rule 2241.08.
    \68\ See proposed FINRA Rule 2241(d)(3).
---------------------------------------------------------------------------

Disclosure Required by Other Provisions
    With respect to both research reports and public appearances,
members and research analysts would continue to be required to comply
with applicable disclosure provisions of FINRA Rule 2210, Incorporated
NYSE Rule 472 and the federal securities laws.\69\
---------------------------------------------------------------------------

    \69\ See proposed FINRA Rule 2241(e). This is substantively the
same as NASD Rule 2711(h)(9).
---------------------------------------------------------------------------

Termination of Coverage
    The proposal retains with non-substantive modifications the
provision in the current rules that requires a member to notify its
customers if it intends to terminate coverage of a subject company.\70\
Such notification must be made promptly \71\ using the member's
ordinary means to disseminate research reports on the subject company
to its various customers. Unless impracticable, the notice must be
accompanied by a final research report, comparable in scope and detail
to prior research reports, and include a final recommendation or
rating. If impracticable to provide a final research report,
recommendation or rating, a firm must disclose to its customers the
reason for terminating coverage. FINRA expects such circumstances to be
exceptional, such as where a research analyst covering a subject
company or sector has left the member or the member has discontinued
coverage of the industry or sector. FINRA believes this provision,
which is consistent with the current rules, has been effective in
achieving its original purpose to prevent firms from dropping coverage
without notice or explanation instead of issuing a negative report on a
current or prospective investment banking client.
---------------------------------------------------------------------------

    \70\ See proposed FINRA Rule 2241(f).
    \71\ While current Rule 2711(f)(6) does not contain the word
``promptly,'' FINRA has interpreted the provision to require prompt
notification of termination of coverage of a subject company.

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

Distribution of Member Research Reports
    The proposal codifies an existing interpretation of FINRA Rule 2010
and provides additional guidance regarding selective--or tiered--
dissemination of a firm's research reports. In that regard, the
proposal requires firms to establish, maintain and enforce written
policies and procedures reasonably designed to ensure that a research
report is not distributed selectively to internal trading personnel or
a particular customer or class of customers in advance of other
customers that the firm has previously determined are entitled to
receive the research report.\72\ The proposal includes further guidance
to explain that firms may provide different research products and
services to different classes of customers, provided the products are
not differentiated based on the timing of receipt of potentially market
moving information and the firm discloses its research dissemination
practices to all customers that receive a research product.\73\
---------------------------------------------------------------------------

    \72\ See proposed FINRA Rule 2241(g).
    \73\ See proposed FINRA Rule 2241.07.
---------------------------------------------------------------------------

    A member, for example, may offer one research product for those
with a long-term investment horizon (``investor research'') and a
different research product for those customers with a short-term
investment horizon (``trading research''). These products may lead to
different recommendations or ratings, provided that each is consistent
with the meaning of the member's ratings system for each respective
product. Thus, for example, a firm may define a ``buy'' rating in
investor research to mean that a stock will outperform the S&P 500 over
the next 12 months. The same firm may define ``sell'' in trading
research to mean a stock will underperform its sector index over the
next month. The firm could maintain a ``buy'' in investor research at
the same time it had a ``sell'' in trading research on the same stock
if the firm believed, for example, that the company would report an
earnings shortfall next week that would lead to a short-term drop in
price relative to the sector index, but that the stock would recover to
outperform the S&P 500 over the next 12 months. However, a member may
not differentiate a research product based on the timing of receipt of
a recommendation, rating or other potentially market moving
information, nor may a member label a research product with
substantially the same content as a different research product as a
means to allow certain customers to trade in advance of other
customers.
    In addition, a member that provides different research products and
services for certain customers must inform its other customers that its
alternative research products and services may reach different
conclusions or recommendations that could impact the price of the
security. Thus, for example, a member that offers trading research must
inform its investment research customers that its trading research
product may contain different recommendations or ratings that could
result in short-term price movements contrary to the recommendation in
its investment research. FINRA understands, however, that customers may
actually receive at different times research reports originally made
available at the same time because of the mode of delivery elected by
the customer eligible to receive such research services (e.g., in paper
form versus electronic). However, members may not design or implement a
distribution system intended to give a timing advantage to some
customers over others. FINRA will read with interest comments as to
whether a member should be required to disclose to its other customers
when an alternative research product or service does, in fact, contain
a recommendation contrary to the research product or service that those
customers receive.
Distribution of Third-Party Research Reports
    The proposal expands upon the third-party research report
distribution requirements in the current rules. The proposal generally
maintains the existing third-party disclosure requirements,\74\ with
one modification. Consistent with the proposed disclosure requirement
discussed above with respect to a member's own research reports, a
distributing member would be required to disclose if the member or its
affiliates maintain a significant financial interest in the debt or
equity securities of the subject company, including, at a minimum, if
the member or its affiliates beneficially own 1% or more of any class
of common equity securities of the subject company. The proposed rule
change also would require members to disclose any other material
conflict of interest that can reasonably be expected to have influenced
the member's choice of a third-party research provider or the subject
company of a third-party research report.\75\ FINRA believes that it is
important that readers be made aware of any conflicts of interest
present that may have influenced either the selection or content of
research disseminated to investors. As is the case in the existing
Rules, the proposal requires that a member establish, maintain and
enforce written policies and procedures reasonably designed to ensure
the completeness and accuracy of all of the applicable disclosures to
any third-party research it distributes.
---------------------------------------------------------------------------

    \74\ NASD Rule 2711(h)(13)(A) currently requires the
distributing member firm to disclose the following, if applicable:
(1) If the member owns 1% or more of any class of equity securities
of the subject company; (2) if the member or any affiliate has
managed or co-managed a public offering of securities of the subject
company or received compensation for investment banking services
from the subject company in the past 12 months, or expects to
receive or intends to seek compensation for such services in the
next three months; (3) if the member makes a market in the subject
company's securities; and (4) any other actual, material conflict of
interest of the research analyst or member of which the research
analyst knows or has reason to know at the time the research report
is distributed or made available.
    \75\ See proposed FINRA Rule 2241(h)(4).
---------------------------------------------------------------------------

    In addition, the proposal continues to address qualitative aspects
of third-party research reports. For example, the proposal maintains,
but in the form of policies and procedures, the existing requirement
that a registered principal or supervisory analyst review and approve
third-party research reports distributed by a member. To that end, the
proposed rule change requires a member to establish, maintain and
enforce written policies and procedures reasonably designed to ensure
that any third-party research it contains no untrue statement of
material fact and is otherwise not false or misleading. For the purpose
of this requirement, a member's obligation to review a third-party
research report extends to any untrue statement of material fact or any
false or misleading information that should be known from reading the
research report or is known based on information otherwise possessed by
the member.\76\ The proposal further prohibits a member from
distributing third-party research if it knows or has reason to know
that such research is not objective or reliable.\77\ FINRA believes
that, where a member is distributing or ``pushing-out'' third-party
research, the member must have policies and procedures to vet the
quality of the research producers. A member would satisfy the standard
based on its actual knowledge and reasonable diligence; however, there
would be no duty of inquiry to definitively establish that the third-
party research is, in fact, objective and reliable.
---------------------------------------------------------------------------

    \76\ See proposed FINRA Rules 2241(h)(1) and (h)(3).
    \77\ See proposed FINRA Rule 2241(h)(2).
---------------------------------------------------------------------------

    The proposal maintains the existing exceptions for ``independent
third-party research reports.'' Specifically, such

research does not require principal pre-approval or, where the third-
party research is not ``pushed out,'' the third-party disclosures.\78\
As to the latter, a member will not be considered to have distributed
independent third-party research where the research is made available
by the member: (a) Upon request; (b) through a member-maintained Web
site; or (c) to a customer in connection with a solicited order in
which the registered representative has informed the customer, during
the solicitation, of the availability of independent research on the
solicited equity security and the customer requests such independent
research.
---------------------------------------------------------------------------

    \78\ See proposed FINRA Rule 2241(h)(5) and (6).
---------------------------------------------------------------------------

    Finally, under the proposal, members also must ensure that a third-
party research report is clearly labeled as such and that there is no
confusion on the part of the recipient as to the person or entity that
prepared the research report.\79\ This requirement codifies guidance
provided in Notice to Members 04-18.
---------------------------------------------------------------------------

    \79\ See proposed FINRA Rule 2241(h)(7).
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Exemption for Firms With Limited Investment Banking Activity
    The current rule exempts firms with limited investment banking
activity--those that over the previous three years, on average per
year, have managed or co-managed 10 or fewer investment banking
transactions and generated $5 million or less in gross revenues from
those transactions--from the provisions that prohibit a research
analyst from being subject to the supervision or control of an
investment banking department employee because the potential conflicts
with investment banking are minimal.\80\ However, those firms remain
subject to the provision that requires the compensation of a research
analyst to be reviewed and approved annually by a committee that
reports to a member's board of directors, or a senior executive officer
if the member has no board of directors.\81\ That provision further
prohibits representation on the committee by investment banking
department personnel and requires the committee to consider the
following factors when reviewing a research analyst's compensation: (1)
The research analyst's individual performance, including the research
analyst's productivity and the quality of research; (2) the correlation
between the research analyst's recommendations and the performance of
the recommended securities; and (3) the overall ratings received from
clients, the sales force and peers independent of investment banking,
and other independent ratings services.\82\ Thus, the current exemption
provides limited relief with respect to research analyst compensation
determination, even where it is permissible for an investment banker to
supervise and control a research analyst. FINRA believes it follows
logically to allow those who supervise research analysts under such
circumstances also to be involved in all aspects of the evaluation and
determination of those analysts' compensation. Therefore, the proposed
rule change extends the exemption for firms with limited investment
banking activity so that such firms would not be subject to the
compensation committee provision. FINRA notes that the proposal still
prohibits these firms from compensating a research analyst based upon
specific investment banking services transactions or contributions to a
member's investment banking services activities.\83\
---------------------------------------------------------------------------

    \80\ See NASD Rule 2711(k).
    \81\ See NASD Rule 2711(d)(2).
    \82\ See NASD Rule 2711(d) and (k).
    \83\ See proposed FINRA Rules 2241(b)(2)(E) and (i).
---------------------------------------------------------------------------

    The proposed rule change further exempts firms with limited
investment banking activity from the provisions restricting or limiting
research coverage decisions and budget determination. While these two
provisions are not in the current rules, as noted above, FINRA
interprets NASD Rule 2711(b) to prohibit investment banking from making
any final coverage decisions or determination of research budget. As
such, the current exemption in NASD Rule 2711(k) effectively covers
these two new provisions and so the proposal does not represent a
substantive change. In addition, the proposal exempts eligible firms
from the requirement to establish information barriers or other
institutional safeguards to insulate research analysts from the review
or oversight by investment banking personnel or other persons,
including sales and trading personnel, who may be biased in their
judgment or supervision. However, those firms still are required to
establish, maintain and enforce written policies and procedures
reasonably designed to ensure that research analysts are insulated from
pressure by investment banking and other non-research personnel who
might be biased in their judgment or supervision. FINRA believes that
even where research analysts need not be structurally separated from
investment banking or other non-research personnel, they should not be
subject to pressures that could compromise their independence and
objectivity.
    FINRA reviewed and analyzed deal data for calendar years 2009
through 2011 to determine whether any adjustments should be made to
these exemption standards. The review targeted firms that either
managed or co-managed deals and earned underwriting revenues from those
transactions during the review period. The analysis found that 155 of
317 such firms--or 49%--would have been eligible for the exemption. The
data further suggested that incremental upward adjustments to the
exemption thresholds would not result in a significant number of
additional firms eligible for the exemption. For example, increasing
both of the thresholds by 33% (to 40 transactions managed or co-managed
and $20 million in gross revenues over a three-year period) would
result in 18 additional exempted firms. As such, FINRA believes the
current exemption produces a reasonable and appropriate universe of
exempted firms.
Exemption From Registration Requirements for Certain ``Research
Analysts''
    As recommended in the Joint Report, the proposed rule change amends
the definition of ``research analyst'' for the purposes of the
registration and qualification requirements to limit the scope to
persons who produce ``research reports'' and whose primary job function
is to provide investment research (e.g. registered representatives or
traders generally would not be included).\84\ The revised definition is
not intended to carve out anyone for whom the preparation of research
is a significant component of their job; rather, it is intended to
provide relief for those who produce research reports on an occasional
basis. The existing research rules, in accordance with the Sarbanes-
Oxley mandates, are constructed such that the author of a communication
that meets the definition of a ``research report'' is a ``research
analyst,'' irrespective of his or her title or primary job. FINRA
believes that the registration and qualification requirements, which
are not mandated by Sarbanes-Oxley, were intended for those individuals
whose principal job function is to produce research, while the balance
of the research rules are intended to foster objective analysis,
transparency of certain conflicts and to provide beneficial information
to investors. As such, the proposed exemption would extend only to the

registration requirements, while all other obligations applicable to
the production and distribution of research reports would remain.
---------------------------------------------------------------------------

    \84\ See proposed NASD Rule 1050(b) and proposed Incorporated
NYSE Rule 344.10.
---------------------------------------------------------------------------

Attestation Requirement
    The proposal deletes the requirement to attest annually that the
firm has in place written supervisory policies and procedures
reasonably designed to achieve compliance with the applicable
provisions of the rules, including the compensation committee review
provision. FINRA notes that firms already are obligated pursuant to
NASD Rule 3010 (Supervision) to have a supervisory system reasonably
designed to achieve compliance with all applicable securities laws and
regulations and FINRA rules. Moreover, the research rules also are
subject to the supervisory control rules (NASD Rule 3012) and the
annual certification requirement regarding compliance and supervisory
processes (FINRA Rule 3130).\85\ As such, FINRA believes a separate
attestation requirement for the research rules is unnecessary.
---------------------------------------------------------------------------

    \85\ NASD Rules 3010 and 3012 have been adopted with changes as
consolidated FINRA rules. The new rules become effective December 1,
2014. See supra note 20.
---------------------------------------------------------------------------

Obligations of Persons Associated With a Member
    Supplementary Material .09 clarifies the obligations of each
associated person under those provisions of the proposed rule change
that require a member to restrict or prohibit certain conduct by
establishing, maintaining and enforcing particular written policies and
procedures. Specifically, the rule provides that, consistent with FINRA
Rule 0140, persons associated with a member must comply with such
member's policies and procedures as established pursuant to proposed
FINRA Rule 2241.\86\ Failure of an associated person to comply with
such policies and procedures shall constitute a violation of the rule
itself. In addition, consistent with Rule 0140, the rule states that it
shall be a rule violation for an associated person to engage in the
restricted or prohibited conduct to be addressed through the
establishment, maintenance and enforcement of policies and procedures
required by provisions of Rule 2241, including applicable Supplementary
Material, that embed in the policies and procedures specific
obligations on individuals. This Supplementary Material reflects
FINRA's position that associated persons can be held liable for
engaging in conduct that is proscribed by the member under FINRA rules.
FINRA is clarifying this point in the Supplementary Material because
the proposed rule change would adopt a policies and procedures approach
to restricted and prohibited conduct with respect to research in place
of specific proscriptions in the current rules.
---------------------------------------------------------------------------

    \86\ See proposed FINRA Rule 2241.09. FINRA Rule 0140(a), among
other things, provides that persons associated with a member shall
have the same duties and obligations as a member under the Rules.
---------------------------------------------------------------------------

    Thus, for example, where the proposed rule requires a member to
establish policies and procedures to prohibit research analyst
participation in road shows, associated persons also are directly
prohibited from engaging in such conduct, even where a member has
failed to establish policies and procedures. FINRA believes that it is
incumbent upon each associated person to familiarize themselves with
the regulatory requirements applicable to his or her business and
should not be able to avoid responsibility where minimum standards of
conduct have been established for members.
General Exemptive Authority
    The proposed rule change would provide FINRA, pursuant to the Rule
9600 Series, with authority to conditionally or unconditionally grant,
in exceptional and unusual circumstances, an exemption from any
requirement of the proposed rule for good cause shown, after taking
into account all relevant factors and provided that such exemption is
consistent with the purposes of the rule, the protection of investors,
and the public interest.\87\ Given the scope of the rule's subject
matter and the diversity of firm sizes, structures and research
business and distribution models, FINRA believes it would be useful and
appropriate to have the ability to provide relief from a particular
provision of the proposed rules under specific factual circumstances.
---------------------------------------------------------------------------

    \87\ See proposed FINRA Rule 2241(j).
---------------------------------------------------------------------------

    FINRA will announce the effective date of the proposed rule change
in a Regulatory Notice to be published no later than 60 days following
Commission approval. The effective date will be no later than 180 days
following publication of the Regulatory Notice announcing Commission
approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\88\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade and, in general, to protect investors and the
public interest. FINRA believes the proposed rule change protects
investors and the public interest by maintaining, and in some cases
expanding, structural safeguards to insulate research analysts from
influences and pressures that could compromise the objectivity of
research reports and public appearances on which investors rely to make
investment decisions. FINRA further believes that the proposed rule
change prevents fraudulent and manipulative acts and practices by
requiring firms to identify and manage, often with extensive
disclosure, conflicts of interest related to the preparation, content
and distribution of research. At the same time, the proposal furthers
the public interest by increasing information flow to investors in
select circumstances--e.g., before and after the expiration of lock up
provisions--where FINRA believes the integrity of research will not be
compromised.
---------------------------------------------------------------------------

    \88\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    Moreover, the proposed rule change is consistent with Section 15D
of the Act,\89\ which requires rules reasonably designed to address
conflicts of interest that can arise when research analysts recommend
equity securities in research reports and public appearances. The
proposed rule change requires firms to establish, maintain and enforce
written policies and procedures reasonably designed to achieve
compliance with the provisions of Section 15D, including: Restricting
prepublication clearance or approval of research reports by investment
banking personnel or other persons not directly responsible for the
preparation, content and distribution of research reports; prohibiting
persons engaged in investment banking activities from supervision or
control of research analysts, including influence or control over
research analyst compensation evaluation and determination; prohibiting
retaliation or threat of retaliation against research analysts for
research or public appearances that are unfavorable to the member's
business interests; establishing quiet periods after public offerings
during which members that have participated in the offering may not
publish or otherwise distribute research; and establishing structural
or institutional safeguards to protect analysts from the review,
pressure or oversight of investment bankers or other non-research
personnel that might be biased in their judgment or supervision. In
addition, the proposed rule change

requires disclosures consistent with Section 15D, including the
requirement to disclose any material conflict of interest of the
research analyst or member that the research analyst knows or has
reason to know at the time of publication or distribution of a research
report or during a public appearance.
---------------------------------------------------------------------------

    \89\ 15 U.S.C. 78o-6.
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act. The proposed rule change
primarily reorganizes and restructures the current research rules,
while maintaining the core provisions that have generally proven
effective to promote objective and reliable research, as detailed
through academic studies and other observations in the Joint Report and
the GAO Report.\90\ The GAO Report, for example, concluded that
empirical results suggest the rules have resulted in increased analyst
independence and weakened the influence of conflicts of interest on
analyst recommendations.\91\ The proposed rule change also amends the
current rules to ensure the objectives of independent research analysts
and unbiased research are achieved in the most effective manner.
---------------------------------------------------------------------------

    \90\ See Joint Report, supra note 6 at 16-26; see GAO Report,
supra note 7 at 12-23.
    \91\ See GAO Report, supra note 7 at 12-15.
---------------------------------------------------------------------------

    In some places, the proposed rule change reduces regulatory
uncertainty around the applicability of current rules. For example, the
new provision regarding distribution of member research clarifies an
existing interpretation prohibiting selective dissemination of research
and provides guidance as to how members may differentiate research
products to customers. In other places, the proposed rule change
extends existing protections and adds new protections to fill gaps in
the rules. Thus, the proposed rule change requires members to
proactively identify and mitigate emerging conflicts related to the
production and distribution of research, as members are best situated
to spot such conflicts that may arise based on their particular
business models or structures. As another example, the proposed rule
change also extends the obligation to disclose material conflicts to
associated persons with the ability to influence the content of a
research report. This provision would close a gap that exists whereby
persons who oversee research and research analysts could influence the
recommendation or conclusions in a research report without disclosing
their own material conflicts of interest or those of the member of
which only they, and not the research analyst, know or have reason to
know.
    The new rules would impose burdens primarily arising from
establishing, maintaining and enforcing new written policies and
procedures to comply with the rule change, as well as a few new
disclosures to customers to the extent a member's research activities
require them. FINRA believes the additional burdens associated with
these new provisions are minimal, but necessary to ensure the
protections of the rules cannot be frustrated. At the same time, the
proposed rule change provides increased flexibility for members to
create compliance programs more closely tailored to their businesses
and organizational structures, without diminishing investor protection.
For example, as detailed in Item 3 of this filing, the proposed rule
change replaces the many current prescriptive requirements with respect
to personal trading by research analyst accounts with a more flexible
approach that requires policies and procedures to ensure that such
accounts do not benefit in their trading from knowledge of the content
and timing of research before the intended recipients have a reasonable
opportunity to act on the information. FINRA believes this proposed
change will maintain the current protection against a research analyst
putting his or her own financial interests ahead of the analyst's
customers' interest, but the increased flexibility will reduce costs
and create fewer impediments to competition.
    The proposed rule change also promotes capital formation and
lessens compliance costs for firms by eliminating or reducing quiet
periods during which research cannot be published or otherwise
disseminated. FINRA further analyzed deal data to confirm that the
parameters for the exemption for firms with limited investment banking
activity remain appropriate and extended the exemption to include
compensation determination provisions, thereby relieving eligible firms
from an appreciable burden. The proposed rule change also lessens costs
by creating a new limited exemption from the registration requirements
for ``research reports'' produced by persons whose primary job function
is something other than producing research and by eliminating the
annual attestation requirement.
    To help assess and minimize any burden on competition resulting
from the proposal, FINRA consulted with several of its advisory
committees and other industry members to solicit suggested changes to
the existing rules and to obtain feedback on FINRA's proposed changes.
Finally, as set forth in Item 5 of this filing, FINRA carefully
considered comments to an earlier version of the proposed rule change
and made several changes in response to those comments.

C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others

    FINRA solicited comments on an earlier iteration of the proposed
rule change in Regulatory Notice 08-55 (``Notice Proposal''). The
comment deadline expired on November 14, 2008. FINRA received five
responses to the Notice Proposal.\92\ Commenters expressed support for
many aspects of the proposal, including reductions to the quiet period
provisions, the exemption for members with limited investment banking
activity and the more flexible supervisory approach with respect to
research analyst account trading. SIFMA further expressed appreciation
for the guidance with respect to selective dissemination of research
products. Commenters nevertheless urged several modifications to the
proposal, some of which have been incorporated into the proposed rule
change. FINRA responds to the material comments to the Notice Proposal
below.
---------------------------------------------------------------------------

    \92\ Letter from Daniel H. Kolber, to Marcia E. Asquith,
Corporate Secretary, FINRA, dated November 10, 2008 (``Kolber'');
letter from John I. Fitzgerald, Leerink Swann LLC, to Marcia E.
Asquith, Corporate Secretary, FINRA, dated November 10, 2008
(``Leerink''); letter from Goodwin Procter LLP, to Marcia E.
Asquith, Corporate Secretary, FINRA, dated November 11, 2008
(``NVCA''); letter from Elliot R. Curzon, Dechert LLP, to Marcia E.
Asquith, Corporate Secretary, FINRA, dated November 14, 2008
(``Dechert''); and letter from Amal Aly, Managing Director and
Associate General Counsel, Securities Industry and Financial Markets
Association, to Marcia E. Asquith, Corporate Secretary, FINRA, dated
November 14, 2008 (``SIFMA'').
---------------------------------------------------------------------------

Policies and Procedures
    Both the Notice Proposal and the proposed rule change differ in
several respects from current NASD Rule 2711, perhaps most notably in
adopting a policies and procedures approach to identification and
management of equity research-related conflicts. FINRA has reintroduced
several current provisions to the proposed rule change to clarify
certain minimum standards and disclosure requirements. However, FINRA
notes that the proposed rule change also establishes new standards of
conduct. FINRA will provide

guidance, where appropriate, as to the application of the new
standards. FINRA cautions that members should not conclude that, where
specific conduct prohibitions or disclosure requirements that exist in
the current provisions have not been expressly included in the proposed
rule change, such conduct is now permissible or such disclosures are no
longer required. Firms must apply the new proposed standards to make
those determinations. FINRA notes that some of the new standards are
intended to require thoughtful compliance by members that may require
them to adapt and change their policies and procedures as they gain
experience and encounter new circumstances that may impact on the
objectivity and reliability of research.
    SIFMA endorsed the principle in the Notice Proposal and proposed
rule change that members must implement policies and procedures
reasonably designed to identify and effectively manage conflicts of
interest related to the preparation, content and distribution of
research reports and public appearances by research analysts. Yet SIFMA
found ambiguous and overbroad the companion principle that such
policies and procedures should promote ``reliable'' research that
reflects the ``truly held opinions'' of research analysts and prevent
the use of research to ``manipulate or condition the market'' or
``favor the interests of the member or certain current or prospective
clients.'' SIFMA asked FINRA to delete this introductory sentence and
substitute the following alternative: ``a member's policies and
procedures must be reasonably designed to promote independent and
objective research that reflects the personal views of the analyst.''
Among other things, SIFMA asserted that the concept of ``reliable''
research is new and undefined.
    FINRA believes that the term ``reliable'' is commonly understood.
FINRA further believes that the other terms referenced above and cited
by SIFMA as vague are similarly unambiguous in describing the conduct
that a member's policies and procedures must address or guard against.
SIFMA made similar comments with respect to the words ``reliable
information'' in the content and disclosure requirements of the Notice
Proposal. As discussed below in response to that comment, that term is
used in Sarbanes-Oxley without definition.
    SIFMA requested that FINRA confirm that with respect to the
proposed prohibitions on analyst compensation, consistent with current
rules, the proposal would not prevent a member from compensating
analysts for engaging in permissible vetting, commitment committee
participation, due diligence, teach-ins, investor education, and other
permissible banking-related activities. SIFMA also recommended that the
proposal be amended so that compensation committees are required to
consider the enumerated factors when reviewing a research analyst's
compensation only to the extent they are applicable. SIFMA suggested
adding two new factors that are permissible for members to consider in
determining analyst compensation, including the analyst's seniority and
experience, and the market for hiring and retention of analysts, noting
that these factors are critical to the proper determination of analyst
compensation and are specifically identified in the Global Settlement.
    The proposal prohibits compensation based upon specific investment
banking transactions or contributions to a member's investment banking
services activities. It also requires the compensation review committee
to consider the research analyst's productivity and quality of
research. Both of these standards exist in the current rules. As SIFMA
noted, FINRA staff previously stated that ``screening potential
investment banking clients is one of many factors to measure the
quality of an analyst's research.'' \93\ As such, FINRA concluded that
the activity could be considered in determining a research analyst's
compensation but ``may not be given undue weight relative to evaluating
the quality of other research work product.'' FINRA further cautioned,
however, that ``the size of any resultant or excluded investment
banking deals should be irrelevant in assessing the quality of
research.'' \94\ The same guidance applies to the compensation
provisions in the proposed rule change. FINRA considers commitment
committee participation to be part of the vetting process and further
views permissible due diligence and education of the sales force and
investors as other legitimate factors to consider in measuring the
productivity and quality of research, with the same caveats previously
articulated regarding undue weight and the size of related investment
banking services transactions. FINRA has amended the proposed rule text
to clarify that the enumerated factors must be considered only to the
extent applicable. The proposed rule change does not preclude
consideration of additional factors, including the analyst's experience
and market factors. The proposed rule change only sets out requirements
and prohibitions with respect to compensation, and therefore FINRA has
not included in the rule text the suggested permissible factors.
---------------------------------------------------------------------------

    \93\ See Letter from Philip A. Shaikun, Associate General
Counsel, NASD, to James A. Brigagliano, Assistant Director, Division
of Market Regulation, SEC, dated July 29, 2003, at page 8.
    \94\ Id.
---------------------------------------------------------------------------

    SIFMA stated its support for ``the general principle that members
should implement policies and procedures reasonably designed to prevent
market manipulation or front running of research.'' However, SIFMA
questioned the necessity of FINRA's language in proposed Rule
2241(b)(2) that would require a firm's policies and procedures to be
reasonably designed to prevent the use of research reports or research
analysts to ``manipulate or condition the market or favor the interests
of the member or certain current or prospective clients.'' According to
SIFMA, that principle is already codified in existing SEC anti-
manipulation rules and FINRA's front running prohibition in FINRA Rule
5270. Even if true, FINRA believes it is entirely appropriate to
include that important principle as it relates to research reports and
research analysts in a rule that is dedicated to research conflicts of
interest and the conduct of research analysts. Moreover, FINRA notes
that the proscribed conduct in its proposal is not congruent with
either the SEC anti-manipulation or FINRA front running rules.
    The Notice Proposal required members to ``establish information
barriers and other institutional safeguards to ensure that research
analysts are insulated from the review, pressure or oversight of
persons engaged in investment banking services activities or other
persons who might be biased in their judgment or supervision.'' SIFMA
suggested that members should be able to establish information barriers
or other institutional safeguards to foster the required research
analyst objectivity, since some information barriers are not always the
most appropriate or efficient means to manage research conflicts. FINRA
agrees and has amended the proposed rule change accordingly.
    SIFMA further urged FINRA to replace the phrase ``persons who might
be biased in their judgment or supervision'' with ``persons within the
firm who may try to improperly influence analysts' views'' because
SIFMA contended that the former might sweep in salespeople, traders or
subject companies that could have biases. FINRA notes that the proposed
rule text came directly from the provisions of Sarbanes-Oxley related
to management of research conflicts. FINRA believes

that language is intended to apply only to persons within the firm and
does not extend to subject companies, which have no oversight or
supervisory role with respect to research analysts within a broker-
dealer. Moreover, FINRA believes it's appropriate for this conflict
management provision to include salespeople or traders to the extent
that a member employs such individuals in an oversight or supervisory
capacity and has reason to know that some or all of those individuals
might be biased in discharging those obligations. As such, FINRA has
maintained the provision in the proposed rule change.
    The Notice Proposal required members to prevent direct or indirect
retaliation or threat of retaliation against research analysts by
persons engaged in investment banking or other employees as the result
of content of a research report. The proposed rule change maintains
this requirement, but substitutes ``prohibit'' for ``prevent'' to align
with the current rule language. SIFMA stated that the proposed
provision is too broad because it applies to all employees, not just
those involved in the investment banking department, and recommended
that FINRA retain the current anti-retaliation provision in NASD Rule
2711(j). FINRA disagrees. As stated in the Joint Report, FINRA believes
that under no circumstances is retaliation appropriate against a
research analyst who expresses his or her truly held beliefs about a
subject company. To the extent a person outside the investment banking
department is in a position to retaliate or threaten to retaliate
against a research analyst--e.g., if the person is the chief executive
officer, supervises the research analyst or is a member of the
compensation review committee--FINRA believes the ban should cover
them.
    The Notice Proposal provided a more flexible supervisory approach
with respect to trading by analyst accounts in securities of companies
covered by the research analyst. SIFMA supported the proposed approach
but asked FINRA to confirm that if members have adopted internal
policies prohibiting analysts from owning securities issued by
companies the analyst covers, members may permit an analyst to divest
any such holdings pursuant to a reasonable plan of liquidation within
120 days of the effective date of the member's policy even if the sale
is inconsistent with the analyst's current recommendation.
    In response, FINRA has included in the proposed rule change
Supplementary Material .10, which states that FINRA shall not consider
a research analyst account to have traded in a manner inconsistent with
a research analyst's recommendation where a member has instituted a
policy that prohibits any research analyst from holding securities, or
options on or derivatives of such securities, of the companies in the
analyst's coverage universe, provided that the member establishes a
reasonable plan to liquidate such holdings consistent with the
principles that prohibit an analyst from benefitting from his or her
personal trading based on the knowledge of the timing or content of a
research report and that such plan is approved by the member's legal or
compliance department.
    The Notice Proposal required members to establish, maintain and
enforce policies and procedures that prohibit participation by research
analysts in ``road shows and other marketing on behalf of issuers.''
SIFMA asked FINRA to clarify that the proscription does not apply to
``investor education activities'' and further is limited only to
activities in connection with investment banking services transactions.
By way of example, SIFMA suggested that the proposal would prohibit the
practice by research analysts to facilitate meetings between investors
and company management--so-called ``non-deal road shows.'' Leerink also
questioned the scope of the provision and requested clarification with
respect to whether the proposed language intends to eliminate the
condition in Rule 2711 that the prohibition relate to the analyst's
participation in the marketing of a specific investment banking
services transaction and, instead, would prohibit all participation in
marketing by research analysts whether or not related to investment
banking services. Leerink noted that not every contact with a company
should be viewed as marketing the investment banking services of the
analyst's firm or jeopardizing the analyst's objectivity. Leerink
further noted that it would deprive analysts of important information
necessary for their role if they are prohibited from contacts with an
issuer in circumstances where the issuer may be marketing itself,
including attendance by a research analyst at a research conference or
investor forum. SIFMA also requested that FINRA confirm that consistent
with existing guidance (NASD Notice to Members 07-04 and NYSE
Information Memo 07-11) analysts may listen to or view a live webcast
of a transaction-related road show or other widely attended
presentation by investment banking to investors or the sales force from
a remote location, or another room if they are in the same location.
    FINRA agrees that research analysts should be able to educate
investors, provided such education occurs outside the presence of
investment bankers and issuer management and any such presentations are
done in a fair and balanced manner. The proposed rule change therefore
contains Supplementary Material .03 setting forth such permissible
conduct, thus maintaining the current standard.
    As discussed in the Purpose section, FINRA believes the primary
role of research analysts is to function as unbiased intermediaries
between issuers and the investors who buy the issuers' securities.
FINRA believes marketing by research analysts on behalf of issuers is
antithetical to promoting objective research on such issuers'
securities. FINRA is primarily concerned with marketing by research
analysts in connection with an investment banking services transaction,
and therefore FINRA has added that clarification to the provision in
the proposed rule change.
    FINRA notes, however, that the overarching requirement to have
policies and procedures to manage conflicts related to the interaction
between research analysts and, among others, subject companies would
apply to other marketing activity on behalf of an issuer. FINRA does
not believe that merely facilitating a meeting between issuer
management and investors, absent other facts, would constitute
marketing on behalf of the issuer. Similarly, to Leerink's question,
FINRA does not believe that mere attendance by a research analyst at a
conference or forum where an issuer makes a presentation about its
business prospects constitutes marketing ``on behalf of an issuer.''
Nor would FINRA consider it marketing on behalf on an issuer for a
member to sponsor such a conference or forum and permit its research
analysts to attend or facilitate discussion. FINRA believes that there
is a fundamental distinction between an issuer that markets itself and
a research analyst who markets on behalf of the issuer. It is the
latter conduct that FINRA believes creates a conflict for a research
analyst that must be prohibited or otherwise managed.
    As noted in the Purpose section, the existing guidance in Notice to
Members 07-04 would continue to apply to research analyst participation
in road shows. Therefore, a research analyst would be able to listen to
or view a live webcast of a transaction-related road show or other
widely attended presentation by investment banking to

investors or the sales force from a remote location, or another room if
they are in the same location.
Distribution of Member Research Reports
    Leerink sought clarification regarding the scope of proposed Rule
2241(g) in the Notice Proposal, a codification of an interpretation to
then NASD Rule 2110 \95\ that prohibits selective dissemination of a
research report to internal trading personnel or a particular customer
or class of customers in advance of other customers that are entitled
to receive the report. Leerink questioned whether the proposed
Supplementary Material regarding that provision would extend the
prohibition beyond research reports to other services because it refers
to ``research products and services'' and is not limited to ``research
reports.'' Leerink requested clarification as to how FINRA would define
``research products and services'' and whether it would prohibit more
generally favoring one type of client over another. The proposed
Supplementary Material requires a member that provides different
research products and services to different customers to notify the
other customers that its alternative research products and services may
reach different conclusions or recommendations that could impact the
price of the equity security. Leerink also asked whether there should
be a carve out from the notification provision for institutional
clients, and, if not, whether an oral notification would be sufficient,
given the nature of firms' relationships with institutional clients.
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    \95\ FINRA has since adopted NASD Rule 2110 as FINRA Rule 2010
without change. See Securities Exchange Act Release No. 58643
(September 25, 2008), 73 FR 57174 (October 1, 2008) (Order Approving
File No. SR-FINRA-2008-028).
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    FINRA first notes that Leerink mistakenly believed that FINRA was
proposing to modify its prohibition regarding trading ahead of research
reports found in then NASD IM-2110-4. In fact, that Interpretive
Material referred to similar but distinct conduct regarding adjusting a
member's inventory based upon non-public information regarding the
timing or content of an impending research report. The Commission has
since approved FINRA Rule 5280, which transferred NASD IM-2110-4 into
the Consolidated FINRA Rulebook with changes.\96\ The proposed rule
change incorporates the aspect in FINRA Rule 5280 that the content of a
research report may not be provided to internal trading personnel prior
to public dissemination, but goes beyond that more narrow focus to
address dissemination of a research report to one or more customers
prior to other customers that the firm has previously determined are
entitled to that report. The provision and accompanying Supplementary
Material in the proposed rule change are limited by their terms to the
dissemination of research products and services and do not address the
broader question of when a member may not favor one client over
another. FINRA included research ``products and services'' because
FINRA understands that some customers receive not only different types
of research reports than other customers, but also might receive other
additional services related to research, such as more opportunity to
interact directly with a research analyst. The Supplementary Material
explains that offering those different services are permissible,
provided they do not include differential timing in the receipt of
potentially market moving information, including oral dissemination.
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    \96\ See Securities Exchange Act Release No. 59254 (January 15,
2009), 74 FR 4271 (January 23, 2009) (Order Approving File No. SR-
FINRA-2008-054).
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    FINRA believes that the notification requirement in the
Supplementary Material should apply to all customers that receive a
research product or service from the member if the member provides
different research products to different customers. FINRA notes that,
consistent with Sarbanes-Oxley, the other provisions of the current and
proposed rules do not differentiate between retail and institutional
customers and further notes that not all institutional customers have
the sophistication and experience to know without disclosure the nature
and impact of differing research products and services. However, FINRA
believes firms may put in place any reasonably designed notification
process, provided they can evidence compliance with the requirement.
Quiet Periods
    SIFMA, Leerink and NVCA generally supported the provisions in the
Notice Proposal that would reduce the quiet period after IPOs for
managers and co-managers from 40 days to 10 days, eliminate the quiet
period after secondary offerings and eliminate the quiet periods around
the waiver, expiration or termination of a lock-up agreement. These
commenters believed that the Notice Proposal struck an appropriate
balance between addressing conflicts and facilitating the flow of
important information to investors. NVCA agreed with FINRA that other
provisions of the Notice Proposal, together with SEC Regulation AC,
would sufficiently maintain the integrity of research issued during
what are now quiet periods.\97\ The proposed rule change maintains
these provisions, except that it imposes a minimum three-day quiet
period after a secondary offering, unless an exception applies. FINRA
made this change because SEC staff determined that Sarbanes-Oxley
mandates a minimum quiet period for underwriters after a secondary
offering. FINRA believes the proposed three-day period will fairly
effectuate that mandate while minimizing the effect on information
flow.
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    \97\ The remainder of the NVCA letter addressed more general
matters concerning the strength and competitiveness of the U.S. IPO
market that were not specifically directed at the FINRA proposal.
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Content and Disclosure in Research Reports
    With a couple of modifications, the Notice Proposal and the
proposed rule change maintain the current content and disclosure
requirements. The proposed rule change adds a requirement that a member
must establish, maintain and enforce written policies and procedures
reasonably designed to ensure that purported facts in its research
reports are based on reliable information. The proposed rule change
maintains the mandated Sarbanes-Oxley disclosure requirements,\98\ as
well as additional disclosure obligations--meanings and distribution of
ratings and price charts, for example--that are designed to provide
investors with useful information on which to base their investment
decisions.
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    \98\ See Section 501 Sarbanes-Oxley Act, Public Law 107-204, 116
Stat. 745 (2002).
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