covered investment fund research report under proposed rule 139b would
be deemed not to constitute an offer for purposes of sections 2(a)(10)
and 5(c) of the Securities Act, a covered investment fund research
report would no longer need to be deemed to be a section 10(b)
prospectus (such as an advertising prospectus under rule 482) for
purposes of section 5(b)(1) of the Securities Act. In addition, some
communications that previously were considered supplemental sales
literature that must be accompanied or preceded by a statutory
prospectus under rule 34b-1 under the Investment Company Act now could
be considered covered investment fund research reports (which need not
be preceded or accompanied by a statutory prospectus).\144\ Rule 34b-1
incorporates many of the rule 482 requirements relating to performance
disclosure and makes these requirements applicable to supplemental
sales literature.\145\ We are concerned that this shift in regulatory
treatment of research reports about registered investment companies
could result in investor confusion if a communication were not easily
recognizable as research as opposed to an advertising prospectus or
supplemental sales literature. Although there are multiple provisions
in proposed rule 139b that aim to limit the risk that broker-dealers
could use the proposed safe harbor to circumvent the prospectus
requirements of the Securities Act,\146\ there could be circumstances
where, under the proposed rule, broker-dealers could publish or
distribute communications that historically have been viewed as
registered investment company advertisements or selling materials.
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    \141\ See supra note 102 and accompanying text.
    \142\ See rule 482(d)(1)-(4) (for open-end investment companies
other than money market funds) and rule 482(e) (for money market
funds).
    \143\ See rule 482(d)(5). These other performance measures are
not subject to any prescribed method of computation, but must
reflect all elements of return and be accompanied by quotations of
standardized measures of total return as provided for in paragraphs
(d)(3) and (d)(4) of the rule. Rule 482(d)(5) also includes other
requirements for the inclusion of non-standardized performance data,
such as presentation and prominence requirements.
    \144\ See rule 34b-1 under the Investment Company Act. Rule 34b-
1 provides that any advertisement, pamphlet, circular, form letter,
or other sales literature addressed to or intended for distribution
to prospective investors that is required to be filed with the
Commission by section 24(b) of the Investment Company Act will have
omitted to state a fact necessary in order to make the statements
made therein not materially misleading unless it includes certain
specified information.
    \145\ See rule 34b-1(b)(1)-(2).
    \146\ See, e.g., supra sections II.A.1 (affiliate exclusion) and
II.B.1.c (regular course of business requirement). Certain covered
investment fund research reports that meet the definition of
``research report'' in Regulation AC would be subject to the
requirements of Regulation AC. Similarly, covered investment fund
research reports that meet the definition of ``research report'' in
FINRA rule 2241 or the definition of ``debt research report'' in
FINRA rule 2242 would be subject to the content requirements in
those rules as applicable. See supra note 58; infra section II.D.1.
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    Research reports published under rule 139 are not required to
present performance information in any particular fashion. To the
extent the rules we are proposing today diverge from rule 139, these
differences are designed to implement the FAIR Act or tailor existing
provisions of rule 139 to the context of covered investment fund
research reports. Therefore, unlike registered open-end investment
company advertisements that must comply with the requirements of
Securities Act rule 482, covered investment fund research reports would
not be required to present investment performance data in a
standardized manner.\147\ However, we have long recognized that
investors tend to consider investment performance to be a particularly
significant factor in evaluating or comparing investment
companies.\148\ The Commission has previously identified a number of
circumstances in which performance could be disclosed in a misleading
manner.\149\ If a broker-dealer publishes or distributes a covered
investment fund research report in reliance on the safe harbor--and
presents performance information in a manner inconsistent with rule
482--retail investors could be confused about the comparability of the
performance to that presented in the prospectuses, sales literature,
and advertisements of the fund and its competitors.\150\ In addition,
the possibility exists that the requirements of rule 482 or rule 34b-1
could be circumvented by recasting registered investment company
advertisements or selling materials as research reports. We request
comment below as to whether, in light of these concerns, it would be
appropriate to require that covered investment fund research reports
that include performance information present that information in
accordance with the requirements in rule 482 or rule 34b-1.
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    \147\ See supra notes 142-143 and accompanying text.
    \148\ As the Commission has previously noted ``[a]lthough there
are many factors other than performance that an investor should
consider in deciding whether to invest in a particular fund, many
investors consider performance to be one of the most significant
factors when evaluating mutual funds.'' See Amendments to Investment
Company Advertising Rules, Securities Act Release No. 8101 (May 17,
2002) [67 FR 36712 (May 24, 2002)] (``Rule 482 Amendments Proposing
Release'') (proposing release for amendments to investment company
advertising rules).
    \149\ See id. (such circumstances include: Advertising
performance without providing adequate disclosure of unusual
circumstances that have contributed to performance; advertising
performance without providing adequate disclosure of the performance
period, that more current performance information is available, or
that more current performance may be lower than advertised
performance; and advertising performance based on selective dates or
time periods in order to showcase fund performance as of those
specific dates or time periods without providing disclosure that
would permit an investor to evaluate the significance of the
performance).
    \150\ Additional conditions that might lessen potential investor
confusion are if a research report that presents performance
information other than in accordance with the provisions of rule 482
were to: 1) adequately explain how the performance presentation
differs from that which would be required under rule 482, and/or 2)
include a statement noting that the document is a research report,
and is not an investment company advertisement that is subject to
the requirements of rule 482. We request comment on these and other
conditions below.
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    In addition, all covered investment fund research reports under the
proposed safe harbor would remain subject to the antifraud provisions
of the federal securities laws.\151\ The Commission has previously
articulated guidance on factors to be weighed in considering whether
statements involving a material fact in registered investment company
advertisements and sales literature, which are also subject to the
antifraud provisions of the federal securities laws, could be
misleading.\152\ This guidance provided factors to be weighed when
determining whether fund performance in sales literature is adequately
disclosed.\153\ The guidance factors in rule 156 \154\ are

informative in evaluating whether any presentations of registered
investment company performance in these research reports could be
misleading because they reflect principles (such as providing
information to investors that is informative and that does not create
unrealistic investor expectations \155\) that would help guide this
analysis.
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    \151\ See section 2(c)(1) of the FAIR Act (stating that nothing
in the Act shall be construed as in any way limiting the
applicability of the antifraud or antimanipulation provisions of the
Federal securities laws and rules adopted thereunder to a covered
investment fund research report, including section 17 of the
Securities Act of 1933 (15 U.S.C. 77q), section 34(b) of the
Investment Company Act of 1940 (15 U.S.C. 80a-33(b)), and sections 9
and 10 of the Securities Exchange Act of 1934 (15 U.S.C. 78i, 78j)).
    \152\ See Amendments to Investment Company Advertising Rules,
Securities Act Release No. 8294 (Sept. 29, 2003) [68 FR 57759 (Oct.
6, 2003)] (``Amendments to Investment Company Advertising Rules
Adopting Release''); see also rule 156 under the Securities Act [17
CFR 230.156].
    \153\ See Amendments to Investment Company Advertising Rules
Adopting Release, supra note 152.
    \154\ Rule 156(b) under the Securities Act provides guidance
factors concerning misleading statements in investment company sales
literature including: (i) Statements and omissions generally
(including in light of general economic or financial conditions or
circumstances), (ii) representations about past or future investment
performance, and (iii) statements involving a material fact about an
investment company's characteristics or attributes.
    For example, rule 156(b)(2) provides guidance on whether
investment performance representations may be misleading by
highlighting the following situations: (1) Portrayals of past
income, gain, or growth of assets convey an impression of the net
investment results achieved by an actual or hypothetical investment
which would not be justified under the circumstances, including
portrayals that omit explanations, qualifications, limitations, or
other statements necessary or appropriate to make the portrayals not
misleading; and (2) representations, whether express or implied,
about future investment performance, including: (i) Representations,
as to security of capital, possible future gains or income, or
expenses associated with an investment; (ii) representations
implying that future gain or income may be inferred from or
predicted based on past investment performance; or (iii) portrayals
of past performance, made in a manner which would imply that gains
or income realized in the past would be repeated in the future.
    \155\ See Rule 482 Amendments Proposing Release, supra note 148.
---------------------------------------------------------------------------

    Rule 139 includes an instruction on the use of projections of an
issuer's sales and earnings.\156\ This instruction provides that a
projection ``constitutes an analysis or information falling within the
definition of research report'' and includes certain conditions
associated with the use of projections.\157\ We are not incorporating
this or a similar instruction in proposed rule 139b for a number of
reasons. FINRA content standards governing communications with the
public generally prohibit a broker-dealer from using performance
projections.\158\ In addition, rule 156 notes as guidance that
statements and illustrations about a registered fund's future
performance in sales literature could be misleading depending on the
context in which they are made, and lists considerations to weigh in
making this evaluation. The projection instruction in rule 139--which
refers to ``sales'' and ``earnings''--also appears inapplicable to
covered investment funds. A covered investment fund's returns will be
based on the returns of the fund's investments and fund expenses, among
other factors, as opposed to ``earnings'' and ``sales.''
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    \156\ See ``Instruction'' to rule 139 [17 CFR 230.139].
    \157\ See id. The instruction provides that, when a broker or
dealer publishes or distributes projections of an issuer's sales or
earnings in reliance on rule 139(a)(2), it must: (1) Have previously
published or distributed projections on a regular basis in order to
satisfy the ``regular course of its business'' condition; (2) at the
time of publishing or disseminating a research report, be publishing
or distributing projections with respect to that issuer; and (3) for
purposes of rule 139(a)(2)(ii), include projections covering the
same or similar periods with respect to either a substantial number
of issuers in the issuer's industry or sub-industry or substantially
all issuers represented in the comprehensive list of securities
contained in the research report.
    \158\ See FINRA rule 2210(d)(1)(F).
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    We request comment on whether we should adopt any additional
conditions in rule 139b or issue guidance to help mitigate the
potential for investor confusion regarding research reports about
registered investment companies.
     Do commenters anticipate that certain issuer-specific
covered investment fund research reports could be confused with
registered investment company advertisements and sales materials? If
so, what additional conditions could prevent investor confusion,
including, for example, legends?
     If commenters anticipate that certain covered investment
fund research reports could be confused with registered investment
company advertisements and sales materials, what additional conditions
or guidance factors would help mitigate investor confusion? For
example, should we incorporate any of the rule 156 guidance factors,
which are weighed in considering whether statements in investment
company sales literature could be misleading? Why or why not?
Alternatively, should we provide any additional guidance regarding
considerations to be weighed in considering whether research reports
about registered investment companies (including any performance
information presented in these research reports) could be misleading?
Should any additional guidance be limited either to issuer-specific
research reports or to industry research reports?
     Do commenters anticipate that broker-dealers would include
performance information in covered investment fund research reports
about registered open-investment investment companies in a manner
inconsistent with the requirements for the presentation of total return
or yield in rule 482 (``non-482 performance information'')? \159\ We
request that commenters provide specific examples of non-482
performance information that they would consider using in a research
report about an open-end investment company, and why they would use
this information.
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    \159\ As discussed above, rule 482 also permits the inclusion of
performance measures in an open-end registered investment company
advertisement that are not subject to any prescribed method of
computation, provided (among other things) that these other
performance measures are accompanied by certain standardized
performance data. See supra note 143 and accompanying text.
---------------------------------------------------------------------------

     What, if any, risks could result from including non-482
performance information in covered investment fund research reports
about registered open-end investment companies? For example, would the
variability of non-482 performance information result in investor
confusion? Would the inclusion of non-482 performance information
result in any of the concerns that the provisions of rule 482 are meant
to address, such as disclosing performance without providing adequate
disclosure of unusual circumstances that have contributed to
performance; without providing adequate disclosure of the performance
period (including information about current performance); or without
disclosing important context that would permit an investor to evaluate
performance (such as the fact that the performance is based on
selective dates or time periods)? \160\ Would the ability of a covered
investment fund to include non-482 performance information incentivize
broker-dealers to recast registered investment company advertisements
or selling materials as research reports that they could publish or
distribute under proposed rule 139b, instead of meeting the
requirements of rule 482? To what extent would any such risks be
mitigated by regulations that are currently in effect, for example, the
rule 156 guidance factors discussed above, or other factors (such as
the applicable content standards in SRO rules, such as FINRA rule 2210
\161\)?
---------------------------------------------------------------------------

    \160\ See Rule 482 Amendments Proposing Release, supra note 148.
    \161\ See infra section II.D.1.
---------------------------------------------------------------------------

     If we were to permit non-482 performance information to
appear in covered investment fund research reports about registered
open-end investment companies, as proposed, what benefits could result?
Would any benefits of the ability to include the non-482 performance
information be diminished if the broker-dealer were also required to
include the standardized information required by rule 482? \162\
---------------------------------------------------------------------------

    \162\ See supra note 159.
---------------------------------------------------------------------------

     If commenters anticipate that the potential risks of
including non-482 performance information in covered investment fund
research reports would outweigh the benefits, what action should we
take to mitigate these risks? Would these risks be mitigated if we were
to incorporate any of the requirements of rule 482 directly into rule
139b? \163\ Why or why not? If so,

which requirements? For example, should we incorporate a provision in
rule 139b stating that, where a registered open-end investment
company's total return or yield is presented in a covered investment
fund research report, the presentation must be consistent with the
requirements for the presentation of total return or yield in rule 482?
Should we include in rule 139b only certain of the requirements in rule
482, such as those listed in paragraphs (d)(5) and (e) of rule 482 for
the presentation of other, non-482 conforming performance information
measures?
---------------------------------------------------------------------------

    \163\ Rule 34b-1, which governs the use of registered investment
company supplemental sales literature as discussed above, also
incorporates many of the rule 482 requirements relating to
performance disclosure, and a related alternative approach could be
to reference the performance presentation requirements of rule 34b-1
in rule 139b. See supra note 144.
---------------------------------------------------------------------------

     Should we incorporate a requirement in rule 139b relating
to the timeliness of performance data about registered investment
companies, similar to timeliness of performance requirements for
advertising prospectuses under rule 482 \164\ or supplemental sales
literature under rule 34b-1? \165\ If so, why? Would unaffiliated
broker-dealers have any difficulty obtaining this information in order
to comply with such a requirement? Would the inclusion of performance
data in covered investment fund research reports entail the same
concerns about timeliness that rules 482 and rule 34b-1 are designed to
address? Why or why not?
---------------------------------------------------------------------------

    \164\ Rule 482(g) [17 CFR 230.482(g)].
    \165\ Rule 34b-1(b)(2) [17 CFR 270.34b-1(b)(2)].
---------------------------------------------------------------------------

     Alternatively, should we incorporate a provision in rule
139b requiring that a research report must include certain disclosures
or disclaimers when performance information about registered open-end
investment companies is presented as non-482 performance information?
For example, should we require that a research report about a
registered investment company must incorporate disclosure stating that
the document is a research report and is not subject to the
Commission's regulations applicable to sales and advertising? If a
covered investment fund research report about a registered open-end
investment company includes non-482 performance information, should we
require that the research report must disclose the website address for
that registered open-end investment company (including a hyperlink for
research reports in electronic format), to facilitate investor access
to total return or yield disclosure that is presented in a manner
consistent with the requirements in rule 482? Should we require that
the methodology used to calculate the registered open-end investment
company's total return or yield be disclosed, if the research report
includes non-482 performance information?
     Should we include an instruction in rule 139b on the use
of projections that is similar to the instruction on the use of
projections in rule 139? Why or why not? If we were to include such an
instruction, would the instruction in rule 139 be appropriate to
include in rule 139b, or should it be modified in any way? As discussed
above, we recognize that the guidance factors set forth under rule 156
of the Securities Act address future investment performance, and
similarly, certain SRO rules that would apply to covered investment
fund research reports prohibit the prediction or projection of
performance.\166\
---------------------------------------------------------------------------

    \166\ See supra paragraph accompanying notes 156-158.
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D. Role of Self-Regulatory Organizations

1. SRO Content Standards and Filing Requirements for Covered Investment
Fund Research Reports
SRO Content Standards
    The FAIR Act contemplates that SRO content standards applicable to
research reports would apply to covered investment fund research
reports.\167\ Specifically, the FAIR Act provides that, unless covered
investment fund research reports are subject to the content standards
in the rules of any SRO related to research reports, these research
reports may still be subject to the filing requirements of section
24(b) of the Investment Company Act for the review of investment
company sales literature.\168\ As discussed in more detail below, we
are proposing rule 24b-4 to implement this provision of the FAIR Act.
Proposed rule 24b-4 provides that a covered investment fund research
report about a registered investment company will not be subject to
section 24(b) of the Investment Company Act (or the rules and
regulations thereunder), except to the extent the research report is
otherwise not subject to the content standards in SRO rules related to
research reports, including those contained in the rules governing
communications with the public regarding investment companies or
substantially similar standards.\169\
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    \167\ See section 2(b)(4) of the FAIR Act (A covered investment
fund research report shall not be subject to section 24(b) of the
Investment Company Act of 1940 (15 U.S.C. 80a-24(b)) or the rules
and regulations thereunder, except that such report may still be
subject to such section and the rules and regulations thereunder to
the extent that it is otherwise not subject to the content standards
in the rules of any self-regulatory organization related to research
reports, including those contained in the rules governing
communications with the public regarding investment companies or
substantially similar standards.).
    This provision is relevant only to covered investment funds that
are investment companies subject to section 24(b) of the Investment
Company Act. For example, registered closed-end investment
companies, business development companies, and commodity- or
currency-based trusts or funds are covered investment funds that are
not subject to section 24(b) of the Investment Company Act. A
covered investment fund that is not subject to section 24(b) of the
Investment Company Act would have no obligations under that section
even if research reports concerning the covered investment fund were
not subject to the content standards in the rules of any self-
regulatory organization related to research reports.
    \168\ See id.
    \169\ See proposed rule 24b-4.
---------------------------------------------------------------------------

    Currently, the SRO content standards relevant to communications
that would be considered covered investment fund research reports under
proposed rule 139b include the applicable content standards of FINRA
rules 2210, 2241(c)(1), and 2242(c)(1).\170\ FINRA's rule governing
communications with the public (FINRA rule 2210) contains general
content standards that apply broadly to member communications,\171\
including broker-dealer research reports. These general content
standards require, among other things, that all member communications
``must be based on principles of fair dealing and good faith, must be
fair and balanced, and must provide a sound basis for evaluating the
facts in regard to any particular security or type of security,
industry or service.'' \172\
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    \170\ See infra note 174 (discussing the scope of these rules in
more detail, including noting that the scope of certain provisions
of FINRA rule 2210, and the scope of FINRA rules 2241(c)(1) and
2242(c)(2) generally, apply only to a certain subset of
communications that would be considered covered investment fund
research reports under proposed rule 139b).
    \171\ See FINRA rule 2210(d)(1).
    \172\ See FINRA rule 2210(d)(1)(A). FINRA rule 2210's general
content standards also provide, among other things, that FINRA
members may not ``make any false, exaggerated, unwarranted,
promissory or misleading statement or claim in any communication''
nor ``publish, circulate or distribute any communication that the
member knows or has reason to know contains any untrue statement of
a material fact or is otherwise false or misleading.'' See FINRA
rule 2210(d)(1)(B).
---------------------------------------------------------------------------

    The FAIR Act does not explicitly refer to specific content
standards in SRO rules. It refers more generally to ``the content
standards in the rules of any self-regulatory organization related to
research reports, including those contained in the rules governing
communications with the public regarding investment companies or
substantially similar standards.'' \173\ In order to provide clarity
and facilitate consistent and predictable application of proposed rule
24b-4, we interpret section 2(b)(4) of the FAIR Act as

excluding covered investment fund research reports from section 24(b)
of the Investment Company Act so long as they continue to be subject to
the general content standards in FINRA rule 2210(d)(1) (or
substantially similar SRO rules). Accordingly, by operation of proposed
rule 24b-4, covered investment fund research reports under proposed
rule 139b that otherwise would be subject to section 24(b) of the
Investment Company Act would not be subject to that section so long as
they remain subject to the general content standards of FINRA rule
2210(d)(1).\174\ This interpretation is consistent with our belief that
it is important for SRO content standards to continue to apply to
covered investment fund research reports, especially if, as discussed
below, research reports about registered investment companies would no
longer be required to be filed pursuant to section 24(b) of the Act or
rule 497 under the Securities Act,\175\ and therefore would no longer
be subject to routine review.\176\
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    \173\ Section 2(b)(4) of the FAIR Act.
    \174\ A subset of communications that would fall within the
definition of ``covered investment fund research report'' under
proposed rule 139b also would be subject to additional content-
related requirements under FINRA rules that are applicable to
certain research reports, but that are more narrowly applicable than
the general content standards of FINRA rule 2210(d)(1). However,
under our interpretation, whether or not these additional content
standards apply to any given covered investment fund research report
would not determine the applicability of section 24(b) to that
research report under proposed rule 24b-4. A different
interpretation could lead to results that we believe could be
inconsistent with section 2(b)(4) of the FAIR Act (i.e., if only
communications that are subject to additional FINRA content
standards discussed in this footnote (e.g., those applicable to
retail communications) were excluded from section 24(b) filing
requirements).
     Additional FINRA content-related requirements include the
content standards of FINRA rule 2210 that apply only to retail
communications (or retail communications and correspondence, as
those terms are defined in FINRA rule 2210(a)). See, e.g., FINRA
rules 2210(d)(2) (Comparisons), 2210(d)(3) (Disclosure of Member's
Name). Accordingly, covered investment fund research reports that
would meet the definition of institutional communications would not
be subject to some of the content standards of FINRA rule 2210.
     These additional requirements also include the content
standards incorporated in FINRA rules 2241 and 2242, which apply to
certain research reports defined in these FINRA rules. The scope of
FINRA rules 2241 and 2242 only includes research reports or debt
research reports as defined in these rules, and the definitions of
``research report'' and ``debt research report'' in these rules are
different than the definitions of ``research report'' set forth in
rule 139 and proposed rule 139b. Under FINRA rule 2241, ``research
report'' is defined as any written (including electronic)
communication that includes an analysis of equity securities of
individual companies or industries (other than an open-end
registered investment company that is not listed or traded on an
exchange) and that provides information reasonably sufficient upon
which to base an investment decision; similarly, under FINRA rule
2242, ``debt research report'' is defined as any written (including
electronic) communication that includes an analysis of a debt
security or an issuer of a debt security and that provides
information reasonably sufficient upon which to base an investment
decision, excluding communications that solely constitute an equity
research report as defined in [FINRA] rule 2241(a)(11).'' See FINRA
rules 2241(a)(11), 2242(a)(3).
    \175\ See infra discussion at notes 177-181 and accompanying
text.
    \176\ Broker-dealer communications that are excluded from, or
otherwise not subject to FINRA's filing requirements may still be
reviewed by FINRA, for example, through examinations, targeted
sweeps or spot-checks. FAIR Act section 2(c)(2) provides that
nothing in the Act shall be construed as in any way limiting ``the
authority of any self-regulatory organization to examine or
supervise a member's practices in connection with such member's
publication or distribution of a covered investment fund research
report for compliance with applicable provisions of the Federal
securities laws or self-regulatory organization rules related to
research reports, including those contained in rules governing
communications with the public.'' See also, e.g., FINRA rule
2210(c)(6) (``In addition to the foregoing requirements, each
member's written (including electronic) communications may be
subject to a spot-check procedure. Upon written request from
[FINRA's Advertising Regulation] Department, each member must submit
the material requested in a spot-check procedure within the time
frame specified by the Department.'').
---------------------------------------------------------------------------

Filing Requirements for Covered Investment Fund Research Reports
    The FAIR Act, as implemented by proposed rule 24b-4, would modify
the filing requirements that currently apply to certain broker-dealer
communications regarding registered investment companies. As discussed
above, research reports about registered investment companies have
historically not been included within the scope of rule 139.\177\
Therefore, a research report or other communication about a covered
investment fund that is a registered investment company, particularly
one that contains performance information, would ordinarily have to
comply with rule 482.\178\ Today, registered investment company sales
literature, including rule 482 omitting prospectus advertisements, are
required to be filed with the Commission under section 24(b) of the
Investment Company Act \179\ and rule 497 under the Securities
Act.\180\ Rule 24b-3 under the Investment Company Act and rule 497(i)
deem these materials to have been filed with the Commission if filed
with FINRA.\181\
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    \177\ See supra notes 11-15 and accompanying text.
    \178\ See FINRA rule 2210(d)(5) (providing that non-money market
fund open-end management company performance data as permitted by
rule 482 in retail communications and correspondence must disclose
standardized performance information and, to the extent applicable,
certain sales charge and expense ratio information); see also supra
note 140.
    \179\ See supra note 29.
    \180\ 17 CFR 230.497. Rule 497 generally requires investment
company prospectuses, including investment company advertisements
deemed to be a section 10(b) prospectus pursuant to rule 482, to be
filed with the Commission.
    \181\ See supra notes 29, 180.
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    As discussed in the Economic Analysis below, we anticipate that
certain communications that historically have been treated as
investment company sales literature, including rule 482 ``omitting
prospectus'' advertisements, would be published or distributed by a
broker-dealer as covered investment fund research reports pursuant to
the rule 139b safe harbor.\182\ Such communications that previously had
been subject to the filing requirements of section 24(b) no longer
would be subject to these requirements by operation of proposed rule
24b-4 because they would be subject to the general content standards of
FINRA rule 2210(d)(1).\183\
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    \182\ See infra section III.C.3.
    \183\ See supra notes 11-15 and accompanying text.
     A communication that previously had been subject to the filing
requirements of rule 497 also would no longer be subject to the rule
497 filing requirements if it were published or distributed by a
broker-dealer as a covered investment fund research report, because
it would no longer be considered to be a section 10(b) prospectus.
See supra paragraph accompanying notes 141-146.
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    FINRA rule 2210 requires the filing of certain communications,
including retail communications that promote or recommend a specific
registered investment company or family of registered investment
companies.\184\ However, FINRA provides a number of exclusions from the
filing requirements.\185\ For example, with respect to research reports
(as that term is defined in FINRA rule 2241),\186\ FINRA currently
excludes from filing those that concern only securities that are listed
on a national securities exchange, other than research reports required
to be filed with the Commission pursuant to section 24(b) of the
Investment Company Act.\187\ Because covered investment fund research
reports would no longer be required to be filed with the Commission
pursuant to section 24(b),

proposed rule 24b-4 could have the effect of narrowing the types of
communications that would be filed with FINRA (under current FINRA rule
2210) regarding registered investment companies.
---------------------------------------------------------------------------

    \184\ See FINRA rule 2210(c)(3) (broker-dealers must file,
within 10 business days of first use or publication, retail
communications that promote or recommend a specific registered
investment company or family of registered investment companies).
See generally, FINRA rule 2210(c)(1)-(3). In addition to these FINRA
filing requirements, as discussed above, such communications would
be required to be filed with the Commission (and are deemed to have
been filed with the Commission if filed with FINRA). See supra notes
179-181 and accompanying text.
    \185\ See generally FINRA rule 2210(c)(7).
    \186\ See supra note 11.
    \187\ See FINRA rule 2210(c)(7)(O) (excluding ``[r]esearch
reports as defined in Rule 2241 that concern only securities that
are listed on a national securities exchange, other than research
reports required to be filed with the Commission pursuant to Section
24(b) of the Investment Company Act'').
---------------------------------------------------------------------------

    We note, however, that the FAIR Act's rules of construction provide
that the Act shall not be construed as limiting the authority of an SRO
to require the filing of communications with the public if the purpose
of such communications ``is not to provide research and analysis of
covered investment funds.'' \188\ Therefore, even if the exclusion of
covered investment fund research reports from the provisions of section
24(b) affects the applicability of the filing requirements or
exclusions under FINRA rule 2210 with respect to covered investment
fund research reports, it would not affect FINRA's authority to require
the filing of a communication that is included in the FAIR Act's
definition of ``covered investment fund research report'' but whose
purpose is not to provide research and analysis. In addition, a covered
investment fund research report would continue to be subject to FINRA
recordkeeping requirements applicable to communications with the
public, even if the broker-dealer would not be required to file the
research report with FINRA or the Commission.\189\
---------------------------------------------------------------------------

    \188\ See section 2(c)(2) of the FAIR Act.
    \189\ See FINRA rule 2210(b)(4)(A) (requiring members to
maintain all retail communications and institutional communications
for the retention period required by Exchange Act rule 17a-4(b) and
in a format and media that comply with Exchange Act rule 17a-4).
---------------------------------------------------------------------------

    We request comment on issues relating to SRO content standards for
covered investment fund research reports.
     Should we implement FAIR Act section 2(b)(4) through
proposed rule 24b-4? Are there any modifications to the proposed rule
that we should consider?
     Do commenters believe that we should incorporate any of
the SRO content standards currently applicable to research reports into
rule 139b? If so, which ones and why?
2. SRO Limitations
    The FAIR Act directs us to provide that SROs may not maintain or
enforce any rule that would (i) prohibit the ability of a member to
publish or distribute a covered investment fund research report solely
because the member is also participating in a registered offering or
other distribution of any securities of such covered investment fund;
or (ii) prohibit the ability of a member to participate in a registered
offering or other distribution of securities of a covered investment
fund solely because the member has published or distributed a covered
investment fund research report about such covered investment fund or
its securities.\190\ These limitations on an SRO and any rules relating
to research reports that an SRO might adopt would not affect the safe
harbor provided by proposed rule 139b. To provide additional context
for the proposed safe harbor, however, and in light of Congress's
direction that we provide these limitations in implementing the
rulemaking required by the FAIR Act, we have set forth these SRO
limitations in proposed rule 139b.\191\
---------------------------------------------------------------------------

    \190\ Section 2(b)(3) of the FAIR Act.
    \191\ See proposed rule 139b(b).
---------------------------------------------------------------------------

E. Conforming Amendment

    Rule 101 of Regulation M under the Exchange Act \192\ prohibits any
person who participates in a distribution from attempting to induce
others to purchase securities covered by the rule during a specified
period. It provides an exception for certain research activities--
namely, the publication or dissemination of any information, opinion,
or recommendation--if the conditions of Securities Act rule 138 or rule
139 are satisfied. In light of our proposal of Securities Act rule
139b, we are proposing a corresponding change to the exception
contained within rule 101(b)(1) of Regulation M to permit the
publication or dissemination of any information, opinion, or
recommendation so long as the conditions of proposed rule 139b are
satisfied. The proposed conforming amendment is intended to align the
treatment of research under proposed rule 139b with the treatment of
research under rules 138 and 139 for purposes of Regulation M.
---------------------------------------------------------------------------

    \192\ 17 CFR 242.101(a).
---------------------------------------------------------------------------

    In the absence of the conforming amendment, rule 101 could prevent
the publication or dissemination of a covered investment fund research
report under the proposed rule 139b safe harbor by a broker-dealer that
is participating in a distribution that is covered by Regulation M. We
believe that such a result would be contrary to the mandate of the FAIR
Act. As such, the proposed conforming amendment is intended to
harmonize treatment of research under the Securities Act and Exchange
Act rules.
    We request comment on the proposed conforming amendment to
Regulation M.
     Is the proposed conforming amendment appropriate?
     Are there other conforming amendments to Regulation M or
any of our other rules appropriate for consideration based on the FAIR
Act? If so, what rules should be amended and why?

III. Economic Analysis

A. Introduction

    We are mindful of the costs and benefits of our rules. Section 2(b)
of the Securities Act, section 3(f) of the Exchange Act, and section
2(c) of the Investment Company Act state that when the Commission is
engaging in rulemaking under such titles and is required to consider or
determine whether an action is necessary or appropriate in (or, with
respect to the Investment Company Act, consistent with) the public
interest, the Commission shall consider, in addition to the protection
of investors, whether the action will promote efficiency, competition,
and capital formation.\193\ Additionally, Exchange Act section 23(a)(2)
requires us, when making rules or regulations under the Exchange Act,
to consider, among other matters, the impact that any such rule or
regulation would have on competition and states that the Commission
shall not adopt any such rule or regulation which would impose a burden
on competition that is not necessary or appropriate in furtherance of
the Exchange Act.\194\
---------------------------------------------------------------------------

    \193\ 15 U.S.C. 77b(b), 15 U.S.C. 78c(f), 15 U.S.C. 80a-2(c),
and 15 U.S.C. 80b-2(c).
    \194\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The economic analysis proceeds as follows. We begin with a
discussion of the baseline used in the analysis. We then discuss the
proposed rules' costs and benefits, as well as their effects on
efficiency, competition, and capital formation compared to the
baseline. Where possible, we attempt to quantify the economic effects
we discuss. However, we cannot produce reasonable estimates for most of
the effects. In such cases we instead provide qualitative economic
assessments.

B. Baseline

    The Commission's economic analysis evaluates the costs and benefits
of the proposed rule relative to a baseline that represents the best
assessment of relevant markets and market participants in the absence
of the proposed rule. In this section, we begin by characterizing the
relevant market structure and participants.\195\ We then

proceed to describe the relevant regulatory structure.
---------------------------------------------------------------------------

    \195\ To characterize the baseline, we rely on data from year-
end 2017 where possible; however, in some cases, timing issues
related to data availability require us to rely on data from prior
periods.
---------------------------------------------------------------------------

1. Market Structure and Market Participants
    The proposed rules would directly affect broker-dealers, but their
indirect effects would extend to covered investment funds, other
producers of research on covered investment funds, and consumers of
information about covered investment funds.\196\
---------------------------------------------------------------------------

    \196\ The proposed rules, through their effects on capital
formation, may also affect securities issuers more broadly. See
infra section III.C.5.
---------------------------------------------------------------------------

a. Covered Investment Funds
    The ``covered investment fund'' definition in the FAIR Act and
proposed rule 139b has the effect of capturing five common types of
investment vehicles: Mutual funds, ETFs, certain currency and commodity
exchanged traded products (``ETPs''),\197\ closed-end funds, and
BDCs.\198\ As shown in Figure 1, the universe of covered investment
funds is large. At the end of 2017, there were 11,924 such entities,
including 9,564 mutual funds, 1,629 ETFs and ETPs, 596 closed-end
funds, and 135 BDCs.\199\ The total public market value of covered
investment funds exceeds $20 trillion. Of this total, $17 trillion is
held through shares issued by open-end mutual funds, $3 trillion
through shares of ETFs and ETPs, $317 billion through shares of closed-
end funds, and $27 billion through shares of BDCs.\200\
---------------------------------------------------------------------------

    \197\ Exchange-traded trusts with assets consisting primarily of
commodities, currencies, or derivative instruments that reference
commodities or currencies, commonly referred to as currency ETPs and
commodity ETPs, and which are not registered under the Investment
Company Act; see proposed rule 139b(c)(2)(ii).
    \198\ See supra section II.A.3.
    \199\ Mutual fund, ETF, and ETP statistics based on data from
CRSP mutual fund database (2017Q3). Closed-end fund statistics based
on data from CRSP monthly stock file (Dec. 2017). BDC statistics
based on Commission's listing of registered BDCs. Securities and
Exchange Commission, Business Development Company Report: January
2012-September 2017 (Sept. 19, 2017), available at https://www.sec.gov/open/datasets-bdc.html.
    \200\ See supra note 199. Market value of BDC shares based on
information obtained from Compustat and Audit Analytics.
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BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TP08JN18.000

[GRAPHIC] [TIFF OMITTED] TP08JN18.001

BILLING CODE 8011-01-C
    Covered investment fund shares represent a significant fraction of
investment assets held by U.S. residents. Approximately one-third of
U.S. corporate equity issues, one-quarter of U.S. municipal securities,
one-fifth of corporate debt, one-fifth of U.S. commercial paper, and
one-tenth of U.S. treasury and agency securities are held through
covered investment funds.\201\ Mutual funds comprise the bulk (84%) of
covered investment funds.\202\ Nearly half of U.S. households hold
mutual fund shares \203\ and the vast majority (89%) of mutual fund
shares are held through retail accounts (i.e. accounts of retail
investors, or households).\204\ Consequently, at least 75% of the
public market value of all covered investment funds are held through
retail accounts. By analyzing institutional holdings from year-end 2016
Form 13F filings we estimate that across ETF and ETPs, the mean
institutional holding \205\ was 50%.\206\ For BDCs, we estimate the
mean institutional holding was 33%, while for closed-end funds, we
estimate the mean institutional holding was 23%. Based on these
figures, we further estimate that shares representing 87% of the public
market value of all covered investment funds are held through retail
accounts.\207\
---------------------------------------------------------------------------

    \201\ See Investment Company Institute, 2017 Investment Company
Fact Book (2017), available at http://www.icifactbook.org/ (``ICI
Fact Book'').
    \202\ See supra note 200.
    \203\ See Investment Company Institute, Ownership of Mutual
Funds, Shareholder Sentiment, and Use of the internet (2017),
available at https://www.ici.org/pdf/per23-07.pdf.
    \204\ Percentage by value. See ICI Fact Book, supra note 201, at
30. Excluding money market funds (``MMF''), mutual fund shares held
in retail accounts make up an even larger fraction (95%) of mutual
fund shares.
    \205\ We calculated ``institutional holding'' as the sum of
shares held by institutions (as reported on Form 13F filings)
divided by shares outstanding (as reported in CRSP).
    \206\ Year-end 2016 Form 13F filings were used to estimate
institutional ownership. Closed-end funds were matched to reported
holdings based on CUSIP. We note that there are long-standing
questions around the reliability of data obtained from 13F filings.
See Anne M. Anderson, & Paul Brockman, Form 13F (Mis)Filings, SSRN
Scholarly Paper. Rochester, NY: Social Science Research Network
(Oct. 15, 2016), available at https://papers.ssrn.com/abstract=2809128. See also Securities and Exchange Commission,
Office of Inspector General, Office of Audits, Review of the SEC's
Section 13(f) Reporting Requirements (2010).
    \207\ Staff calculated the percentage of net asset value held by
institutions reported on Form 13F for ETFs, ETPs and BDCs as public
market value of shares held by institutions divided by public market
value of all shares. Mutual funds shares are generally not required
to be reported on Form 13F. We estimate institutional ownership of
non-MMF mutual funds using ICI Fact Book estimate (95%). See supra
note 204 and accompanying text.
---------------------------------------------------------------------------

    As depicted in Figure 3, the covered investment fund market is
dynamic. In

2017, 638 covered investment funds were created, while 853 were closed
or merged into other covered investment funds.\208\
---------------------------------------------------------------------------

    \208\ See supra note 199.
    [GRAPHIC] [TIFF OMITTED] TP08JN18.002

    We are requesting comments on our characterization of the covered
investment fund market and data to help us further describe this market
and current market practices.
     Do commenters agree with our characterization of the
covered investment fund market? Do commenters agree with our
characterization of ownership patterns? Are there ways to improve our
estimates?
     Do commenters believe that our estimates of institutional
ownership of covered investment funds are accurate? If not, are there
ways to improve our estimates? Do commenters believe that our estimates
of institutional ownership of different types of covered investment
fund shares (e.g., mutual funds, ETFs, ETPs, BDCs) include shares held
in street name where the beneficial owners are retail investors?
     Do commenters believe that our estimates of institutional
holdings of covered investment funds represent securities held for
investment or securities held for other purposes (e.g. market-making
inventory, proprietary trading)?
b. Broker-Dealers
    The broker-dealers directly affected by the proposed rules are
those who participate in registered offerings of covered investment
funds while at the same time publishing or distributing information
about those funds. The Commission does not have comprehensive data on
the number or characteristics of broker-dealers currently publishing
and distributing communications about covered investment funds, the
extent of their communications, and their distribution arrangements
with covered investment funds. Therefore we rely on inferences based on
the data that are available \209\ and make certain assumptions when
characterizing the baseline.
---------------------------------------------------------------------------

    \209\ We rely here primarily on broker-dealers' quarterly FOCUS
reports.
---------------------------------------------------------------------------

    We believe that broker-dealers that do not derive revenues from the
distribution of covered investment funds are less likely to be directly

affected by the proposed rules.\210\ As discussed above, registered
investment companies represent the vast majority of covered investment
funds.\211\ Broker-dealers report revenues from the distribution of
investment company shares in regulatory filings,\212\ and we use this
to estimate broker-dealers' revenues from distribution of covered
investment funds. We estimate that for the 3,882 broker-dealers active
in 2017, revenues related to distribution of covered investment funds
exceeded $28 billion, or 9% of total broker-dealers' revenues. Of these
3,882 broker-dealers, 1,417 reported revenues from the distribution of
investment company shares. These 1,417 ``affected'' broker-dealers
accounted for 74% of total broker-dealer revenues and 59% of total
broker-dealer assets.\213\ As shown in Figure 4, among the affected
broker-dealers, the importance of revenues from the distribution of
covered investment funds varies widely.\214\ However, in aggregate,
these revenues accounted for 13% of affected broker-dealers' total
revenues.\215\ For comparison, among the affected broker-dealers,
revenues from brokerage trading commissions and account management
accounted for 9%, and 20% of total revenues, respectively, while
revenues from propriatery trading and underwriting accounted for 4% and
8% of total revenues, respectively.
---------------------------------------------------------------------------

    \210\ We believe that broker-dealers that do not participate in
the distribution of covered investment funds are less likely to
publish or distribute research reports about such funds and--to the
extent that they do--may not derive significant benefits from the
safe harbor of proposed rule 139b.
    \211\ See supra section III.B.1.a.
    \212\ The sum of FOCUS Supplemental Statement of Income items:
13970 (``revenues from sales of investment company shares''), 11094
(``12b-1 fees''), and 11095 (``mutual fund revenue other than
concessions or 12b-1 fees'').
    \213\ We describe these dealers as ``affected,'' but note that
the degree to which they are affected will vary based on individual
characteristics. Other things being equal, we expect broker-dealers
that are currently more active in the marketing of covered
investment funds would be more affected.
    \214\ This suggests that the degree to which the ``affected''
broker-dealers are affected by the proposed rule will also vary
widely.
    \215\ Estimates are based on staff analysis of FOCUS filings.
    [GRAPHIC] [TIFF OMITTED] TP08JN18.003

    We are seeking comment on our assumptions used in characterizing
this market.
     Do commenters agree with our estimates of the immediately-
affected broker-dealers based on revenue from sales of investment
company shares? If not, what other proxy would be more appropriate?
c. Research on Covered Investment Funds
    The Commission does not have comprehensive data on broker-dealers
that publish or distribute research reports on entities that would be
included within the definition of ``covered investment fund'' under
proposed rule 139b.\216\ The Commission estimates that in 2017, there
were 1,417 broker-dealers that reported revenues from the distribution
of covered investment funds.\217\ We assume that these broker-dealers
would have incentives to publish or distribute research reports about
covered investment funds. However, due to the large number of covered
investment funds, we do not expect that many broker-dealers' in-house
research departments (if they have such

departments) are currently capable of providing research on a large
percentage of covered investment funds.
---------------------------------------------------------------------------

    \216\ See supra section III.B.1.b.
    \217\ See id.
---------------------------------------------------------------------------

    As discussed above, ``research reports'' pertaining to most covered
investment funds are not specifically addressed in existing Commission
or SRO rules.\218\ Consequently, it is not possible to identify which
broker-dealer communications under the baseline would be considered
``research reports'' as defined in proposed rule 139b. However, we
understand that some broker-dealers have published and distributed
communications styled as ``research reports'' in compliance with rule
482 under the Securities Act.\219\ FINRA member firms--the vast
majority \220\ of broker-dealers--file these communications with
FINRA.\221\ The number of communications filed with FINRA help to
provide a baseline estimate of the number of communications currently
published or distributed by broker-dealers that could potentially be
considered ``research reports'' under proposed rule 139b. FINRA staff
have reported reviewing 47,707 filings subject to rule 482 in 2017.
FINRA staff reviewed an additional 8,528 communications that are
subject to Investment Company Act rule 34b-1, for a total of 56,235
communications.\222\ There are several factors that limit our ability
to extrapolate from these estimates the number of communications that
broker-dealers currently publish or distribute that would satisfy the
definition of ``covered investment fund research report'' under
proposed rule 139b. First, these data do not reflect the affiliate
exclusion incorporated in the proposed rule 139b definition of
``covered investment fund research report,'' which would have the
effect of excluding from the proposed safe harbor research reports that
are published or distributed by persons covered by the affiliate
exclusion.\223\ Second, the data do not include communications about
entities that would be considered ``covered investment funds,'' but
that do not need to comply with the requirements of rule 482 (e.g.,
commodity- or currency-based trusts or funds). Third, for those
communications that are currently filed as rule 482 advertising
prospectuses or rule 34b-1 supplemental sales literature, we are
uncertain what percentage of these communications brokers dealers would
continue to structure as rule 482 advertising prospectuses or rule 34b-
1 supplemental sales literature, as opposed to publishing or
distributing them as covered investment fund research reports under the
proposed rule 139b safe harbor.
---------------------------------------------------------------------------

    \218\ See supra note 174 and accompanying text.
    \219\ See supra note 101.
    \220\ Based on staff analysis of FOCUS filings, we estimate that
as of year-end 2016, there were 3,882 registered broker-dealers,
3,755 of which were members of FINRA.
    \221\ See supra note 181 and accompanying text.
    \222\ Under rule 34b-1, ``sales literature'' required to be
filed by section 24(b) shall have omitted to state a fact necessary
in order to make the statements made therein not materially
misleading unless the sales literature includes certain specified
information. See rule 34b-1 [17 CFR 270.34b-1]; see also supra notes
144-145 and accompanying text.
    Of the 47,707 filings subject to rule 482, 229 were also subject
to rule 34b-1. These 229 are not included in the 8,528 figure.
Statistics provided by FINRA.
    \223\ See supra note 36 and accompanying text.
---------------------------------------------------------------------------

    We have also analyzed the number of ``research reports'' as defined
under FINRA rules 2241 and 2242 that FINRA staff reviewed in 2017.
However, for reasons discussed below, we also believe that these data
have limited value in assessing the number of covered investment fund
research reports whose publication or distribution could be eligible
for the safe harbor under proposed rule 139b. FINRA reviewed 354
filings in 2017 that were identified as ``research reports'' as defined
in FINRA rules 2241 and 2242. However, the definitions of ``research
report'' and ``debt research report'' under FINRA rules 2241 and 2242,
respectively, do not correspond in every respect to the term ``research
report'' as defined in the FAIR Act and proposed rule 139b.
    Under FINRA rule 2241, the term ``research report'' includes any
written communication that includes an analysis of equity securities
(other than mutual fund securities) and that provides information
reasonably sufficient upon which to base an investment decision.\224\
Under FINRA rule 2242, the term ``debt research report'' includes any
written communication that includes an analysis of a debt security or
an issuer of a debt security and that provides information reasonably
sufficient upon which to base an investment decision.\225\ As discussed
above, the FAIR Act and proposed rule 139b definition of ``research
report'' would not require a communication to provide information
reasonably sufficient upon which to base an investment decision.\226\
Also, unlike the definition of ``research report'' in FINRA rule 2241,
the FAIR Act and proposed rule 139b definitions of ``research report''
would include communications about mutual funds. Thus, while the number
of ``research reports'' as defined in FINRA rules 2241 and 2242 that
FINRA staff has historically reviewed provides an estimate of a subset
of communications currently being styled as research reports whose
publication or distribution could be eligible for the proposed rule
139b safe harbor, this number would represent only a small portion of
the complete universe of research reports whose publication or
distribution could be eligible for this safe harbor. We also understand
that the reported number of ``research reports'' as defined in FINRA
rules 2241 and 2242 that FINRA staff has historically reviewed also
could relate to research reports for securities products other than
entities that would be considered ``covered investment funds'' (e.g.,
certain stocks, bonds, or master limited partnership interests).
---------------------------------------------------------------------------

    \224\ See FINRA rule 2241(a)(11).
    \225\ See FINRA rule 2242(a)(3).
    \226\ See supra note 44 and accompanying text.
---------------------------------------------------------------------------

    In addition to broker-dealers, various firms that are independent
of the offering process currently provide data and analysis on
different subsets of the covered investment fund universe (e.g.,
through subscription services or through licensing agreements with
broker-dealers). Because data and analysis provided by these firms play
an important role in investors' information environment under the
baseline, these firms would be affected by changes to the competitive
environment resulting from the proposed rules.\227\ We understand that
communications styled as research reports on covered investment funds
distributed by broker-dealers may rely on information obtained from
these independent sources. In particular, we understand that
information that is commonly provided by these independent firms may
include: (1) Information obtained from regulatory filings, such as
narrative descriptions of fund objectives, information about key
personnel, performance history, fees, and top holdings; (2) statistics
and other information derived from public, proprietary, and licensed
data sources, such as risk exposures (e.g., geographic, sectoral),
quantitative characteristics (e.g., beta, correlations, tracking
error), and peer group; and (3) fund ratings. The fund ratings that
independent firms may provide are generally based on methodologies
proprietary to each firm.\228\
---------------------------------------------------------------------------

    \227\ See infra section III.C.5.
    \228\ See, e.g., Zacks Investment Research, ETF Rank Guide (Mar.
12, 2013), available at https://www.zacks.com/stock/news/94561/zacks-etf-rank-guide; Morningstar, Morningstar's Two Rating for
Assessing a Fund (2014), available at http://corporate1.morningstar.com/Documents/UK/Landing/Morningstars-Two-Ratings-For-Assessing-A-Fund/; and McGraw Hill Financial, S&P
Capital IQ's Mutual Fund Ranking Methodology, available at https://marketintelligence.spglobal.com/documents/products/Mutual_Fund_Methodology_v2.pdf.

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

    We are seeking comment on our characterization of the market for
research reports on covered investment funds.
     What other data are available on broker-dealers' current
publication or distribution of research reports on entities that would
be included within the definition of ``covered investment fund'' under
proposed rule 139b? On the scope of their coverage? On their consumers?
     Do commenters agree with our characterization of the data
and analysis on covered investment funds that is provided by
independent (non-broker-dealer) research firms? Are there significant
gaps or limitations to the information and analysis on covered
investment funds provided by such firms?
2. Regulatory Structure
a. Current Legal and Regulatory Framework Applicable to Statements
Included in Covered Investment Fund Research Reports
    As discussed above, the rule 139 safe harbor is currently not
available for broker-dealers that publish or distribute research
reports about most covered investment funds.\229\ A broker-dealer's
publication or distribution of a covered investment fund research
report could therefore be deemed to constitute an offer that otherwise
could be a non-conforming prospectus whose use in the offering may
violate section 5 of the Securities Act.\230\ We understand that some
broker-dealers currently publish and distribute communications styled
as ``research reports'' regarding covered investment funds in
compliance with rule 482 under the Securities Act.\231\ Unlike research
reports covered under the rule 139 safe harbor, broker-dealers'
publication or distribution of rule 482 advertisements could subject
the broker-dealer to liability under section 12(a)(2) of the Securities
Act \232\ In addition, rule 482 advertisements are subject to
requirements on the standardized presentation of performance
information.\233\
---------------------------------------------------------------------------

    \229\ Among covered investment funds, only issuers that register
their offerings under the Securities Act (certain commodity and
currency ETPs eligible to use Form S-3) qualify for inclusion in
research reports under the rule 139 safe harbor. See supra note 11-
15 and accompanying text.
    \230\ See supra note 13 and accompanying text.
    \231\ Research reports regarding covered investment funds could
also be distributed today as ``supplemental sales literature'' under
rule 34b-1 under the Investment Company Act. However, research
reports distributed under rule 34b-1 would need to be preceded or
accompanied by a statutory prospectus. See supra note 144 and
accompanying text.
    \232\ Section 12(a)(2) provides express remedies to the person
purchasing the security (i.e., a private right of action) for
material misstatements and omissions made by any seller of the
security. It also provides a different standard for claims for
damages than under Exchange Act rule 10b-5, which requires proof of
scienter in the representations made. See 15 U.S.C. 77l(a)(2); see
also rule 10b-5 [17 CFR 240.10b-5].
    \233\ Research reports that are published or distributed as rule
34b-1 supplemental sales literature also would be subject to
requirements relating to the standardized presentation of
performance information, because rule 34b-1 incorporates many of the
rule 482 requirements relating to performance disclosure. See supra
notes 231, 145.
---------------------------------------------------------------------------

    Additionally, certain SRO rules governing content standards may
apply to communications that would be considered covered investment
fund research reports under proposed rule 139b or advertisements styled
as ``research reports'' under rule 482. These include FINRA rule 2210
which contains general content standards that apply broadly to member
communications.\234\ In addition, covered investment fund research
reports pertaining to funds other than open-end registered investment
companies that are not listed or traded on an exchange (i.e., ETFs,
ETPs, closed-end funds, and BDCs) may be subject to FINRA rules 2241
and 2242 governing content standards of ``research reports'' as defined
by FINRA.\235\
---------------------------------------------------------------------------

    \234\ See FINRA rule 2210(d)(1).
    \235\ See supra note 174 (discussing the scope of these rules in
more detail, including noting that the scope of FINRA rules
2241(c)(1) and 2242(c)(2) generally apply only to a subset of
communications that would be considered covered investment fund
research reports under proposed rule 139b).
---------------------------------------------------------------------------

    Exposure to liability under section 12(a)(2) of the Securities Act,
rule 482 requirements on the standardized presentation of performance
information, and the various aforementioned FINRA rules impose costs on
broker-dealers. These include conduct costs resulting from additional
liability (e.g. foregoing publication of certain reports), and
compliance costs associated with the relevant content standards. We are
not able to quantify these costs and are seeking comments on our
characterization of these costs:
     What do commenters view as the most significant costs
associated with distributing and publishing research reports on covered
investment funds under existing regulation? Can commenters quantify
these costs?
b. Current Filing Requirements
    As discussed above, the rule 139 safe harbor currently is not
available for broker-dealers' publication and distribution of research
reports about specific registered investment companies and BDCs.\236\
Therefore, a research report or other communication about a covered
investment fund that is a registered investment company would have to
comply with the requirements of Securities Act rule 482.\237\ Today,
registered investment company sales material, including rule 482
``omitting prospectus'' advertisements as well as supplemental sales
literature,\238\ are required to be filed with the Commission under
section 24(b) of the Investment Company Act.\239\ Broker-dealers that
are FINRA members are also subject to certain additional filing
requirements under current FINRA rule 2210.\240\
---------------------------------------------------------------------------

    \236\ See supra note 15.
    \237\ See FINRA rule 2210(d)(5) (providing that non-money market
fund open-end management company performance data as permitted by
rule 482 in retail communications and correspondence must disclose
standardized performance information and, to the extent applicable,
certain sales charge and expense ratio information); see also supra
note 178.
    \238\ See supra note 231.
    \239\ Rule 24b-3 under the Investment Company Act deems these
materials to have been filed with the Commission if filed with
FINRA. See supra note 29.
    \240\ FINRA rule 2210's filing requirements include a number of
exclusions, including an exclusion for certain research reports,
except that broker-dealers are required to file research reports
with FINRA if they are also required to be filed with the Commission
pursuant to section 24(b) of the Investment Company Act. See supra
notes 167-169, and accompanying text.
---------------------------------------------------------------------------

C. Costs and Benefits

    In this section, we first consider the overarching costs and
benefits associated with the FAIR Act's statutory mandates. Second, we
evaluate the costs and benefits of the specific proposed provisions and
their relation to the overarching considerations resulting from the
statutory mandate. Next, we discuss the effects on efficiency,
competition, and capital formation of the proposed rules. We conclude
with a discussion of alternatives considered.
1. FAIR Act Statutory Mandate
a. Benefits
    We believe that the proposed expansion of the rule 139 safe harbor
(as mandated by the FAIR Act) will generally reduce broker-dealers'
costs of publishing and distributing research reports about covered
investment funds. These cost reductions are expected because under the
proposed rules a broker-dealer could publish or distribute covered
investment fund

research reports without reliance on rule 482 or rule 34b-1 and without
being required to file these reports under section 24(b) of the
Investment Company Act and the rules and regulations thereunder.\241\
Broker-dealers publishing or distributing covered investment fund
research reports in reliance on the expanded safe harbor would not be
subject to the liability provisions of section 12(a)(2) of the
Securities Act,\242\ the content requirements of rule 482 or rule 34b-
1, or the filing requirements of section 24(b) of the Investment
Company Act.\243\ Thus, they would be expected to incur lower costs
associated with liability under section 12(a)(2), lower conduct costs,
and lower compliance costs (including fewer content and filing
requirements).\244\ Because of these cost reductions, we expect
publication and distribution of such reports to increase. First, we
expect that certain broker-dealers that had previously published and
distributed communications under rule 482 that could be styled as
``research reports'' would aim to meet the conditions of the expanded
safe harbor and increase their supply of covered investment fund
research as a result. Second, we expect some broker-dealers that have
previously not published or distributed such reports (due to the
activity being deemed too costly or subject to too many restrictions),
to begin doing so. We believe that the aforementioned effects will
generally benefit broker-dealers and advisers to covered investment
funds if, as we expect, they increase broker-dealers' sales of covered
investment funds.
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    \241\ See supra section II.D.1.
    \242\ See supra note 232.
    \243\ See supra section II.D.1.
    \244\ We note, however, that we would not expect any lower costs
of compliance for any research reports that currently are structured
as rule 34b-1 supplemental sales literature (and are not rule 482
advertising prospectuses), because supplemental sales literature is
not an ``offer'' to which prospectus liability under section
12(a)(2) of the Securities Act would attach.
---------------------------------------------------------------------------

    Because there is limited historical experience dealing specifically
with broker-dealers' research reports on covered investment funds,
there is little in the way of direct empirical evidence on the value of
such reports to investors. Prior research on the informativeness of
broker-dealers' research on operating companies suggests that broker-
dealers can produce research that positively contributes to the
information content of market prices,\245\ and--perhaps more
importantly--that broker-dealers may enjoy a comparative advantage in
its production.\246\ However, other studies have questioned the
investment value of such research to investors\247\ or its continued
relevance.\248\
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    \245\ See, e.g., Brad M. Barber, Reuven Lehavy, & Brett Trueman,
Ratings changes, ratings levels, and the predictive value of
analysts' recommendations, 39 Financial Management 2, 533-553 (2010)
(broker-dealers' research analysts' upgrades (downgrades) elicit
positive (negative) price reactions, respectively). See also Scott
E. Stickel, The Anatomy of the Performance of Buy and Sell
Recommendations, 51 Financial Analysts Journal 5, 25-39 (Sept. 1,
1995) (broker-dealers' research provides new information,
particularly for smaller firms, where information is less generally
available). See also Kent L. Womack, Do Brokerage Analysts'
Recommendations Have Investment Value?, 51 The Journal of Finance 1,
137-167 (1996) (price reactions are permanent and exhibit post-
announcement drift).
    \246\ See, Boris Groysberg, Paul Healy & Craig Chapman, Buy-Side
vs. Sell-Side Analysts' Earnings Forecasts, 64 Financial Analysts
Journal 4, 25-39 (July 1, 2008) (informativeness of broker-dealers'
sell-side research is superior to that of buy-side firms).
    \247\ See Brad Barber, Reuven Lehavy, Maureen McNichols & Brett
Trueman, Can Investors Profit from the Prophets? Security Analyst
Recommendations and Stock Returns, 56 The Journal of Finance 2, 531-
563 (Apr. 1, 2001) (investors hoping to exploit research analysts'
recommendations must trade frequently and these transaction costs
often exceed the gains from trading); see also Xi Li, The
persistence of relative performance in stock recommendations of
sell-side financial analysts, Journal of Accounting and Economics
40.1-3, 129-152 (2005). See also Narasimhan Jegadeesh, Joonghyuk
Kim, Susan D. Krische & Charles M.C. Lee, Analyzing the Analysts:
When Do Recommendations Add Value?, 59 The Journal of Finance 3,
1083-1124 (2004) (significant portion of investment value may be
attributable to previously documented trading signals, with little
incremental value attributable to the broker-dealer research). See
also Yongtae Kim & Minsup Song, Management Earnings Forecasts and
Value of Analyst Forecast Revisions, 61 Management Science 7, 1663-
1683 (2015) (past estimates of the informativeness of analyst
recommendations may be confounded by the impact of forecasts issued
by management).
    \248\ See Oya Alt[inodot]nk[inodot]l[inodot][ccedil], Robert S.
Hansen & Liyu Ye, Can analysts pick stocks for the long-run?, 119
Journal of Financial Economics 2, 371-398 (Feb. 2016) (reductions in
transactions costs and increases in computational speed reduced the
amount of new information available for analysts to discover).
---------------------------------------------------------------------------

    We are cautious in drawing implications from these findings to
broker-dealers' research on covered investment funds. While analysts
researching operating companies generally endeavor to identify
mispricing--to forecast the idiosyncratic component of firms' future
returns--covered investment funds represent portfolios of securities,
and many covered investment funds are priced at net asset value
(``NAV'').\249\ Although individual securities within a covered
investment fund's portfolio may be individually viewed as ``mispriced''
by a research analyst, diversification effects will tend to drown out
such effects at the fund level and minimize idiosyncratic variation in
investors' return on their investment in the fund. Therefore, any
``investment value'' \250\ of research on covered investment funds
would likely be rooted in analysts' ability to predict broader market
movements. Such ability is generally believed to be rather rare.\251\
We therefore believe that the value to investors of information in
broker-dealers' research reports will largely be limited to the
synthesis or discovery of factual information about fund
characteristics, fees, or other transactions costs. For example,
investors may find analysts' views of a fund's management, objectives,
risk exposures, tracking error, volatility, tax efficiency, fees, or
other fund characteristics to be valuable. Such analysis could be
valuable a source of information for investors evaluating relative fund
performance.\252\
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    \249\ Closed-end funds, for example, are not priced on a NAV
basis and their (mis-) pricing has long served as a puzzle in the
finance literature. See, e.g., Charles M.C. Lee, Andrei Schleifer, &
Richard H. Thaler, Investor Sentiment and the Closed-End Fund
Puzzle, 46 The Journal of Finance 1 (Mar. 1991). Similar pricing
issues may arise in BDCs.
    \250\ We mean this in the sense of providing a signal about
future investment performance.
    \251\ See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman, &
Russ Wermers, Measuring Mutual Fund Performance with Characteristic-
Based Benchmarks, 52 The Journal of Finance 3, 1035-1058 (July
1997).
    \252\ See, e.g., W.J. Armstrong, Egemen Genc & Marno Verbeek,
Going for Gold: An Analysis of Morningstar Analyst Ratings,
Management Science (Aug. 2017).
---------------------------------------------------------------------------

    We believe that the quantity of information available to potential
investors of covered investment funds would increase as a result of
broker-dealers' increased publication and distribution of covered
investment fund research reports. The proposed rules will also allow
for greater flexibility in the type of information that broker-dealers
may communicate to customers.\253\ To the extent that this new
information is valuable, it will benefit investors by providing them
with additional information to help shape investment decisions.
Finally, we believe that important negative information about a covered
investment fund, such as high fees, high risk exposure, or an
inefficient portfolio strategy will be more likely to be publicized as
a result of increased competition among information providers, with
attendant benefits to investors.\254\
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    \253\ Currently such communications would be subject to rule 482
requirements, including standards on the presentation of performance
information. See supra section II.C.
    \254\ See Matthew Gentzkow & Jesse M. Shapiro, Media Bias and
Reputation, 114 Journal of Political Economy 2, 280-316 (Apr. 1,
2006).
---------------------------------------------------------------------------

    We request comment generally on the benefits that we anticipate may
arise

from proposed rule 139b and proposed rule 24b-4 as a result of the FAIR
Act's statutory mandate.
     Do commenters generally agree with our assessment of the
cost reductions that we expect to result from the proposed rules?
     To what extent would broker-dealers rely on the proposed
rule 139b safe harbor to publish or distribute communications that are
currently structured as rule 482 advertising prospectuses or rule 34b-1
supplemental sales literature? What would motivate broker-dealers to
instead use the proposed rule 139b safe harbor? For example, would
broker-dealers expect to incur significantly lower legal and compliance
costs and lower costs related to potential litigation due to covered
investment fund research reports' lack of prospectus liability under
section 12(a)(2) of the Securities Act under the safe harbor?
Alternatively, would the primary cost savings arise in other ways (for
example, because covered investment fund research reports would not be
subject to section 24(b) filing requirements, including filing and
review by FINRA, and would not be subject to the content requirements
of rule 482 or rule 34b-1)? What other factors could determine whether
a broker-dealer that is currently publishing or distributing
communications under rule 482 or rule 34b-1 might continue to do so,
even if these communications could fall within the definition of a
``covered investment fund research report''?
     Have we appropriately captured the potential benefits that
the proposed rule could generate for investors?
b. Costs
    Prior experience and academic research suggests that, unchecked,
broker-dealers' conflicts of interest can lead to bias in research
reports,\255\ and that such bias has the potential to adversely affect
investor welfare.\256\ Broker-dealers' financial incentives to sell
covered investment funds could undermine the objectivity of the
information they produce about such funds, and the existence of the
proposed safe harbor could increase opportunities for broker-dealers to
promote funds from which they derive the most financial benefits. If
such conflicts are unrecognized by or unknown to investors, they could
reduce investor welfare. Although market mechanisms \257\ as well as
existing regulation \258\ may limit the extent of such actions, there
is the potential that they could nonetheless impose costs on
investors--particularly retail investors.\259\
---------------------------------------------------------------------------

    \255\ See Amitabh Dugar & Siva Nathan, The Effect of Investment
Banking Relationships on Financial Analysts' Earnings Forecasts and
Investment Recommendations*, 12 Contemporary Accounting Research 1,
131-160 (Sept. 1, 1995) (``Dugar and Nathan Article'') (affiliated
analysts issue more optimistic earnings forecasts and investment
recommendations about companies with which their firms had an
investment banking relationship). See also Hsiou-wei Lin & Maureen
F. McNichols, Underwriting Relationships, Analysts' Earnings
Forecasts and Investment Recommendations, 25 Journal of Accounting
and Economics 1, 101-127 (Feb. 26, 1998) (``Lin and McNichols
Article'') (affiliated analysts are more optimistic in their long-
term growth forecasts and investment recommendations).
    \256\ See Roni Michaely & Kent L. Womack, Conflict of Interest
and the Credibility of Underwriter Analyst Recommendations, 12 The
Review of Financial Studies 4, 653-686 (July 2, 1999) (``Michaely
and Womack Article'') (stock recommendations of affiliated analysts
perform worse prior to, at the time of, and subsequent to the
recommendation); see also Patricia M. Dechow, Amy P. Hutton &
Richard G. Sloan, The Relation between Analysts' Forecasts of Long-
Term Earnings Growth and Stock Price Performance Following Equity
Offerings*, 17 Contemporary Accounting Research 1, 1-32 (Mar. 1,
2000). See also Lit. Rel. No. 18438, supra note 37 (The court issued
an Order approving a $1.4 billion global settlement of the SEC
enforcement actions against several investment firms and certain
individuals alleging undue influence of investment banking interests
on securities research); see also Deutsche Bank Securities Inc. and
Thomas Weisel Partners LLC Settle Enforcement Actions Involving
Conflicts of Interest Between Research and Investment Banking, SEC
Press Release 2004-120 (Aug. 26, 2004). The settlement was an action
in response to conflicts of interest that certain broker-dealers
were found to have failed to manage in an adequate or appropriate
manner and was modified in 2010 to remove certain requirements where
FINRA and NYSE rules addressed the same concerns. See Lit. Rel. No.
21457, supra note 37.
    \257\ See infra section III.C.1.b(2).
    \258\ See infra section III.C.1.b(1).
    \259\ See infra section III.C.1.b(2).
---------------------------------------------------------------------------

    The potential for conflicts of interest to lead to actions that
impose costs on investors depends in large part on the strength of the
underlying incentives. In the context of broker-dealers' research on
covered investment funds, the greatest conflicts of interest are faced
by broker-dealers serving as investment advisers to covered investment
funds, who--due to asset-based management fees--have strong incentives
to increase demand for the funds that they advise. Because the FAIR Act
by its terms,\260\ and also proposed rule 139b,\261\ would not extend
the safe harbor to a broker-dealer that is publishing or distributing a
research report about a covered investment fund for which the broker-
dealer serves as an investment adviser (or where the broker-dealer is
an affiliated person of the investment adviser), we believe that there
would be limited potential for the greatest conflicts of interest to
impose costs on investors.
---------------------------------------------------------------------------

    \260\ See section 2(f)(3) of the FAIR Act.
    \261\ See proposed rule 139b(a).
---------------------------------------------------------------------------

    Other conflicts of interest may nevertheless arise from incentives
in fund distribution arrangements.\262\ Distributing broker-dealers may
receive compensation from sales loads, 12b-1 fees,\263\ shelf space
fees, or other revenue sharing agreements, all of which create
financial incentives for broker-dealers to promote and sell funds and
potentially to promote and sell particular funds or share classes.\264\
Associated persons of broker-dealers (i.e. analysts) may face similar
conflicts of interests arising from incentives in their compensation
agreements.\265\ Finally, broker-dealers may have fewer direct or non-
pecuniary incentives.\266\ However, in all of these cases, the risk

that such conflicts of interest could result in actions that negatively
impact information communicated to investors are mitigated by the fact
that a broker-dealer will bear the costs of such actions, but generally
may be unable to fully appropriate the benefits.\267\
---------------------------------------------------------------------------

    \262\ See Susan E. K. Christoffersen, Richard Evans & David K.
Musto, What Do Consumers' Fund Flows Maximize? Evidence from Their
Brokers' Incentives, 68 The Journal of Finance 1, 201-235 (Feb. 1,
2013) (where brokers' compensation arrangements with funds are found
to drive their customers' fund flows).
    \263\ See rule 12b-1 under the Investment Company Act [17 CFR
270.12b-1].
    \264\ See infra note 278 (noting that the Commission has
historically charged broker-dealers with violating sections 17(a)(2)
and (3) of the Securities Act for making recommendations of more
expensive mutual fund share classes while omitting material facts).
    \265\ Such conflicts of interest arising from incentives in
compensation agreements involving research analyst issuing research
reports covered by FINRA Rule 2241 are mitigated by FINRA rules
2241(b)(2)(C), (E), (F), and (K). Additionally, section 501(a)(2) of
Regulation AC (17 CFR 242.501(a)(2)) requires specific disclosure
regarding research analyst compensation in order to mitigate the
conflicts of interest that can arise based on analyst compensation
arrangements.
    \266\ For example, although it is prohibited conduct, a broker-
dealer may have a financial incentive to provide coverage for, or to
promote, a fund based on an understanding that the fund will
participate in offerings underwritten by the broker-dealer. See,
e.g., FINRA rule 2241(b)(2) (requiring that a member's written
policies and procedures must be reasonably designed to, among other
things, ``prevent the use of research reports or research analysts
to manipulate or condition the market or favor the interests of the
member''); see also NASD Fines U.S. Bancorp Piper Jaffray and
Managing Director $300,000, FINRA News Release (June 25, 2002)
available at http://www.finra.org/newsroom/2002/nasd-fines-us-bancorp-piper-jaffray-and-managing-director-300000 (announcing
settlement with U.S. Bancorp Piper Jaffray and one of its managing
directors in which the NASD found that the firm violated a NASD (now
FINRA) rule requiring all firms and associated persons to adhere to
high standards of commercial honor and just and equitable principles
of trade when it threatened to discontinue research coverage of a
company if the company did not select it as lead underwriter for an
upcoming offering). But see also note 43.
     Rule 12b-1(h)(1) prohibits funds from compensating a broker-
dealer for promoting or selling funds shares by directing brokerage
transactions to that broker. See rule 12b-1(h)(1) under the
Investment Company Act [17 CFR 270.12b-1(h)(1)]; see also
Prohibition on the Use of Brokerage Commissions to Finance
Distribution, Investment Company Act Release No. 26591 (Sept. 2,
2004) [69 FR 54727 (Sept. 9, 2004)].
    \267\ For example, if a broker-dealer firm publishes biased
research about a fund, some of the gains (i.e. compensation from
sales of that fund) may accrue to other broker-dealer firms (i.e.
other broker-dealer firms that distribute the same fund) while the
costs of the action (i.e., reputation costs, litigation risk, and
risk of regulatory action) will be borne entirely by the broker-
dealer firm that published the biased research.
---------------------------------------------------------------------------

    It is difficult for us to quantify the aforementioned costs in the
context of this proposal. We are not aware of any studies directly
examining the role that conflicts of interest play in broker-dealers'
research reports on covered investment funds in U.S. markets, or of any
data that would support a quantitative analysis of an expanded safe
harbor in this context.\268\ As with the potential benefits discussed
above, we are limited to characterizing the potential costs
qualitatively. While we believe that expanding the rule 139 safe harbor
to broker-dealers' publication or distribution of covered investment
fund research reports has the potential to impose costs on retail
investors, existing regulations, specific provisions of the rules that
we are proposing,\269\ and certain market mechanisms would reduce these
costs.
---------------------------------------------------------------------------

    \268\ Authors have examined the impact of conflicts of interest
on mutual fund research in China, providing evidence consistent with
bias arising from conflicts of interest in that market, though
differences between Chinese and U.S. markets and corresponding
regulatory frameworks make it difficult to apply inferences drawn
from experience in Chinese markets to U.S. markets. See Y. Zeng, Q.
Yuan & J. Zhang, Blurred stars: Mutual fund ratings in the shadow of
conflicts of interest, Journal of Banking & Finance 60, 284-295
(2015).
    \269\ See infra section III.C.2.
---------------------------------------------------------------------------

(1) Existing Regulation
    Rules and regulations have been implemented to address potential
conflicts of interest that may arise with broker-dealers specifically
in the context of research reports.\270\ As discussed in detail
above,\271\ the definition of ``research report'' for purposes of
Regulation AC and FINRA rule 2241 is narrower than the definition of
``research report'' for purposes of the FAIR Act and proposed rule
139b. However, to the extent a research report meets both the
definition of a research report under proposed rule 139b and the
definition of research report as defined in Regulation AC, Regulation
AC would be applicable to that research report (and, if it meets the
definition of ``research report'' in FINRA rule 2241, FINRA rule 2241
also would apply if the research report otherwise were within the scope
of rule 2241 \272\). These rules may help promote objective and
reliable research.\273\
---------------------------------------------------------------------------

    \270\ See supra note 37.
    \271\ See supra notes 11, 21, 43, and 174.
    \272\ See supra note 174.
    \273\ See Regulation AC Adopting Release, supra note 37. Several
studies have analyzed bias in broker-dealers' research following the
Global Settlement and subsequent regulatory changes, in particular
at sanctioned banks. See O. Kadan, L. Madureira, R. Wang, & T. Zach,
Conflicts of interest and stock recommendations: The effects of the
global settlement and related regulations 22 The Review of Financial
Studies 10, 4189-4217 (2009). See also, S.A. Corwin, S.A. Larocque &
M.A. Stegemoller, Investment banking relationships and analyst
affiliation bias: The impact of the global settlement on sanctioned
and non-sanctioned banks, 124 Journal of Financial Economics 3, 614-
631(2017).
---------------------------------------------------------------------------

    Additionally, as described above, FINRA rule 2210 contains general
content standards that apply broadly to member communications,
including broker-dealer research reports. These general content
standards require, among other things, that all member communications
``must be based on principles of fair dealing and good faith, must be
fair and balanced, and must provide a sound basis for evaluating the
facts in regard to any particular security or type of security,
industry or service.'' \274\
---------------------------------------------------------------------------

    \274\ See supra section II.D.1.
---------------------------------------------------------------------------

    If a broker-dealer recommends \275\ a covered investment fund to
its customers, additional obligations under the federal securities laws
and FINRA rules would apply. As a general matter, broker-dealers must
deal with their customers fairly \276\--and, as part of that
obligation, have a reasonable basis for any recommendation.\277\
Furthermore, when making recommendations, broker-dealers may be
generally liable under the antifraud provisions if they do not give
``honest and complete information'' or disclose any material adverse
facts or conflicts of interest, including any economic self-
interest.\278\
---------------------------------------------------------------------------

    \275\ See, e.g., Additional Guidance on FINRA's New Suitability
Rule, FINRA Regulatory Notice 12-25 (May 2012), at Q.2 and Q.3
(regarding the scope of ``recommendation'') and n.25.
    \276\ See, e.g., Duker & Duker, Exchange Act Release No. 2350
(Dec. 19, 1939), at 2 (Commission opinion) (``Inherent in the
relationship between a dealer and his customer is the vital
representation that the customer be dealt with fairly, and in
accordance with the standards of the profession.'').
    \277\ See Mac Robbins & Co., Exchange Act Release No. 6846 (July
11, 1962), at 3 (``[T]he making of representations to prospective
purchasers without a reasonable basis, couched in terms of either
opinion or fact and designed to induce purchases, is contrary to the
basic obligation of fair dealing borne by those who engage in the
sale of securities to the public.''), aff'd sub nom., Berko v. SEC,
316 F.2d 137 (2d Cir. 1963). A broker-dealer's recommendation must
also be suitable for the customer. See, e.g., J. Stephen Stout,
Exchange Act Release No. 43410 (Oct. 4, 2000), at 11 (Commission
opinion) (``As part of a broker's basic obligation to deal fairly
with customers, a broker's recommendation must be suitable for the
client in light of the client's investment objectives, as determined
by the client's financial situation and needs.''); see also FINRA
Rule 2111.05(b) (``The customer-specific obligation requires that a
member or associated person have a reasonable basis to believe that
the recommendation is suitable for a particular customer based on
that customer's investment profile, as delineated in Rule
2111(a).'').
    \278\ See, e.g., De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d
1293, 1302 (2d Cir. 2002); Chasins v. Smith, Barney & Co., 438 F.2d
1167, 1172 (2d Cir. 1970). Generally, under the antifraud
provisions, whether a broker-dealer has a duty to disclose material
information to its customer is based upon the scope of the
relationship with the customer, which is fact intensive. See, e.g.,
Conway v. Icahn & Co., Inc., 16 F.3d 504, 510 (2d Cir. 1994) (``A
broker, as agent, has a duty to use reasonable efforts to give its
principal information relevant to the affairs that have been
entrusted to it.''). For example, where a broker-dealer processes
its customers' orders, but does not recommend securities or solicit
customers, then the material information that the broker-dealer is
required to disclose is generally narrow, encompassing only the
information related to the consummation of the transaction. See,
e.g., Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 536 (2d
Cir. 1999). The Commission has historically charged broker-dealers
with violating sections 17(a)(2) and (3) of the Securities Act for
making recommendations of more expensive mutual fund share classes
while omitting material facts. See, e.g., In re IFG Network Sec.,
Inc., Exchange Act Release No. 54127 (July 11, 2006), at 15
(Commission opinion) (registered representative violated 17(a)(2)
and (3) by omitting to disclose to his customers material
information concerning his compensation and its effect upon returns
that made his recommendation that they purchase Class B shares
misleading; ``The rate of return of an investment is important to a
reasonable investor. In the context of multiple-share-class mutual
funds, in which the only bases for the differences in rate of return
between classes are the cost structures of investments in the two
classes, information about this cost structure would accordingly be
important to a reasonable investor.'').
---------------------------------------------------------------------------

(2) Market Mechanisms
    We believe that by facilitating production of information on
covered investment funds, the FAIR Act's mandates will contribute to
competition among information providers,\279\ which we believe can
mitigate the effects of conflicts of interest on research reports.\280\
With respect to broker-dealers' research on operating companies,
analysts' career concerns \281\

have also been found to have similar effects, and, in principle,
broker-dealers' reputations could as well.\282\ However, we do not
believe that analyst career concerns or broker-dealer reputation will
play as significant a role in the context of covered investment fund
research reports. Research reports about operating companies have
traditionally been provided to institutional investors as part of a
bundle of services provided by full-service brokerages.\283\ In this
setting, broker-dealers benefit from institutional customers that are
willing to pay for broker-dealers' additional services (e.g.,
research).\284\ They are also generally capable of producing similar
reports, and so can evaluate the quality of broker-dealers'
research.\285\ Thus, institutional investors can provide market
discipline: broker-dealers' provision of low-quality or misleading
information could plausibly be discovered and lead to the loss of
valuable customer relationships. We do not believe that similar
mechanisms would be as effective in the covered investment fund
context. We expect broker-dealers to publish and distribute covered
investment fund research reports on funds that they distribute to their
customers.\286\ With retail investors, information asymmetries are
greater: retail investors do not generally possess the capabilities to
replicate an analyst report or evaluate its quality.\287\ Moreover, the
problem of evaluating the performance of analysts is harder in the
context of covered investment funds.\288\ Because institutional
investors are not major investors in covered investment funds,\289\ we
believe they are unlikely to provide market discipline in this
context,\290\ and we do not believe that individual retail investors
could be similarly effective in this role. Thus, we believe that in the
context of covered investment fund research reports, providing market
discipline would largely fall on retail investors' investment advisers.
---------------------------------------------------------------------------

    \279\ See infra section III.C.5.
    \280\ See Harrison Hong & Marcin Kacperczyk, Competition and
Bias, 125 The Quarterly Journal of Economics 4, 1683-1725 (Nov. 1,
2010) (reduction in (analyst) competition resulting from mergers
reduces analyst coverage and increases bias in the remaining
coverage).
    \281\ See Harrison Hong & Jeffrey D. Kubik, Analyzing the
Analysts: Career Concerns and Biased Earnings Forecasts, 58 The
Journal of Finance 1, 313-351 (2003) (analysts' reputation plays a
role in the analyst's career outcome); see also Andrew R. Jackson,
Trade Generation, Reputation, and Sell-Side Analysts, 60The Journal
of Finance 2, 673-717 (Apr. 1, 2005) see also Lily Fang & Ayako
Yasuda, The Effectiveness of Reputation as a Disciplinary Mechanism
in Sell-Side Research, 22 The Review of Financial Studies 9, 3735-
3777 (Sept. 1, 2009) (``Fang and Yasuda Article'')
    \282\ For a discussion of the role of reputation in financial
intermediation, see Thomas J. Chemmanur & Paolo Fulghieri,
Investment Bank Reputation, Information Production, and Financial
Intermediation, 49 The Journal of Finance 1, 57-79 (1994)
(``Chemmanur and Fulghieri Article''). See also Fang and Yasuda
Article, supra note 281 (analyst reputation mitigates bias, but
institutional reputation does not).
    \283\ See Mehran, Hamid, and Ren[eacute] M. Stulz, The Economics
of Conflicts of Interest in Financial Institutions, 85 Journal of
Financial Economics 2, 267-296 (Aug. 1, 2007) (``Mehran and Stulz
Article'').
    \284\ Institutional customers are valuable in that they are
willing to pay for brokers-dealers' additional services (e.g.
research). Payments for such services need not be direct and be
reflected in (relatively) higher brokerage commissions. See Michael
A. Goldstein, Paul Irvine, Eugene Kandel & Zvi Wiener, Brokerage
Commissions and Institutional Trading Patterns, 22 The Review of
Financial Studies 12, 5175-5212 (Dec. 1, 2009).
    \285\ See id. See also Ulrike Malmendier & Devin Shanthikumar,
Are Small Investors Naive about Incentives?, 85 Journal of Financial
Economics 2, 457-489 (Aug. 1, 2007) (``Malmendier and Shanthikumar
Article'') (institutions account for bias in analyst's
recommendations while retail investors do not).
    \286\ See supra section III.B.1.c.
    \287\ See Mehran and Stulz Article, supra note 283.
    \288\ Traditional analyst research reports on operating
companies largely focus on firm-specific factors, and thus are more
akin to ``stock picking'' than ``market timing'': they attempt to
forecast the idiosyncratic component of firms' future returns.
Covered investment funds represent portfolios of securities and
diversification effects reduce the amount of idiosyncratic variation
in their returns. Thus, abstracting from fees, ``fund picking'' is
more akin to ``market timing'' than ``stock picking.'' Market timing
is a skill that is relatively rare and econometrically difficult to
detect. See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman &
Russ Wermers. Measuring Mutual Fund Performance with Characteristic-
Based Benchmarks, 52 The Journal of Finance 3, 1035-1058 (July
1997).
    \289\ See supra section III.B.1.a
    \290\ See Alexander Ljungqvist, Felicia Marston, et al.,
Conflicts of Interest in Sell-Side Research and the Moderating Role
of Institutional Investors, 85 Journal of Financial Economics 2,
420-456 (Aug. 1, 2007) (securities of interest to institutional
investor receive coverage that is less biased).
---------------------------------------------------------------------------

    We also acknowledge that bias resulting from conflicts of interest
need not adversely impact investors if investors disregard,\291\
discount,\292\ or de-bias \293\ the recommendations of conflicted
analysts.\294\ We believe however, that retail investors who are
primary clientele for covered investment funds are less likely to be
aware of potential bias in analysts' recommendations,\295\ may fail to
de-bias or otherwise condition their trades based on the credibility of
the recommendation,\296\ and could thus be led to invest in
underperforming securities.\297\
---------------------------------------------------------------------------

    \291\ See Dugar and Nathan Article, supra note 255.
    \292\ See Michaely and Womack Article, supra note 256.
    \293\ See Lin and McNichols Article, supra note 255.
    \294\ Institutional market participants generally attribute bias
in sell-side analysts' research reports to conflicts of interest.
See Michaely and Womack Article, supra note 256.
    \295\ See Michael B. Mikhail, Beverly R. Walther & Richard H.
Willis, When Security Analysts Talk, Who Listens?, 82 The Accounting
Review 5, 1227-1253 (2007) (``Mikhail Walther and Willis Article'').
See also Diane Del Guercio & Paula A. Tkac, Star Power: The Effect
of Morningstar Ratings on Mutual Fund Flow, 43 Journal of Financial
and Quantitative Analysis 4, 907-936 (Dec. 2008) (retail investors
in mutual funds are very sensitive to fund rankings). See
Christopher R. Blake & Matthew R. Morey, Morningstar Ratings and
Mutual Fund Performance, 35 The Journal of Financial and
Quantitative Analysis 3, 451-483 (2000) (mutual fund ranking have
little predictive power for future performance).
    \296\ See id. and Malmendier and Shanthikumar Article, supra
note 285.
    \297\ See Mikhail Walther and Willis Article, supra note 295.
See also Malmendier and Shanthikumar Article, supra note 285. See
also Amanda Cowen, Boris Groysberg & Paul Healy, Which Types of
Analyst Firms Are More Optimistic?, 41 Journal of Accounting and
Economics 1, 119-146 (Apr. 1, 2006) (finding that analysts at retail
brokerage firms are more optimistic than those serving only
institutional investors). See Xuanjuan Chen, Tong Yao & Tong Yu,
Prudent Man or Agency Problem? On the Performance of Insurance
Mutual Funds, 16 Journal of Financial Intermediation 2, 175-203
(Apr. 1, 2007) (underperformance of mutual funds sponsored by
insurance companies is attributed to inadequate monitoring by less
sophisticated retail customers who are subject to cross-selling
efforts by their insurer). See also Daniel Bergstresser, John M.R.
Chalmers, and Peter Tufano, Assessing the Costs and Benefits of
Brokers in the Mutual Fund Industry, 22 Review of Financial Studies
10, 4129-4156 (Oct. 2009) (broker-sold mutual funds deliver lower
risk-adjusted returns (even before subtracting distribution fees)
than direct-sold funds). See also Diane Del Guercio & Jonathan
Reuter, Mutual Fund Performance and the Incentive to Generate Alpha,
69 The Journal of Finance 4, 1673-1704 (Aug. 1, 2014)
(underperformance of actively managed mutual funds is attributed to
the underperformance of funds sold by brokers; the authors find
little evidence for underperformance in the subset of funds that are
sold directly to investors).
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    We request comment generally on the costs that we anticipate may
arise from proposed rule 139b and proposed rule 24b-4 as a result of
the FAIR Act's statutory mandate.
     Do commenters generally agree with our assessment of the
costs that we expect to result from the proposed rules?
     Do commenters expect conflicts of interest to materially
affect research reports on covered investment funds? If so, in what
way? If not, why not?
2. Proposed Rule 139b
    As discussed above, proposed rule 139b conditions eligibility for
the safe harbor on satisfaction of several conditions.\298\ These
conditions are generally modeled on and resemble similar provisions in
rule 139 (with differences from rule 139 that the FAIR Act specifically
directs, or that tailor the provisions of rule 139 more directly or
specifically to the context of covered investment fund research
reports).\299\ We believe that modeling proposed rule 139b on rule 139
will benefit market participants through regulatory consistency and
reduced opportunities for investor confusion. We address these
conditions in turn in the sections that follow.
---------------------------------------------------------------------------

    \298\ See supra section II.B.
    \299\ See supra paragraph accompanying notes 32-34.
---------------------------------------------------------------------------

a. Affiliate Exclusion
    Under the affiliate exclusion proposed in rule 139b,\300\ a broker-
dealer who is

an affiliate of a covered investment fund (or is an investment adviser
or an affiliated person of the investment adviser to a covered
investment fund), would not be eligible for the safe harbor of proposed
rule 139b when publishing or distributing a research report about that
covered investment fund. The economic benefit of the affiliate
exclusion is that it reduces the potential for retail investors to
receive research reports containing information that was published,
distributed, authorized, or approved by persons whose financial
incentives create the greatest conflicts of interest.\301\ The primary
cost of the affiliate exclusion will be borne by broker-dealers that
both distribute covered investment funds and act as investment advisers
to such funds (or do so through affiliated persons). These broker-
dealers will be unable to provide research reports to their customers
on funds that they (or their affiliated persons) advise.\302\ In
addition, we believe that smaller broker-dealers, and broker-dealers
without significant research departments and who would want to rely on
pre-publication materials distributed by a covered investment fund, its
adviser, or affiliated persons, would also be significantly affected by
the proposed rules.
---------------------------------------------------------------------------

    \300\ See section 2(f)(3) of the FAIR Act. See supra section
II.A.1.
    \301\ See supra section III.C.1.b.
    \302\ See supra note 21.
---------------------------------------------------------------------------

    We expect covered investment funds and their investment advisers to
engage in a broad range of marketing activities to support the
distribution of fund shares (particularly in the case of redeemable
securities such as those issued by mutual funds), and that funds and
their advisers prepare and distribute materials to distributing broker-
dealers intended to increase sales. As discussed in section II.A.1, we
note that, if a broker-dealer were to publish or distribute a research
report that were to include pre-publication materials that were
specifically authorized or approved by a person covered by the
affiliate exclusion for purposes of inclusion in a research report,
this could inappropriately circumvent the affiliate exclusion. This
guidance reduces the potential for retail investors to receive research
reports containing materials from persons whose financial incentives
create the greatest conflicts of interest.\303\
---------------------------------------------------------------------------

    \303\ Persons covered by the affiliate exclusion may have strong
financial interests to increase sales of associated covered
investment funds. See supra paragraph accompanying note 260.
---------------------------------------------------------------------------

    The proposed affiliate exclusion is also likely to limit the
benefits of the proposed rule for certain broker-dealers. Many broker-
dealers distributing covered investment fund securities do not have
sizeable research departments, and we understand that very few broker-
dealers operate at a scale that would allow for comprehensive coverage
of the covered investment funds that they distribute. The proposed
affiliate exclusion could have the effect of limiting broker-dealers'
ability and willingness to publish and distribute research reports
about the funds they distribute: in order to rely on the rule to
publish or distribute a covered investment fund research report, these
broker-dealers would need to conduct their own research in-house or to
rely on independent third-party service providers for their
information.
    We are also seeking commenters' views on our analysis:
     Will the proposed affiliate exclusion reduce the potential
for investors to receive research reports that were affected by
significant conflicts of interest?
     Will smaller broker-dealers, or broker-dealers without
significant research departments, be most impacted by the proposed
affiliate exclusion (and our guidance on the proposed affiliate
exclusion)? If not, which broker-dealers would be most affected, and
why?
     Are there additional benefits associated with the content
and presentation standards that we have not considered?
     Are there additional costs associated with content and
presentation requirements that we have not considered?
b. Regular-Course-of-Business Requirement
    Under proposed rule 139b, research reports (both issuer-specific
research reports and industry research reports) would need to be
published or distributed by the broker-dealer in the ``regular course
of its business'' in order to rely on the safe harbor.\304\ For issuers
that do not have a class of securities in ``substantially continuous
distribution,'' issuer-specific research reports that represent the
initiation of publication of research reports about the issuer or its
securities or reinitiation following discontinuation of publication of
such research reports would be deemed to not satisfy the regular-
course-of-business requirement.\305\ The regular-course-of-business
requirement being proposed under rule 139b is similar to that of rule
139, except that, as directed by the FAIR Act, rule 139b specifies that
the ``initiation or reinitiation requirement'' only applies to research
reports regarding a covered investment fund that does not have a class
of securities in substantially continuous distribution.\306\
---------------------------------------------------------------------------

    \304\ See supra sections II.B.1.c and II.B.2.b.
    \305\ See supra note 96 and accompanying text.
    \306\ See section 2(b)(1) of the FAIR Act; see also supra
discussion at note 98.
---------------------------------------------------------------------------

    Given the breadth of the definition of ``research report'' under
the FAIR Act (and the definition of ``research report'' that we propose
under rule 139b), certain communications that are currently treated as
covered investment fund advertisements under Securities Act rule 482
could fall under the proposed rule 139b definition of ``research
report.'' \307\ Investors, particularly retail investors, may be
unaware of the differences in regulatory status and purpose among the
various types of communications regarding registered investment
companies and business development companies. This may result in
investors not being able to readily discern what constitutes a research
report and what constitutes an advertisement about these issuers.\308\
We believe that broker-dealers that publish or distribute research
reports in the regular course of business are more likely to publish
analysis that investors recognize as research.\309\ Therefore, in
principle we expect this requirement to benefit investors by reducing
opportunities for communications published or distributed under the
safe harbor to cause confusion about their intended purpose. However we
also believe that establishing whether a research report is published
in the ``regular course of business'' could, in practice, prove
uniquely challenging in the covered investment funds context.\310\
---------------------------------------------------------------------------

    \307\ See supra note 102 and accompanying text.
    \308\ See supra paragraph accompanying note 103.
    \309\ See supra paragraph accompanying note 104.
    \310\ See supra requests for comment in section II.B.1.c
(requesting comment on the application of the regular-course-of-
business requirement in the context of broker-dealers' publication
or distribution of covered investment fund research reports and
unique concerns relevant to this context (e.g., whether the proposed
requirement should be modified to address broker-dealers that have
not previously published or distributed covered investment fund
research reports)).
---------------------------------------------------------------------------

    First, in the context of covered investment funds, the distinction
between communications intended as sales materials and those intended
as research could be difficult to discern. Research reports about debt
and equity securities have traditionally been provided to institutional
customers as part of the broker-dealer's collection of services.\311\
Institutional customers are generally capable of producing similar
reports, and so can more readily evaluate the quality of broker-
dealers'

research.\312\ In these circumstances, broker-dealers have a compelling
business rationale for producing high-quality research as distinct from
sales materials.
---------------------------------------------------------------------------

    \311\ See Mehran and Stulz Article, supra note 283.
    \312\ See id; see also Malmendier and Shanthikumar Article,
supra note 285.
---------------------------------------------------------------------------

    In contrast, we expect covered investment fund research reports to
be produced by broker-dealers that distribute covered investment funds
to retail customers.\313\ With retail investors, information
asymmetries are greater: retail investors do not generally possess the
capabilities to produce an analyst report or evaluate its quality, and
some may have difficulty differentiating between research and sales
literature.\314\ Moreover, the problem of evaluating the performance of
research analysts is harder in the context of covered investment
funds.\315\ Thus, we believe that cultivating a reputation for high-
quality research is less likely to serve as the primary business
rationale for broker-dealers' publication and distribution of research
reports on covered investment funds. Rather, we expect that
facilitating the marketing of covered investment funds to customers (so
as to increase revenues derived from distribution arrangements) will
motivate these activities. In this setting, the distinction between
different types of communications is not as clear.
---------------------------------------------------------------------------

    \313\ See supra section III.B.1.c.
    \314\ See Mehran and Stulz Article, supra note 283.
    \315\ Traditional analyst research reports on operating
companies largely focus on firm-specific factors, and thus are more
akin to ``stock picking'' than ``market timing'': they attempt to
forecast the idiosyncratic component of firms' future returns.
Covered investment funds represent portfolios of securities and
diversification effects reduce the amount of idiosyncratic variation
in their returns. Thus, abstracting from fees, ``fund picking'' is
more akin to ``market timing'' than ``stock picking.'' Market timing
is a skill that is relatively rare and econometrically difficult to
detect. See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman &
Russ Wermers. Measuring Mutual Fund Performance with Characteristic-
Based Benchmarks, 52 The Journal of Finance 3, 1035-1058 (July
1997).
---------------------------------------------------------------------------

    Second, we note that the information environment surrounding
covered investment funds further complicates establishing whether
publishing research reports about covered investment funds is
undertaken in the regular course of business. In the context of
research reports about operating companies, a research analyst
``following'' an operating company continually monitors that company so
as to provide timely forecasts and recommendations. Because of
differences in the nature of covered investment funds and operating
companies, we believe that the same is less likely to hold for a
research analyst ``following'' a covered investment fund.\316\ We
believe that the opportunities for acquiring idiosyncratic information
relevant to future returns of covered investment funds are generally
more limited: Covered investment funds represent portfolios of
securities and diversification effects reduce the value of
idiosyncratic (i.e., firm-specific) information.\317\ Consequently, we
expect research analysts ``following'' covered investment funds to
focus instead on information related to fund characteristics (e.g.,
fees, portfolio composition, or index tracking strategy) and on
developments at the sector- or macro-level. Because we do not expect
the arrival of such information to be as frequent, we expect that the
inclusion of new analysis in research reports about covered investment
funds could be more rare than in the context of operating company
research reports. Consequently, the publication or distribution of
covered investment fund research reports could occur relatively
infrequently, or could be driven largely by market-wide factors. This
could make it more difficult to establish whether a covered investment
fund research report is published in the regular course of business.