[Federal Register Volume 80, Number 140 (Wednesday, July 22, 2015)]
[Notices]
[Pages 43528-43547]
[FR Doc No: 2015-17972]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-75472; File No. SR-FINRA-2014-048]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by
Amendment No. 1 Thereto, To Adopt FINRA Rule 2242 (Debt Research
Analysts and Debt Research Reports)

July 16, 2015.

I. Introduction

    On November 14, 2014, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission''), pursuant to section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule to adopt new FINRA Rule 2242 (Debt
Research Analysts and Debt Research Reports) to address conflicts of
interest relating to the publication and distribution of debt research
reports. The proposal was published for comment in the Federal Register
on November 24, 2014.\3\ The Commission received five comments on the
proposal.\4\ On February 19, 2015, FINRA filed Amendment No. 1
responding to the comments received to the proposal as well as to
propose amendments in response to these comments. The proposal, as
amended by Amendment No. 1, was published for comment in the Federal
Register on March 18, 2015.\5\ On February 20, 2015, the Commission
issued an order instituting proceedings pursuant to section 19(b)(2)(B)
of the Act \6\ to determine whether to approve or disapprove the
proposal. The order was published for comment in the Federal Register
on February 26, 2015.\7\ The Commission received a further four
comments regarding the proceedings or in response

to Amendment No. 1,\8\ to which FINRA responded via letter on May 5,
2015.\9\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Exchange Act Release No. 73623 (Nov. 18, 2014); 79 FR 69905
(Nov. 24, 2014) (``Notice''). On January 6, 2015, FINRA consented to
extending the time period for the Commission to either approve or
disapprove the proposed rule change, or to institute proceedings to
determine whether to approve or disapprove the proposed rule change,
to February 20, 2015.
    \4\ See Letter from Kevin Zambrowicz, Associate General Counsel
& Managing Director and Sean Davy, Managing Director, SIFMA, dated
Dec. 15, 2014 (``SIFMA''), Letter from Hugh D. Berkson, President-
Elect, Public Investors Arbitration Bar Association, dated Dec. 15,
2014 (``PIABA Debt''), Letter from Yoon-Young Lee, WilmerHale, dated
Dec. 16, 2014 (``WilmerHale Debt One''), Letter from William Beatty,
President and Washington (State) Securities Administrator, North
American Securities Administrators Association, Inc., dated Dec. 19,
2014 (``NASAA Debt One''), and Letter from Kurt N. Schacht, CFA,
Managing Director, Standards and Financial Market Integrity and
Linda L. Rittenhouse, Director, Capital Markets Policy, CFA
Institute, dated Feb. 9, 2015 (``CFA Institute One'').
    \5\ Exchange Act Release No. 74490 (Mar. 12, 2015); 80 FR 14198
(Mar. 18, 2015) (``Amendment Notice'').
    \6\ 15 U.S.C. 78s(b)(2)(B).
    \7\ Exchange Act Release No. 74340 (Feb. 20, 2015); 80 FR 10538
(Feb. 26, 2015). Specifically, the Commission instituted proceedings
to allow for additional analysis of the proposed rule change's
consistency with section 15A(b)(9) of the Act, which requires that
FINRA's rules be designed to, among other things, promote just and
equitable principles of trade, remove impediments to and perfect the
mechanism of a free and open market and a national market system,
and, in general, to protect investors and the public interest. See
id.
    \8\ Letter from Stephanie R. Nicholas, WilmerHale, dated Apr. 6,
2015 (``WilmerHale Debt Two''), Letter from Kurt N. Schacht,
Managing Director, Standards and Financial Market Integrity, and
Linda L. Rittenhouse, Director, Capital Markets Policy, CFA
Institute, to Brent J. Fields, Secretary, SEC, dated Apr. 7, 2015
(``CFA Institute Two''), an anonymous comment dated Apr. 8, 2015
(``Anonymous''), and Letter from William Beatty, President and
Washington (State) Securities Administrator, North American
Securities Administrators Association, Inc., dated Apr. 17, 2015
(``NASAA Debt Two'').
    \9\ Letter from Philip Shaikun, Vice President and Associate
General Counsel, FINRA, dated May 5, 2015 (``FINRA Response'').
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    This order approves the proposed rule change.

II. Description of the Proposed Rule Change

    As described more fully in the Notice, FINRA proposed to adopt
FINRA Rule 2242 to address conflicts of interest relating to the
publication and distribution of debt research reports. Proposed FINRA
Rule 2242 would adopt a tiered approach that FINRA believed, in
general, would provide retail debt research recipients with extensive
protections similar to those provided to recipients of equity research
under current and proposed FINRA rules,\10\ with modifications to
reflect differences in the trading of debt securities.
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    \10\ See Exchange Act Release No. 73622 (Nov. 18, 2014); 79 FR
69939 (Nov. 24, 2014) (SR-FINRA-2014-047) (proposing amendments to
current SRO rules relating to equity research).
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    As stated above, the Commission received five comments on the
proposal. All of the relevant commenters expressed general support for
the proposal. Of the four comments received in regards to the
proceedings or Amendment No. 1, one was supportive of the proposal as
amended by Amendment No. 1 with certain specific comments,\11\ one
stated that Amendment No. 1 addressed their specific comments,\12\ one
reiterated prior concerns regarding the principles-based nature of the
proposal,\13\ and one did not seem to be related to the proposed rule
change.\14\
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    \11\ WilmerHale Debt Two.
    \12\ CFA Institute Two.
    \13\ NASAA Debt Two.
    \14\ Anonymous. The comment, in total, was: ``[I]s this a due
diligence report where numbers amounts are fabricated? Is a
qualified professional `valuing' as a way of adjusting the
amounts[?] I believe individuals should be leery of using `debt'
excessively when processing accounting matters. Especially with the
prevalence of automated software and attitude of today[']s
workers.'' Id. Neither we nor FINRA see any issues raised by this
comment relevant to the proposed rule change. See FINRA Response.
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A. Definitions

    FINRA represented that most of the defined terms closely follow the
defined terms for equity research in NASD Rule 2711, as amended by the
equity research filing, with minor changes to reflect their application
to debt research. The proposed definitions are set forth below.
    Under the proposed rule change, the term ``debt research analyst''
would mean an associated person who is primarily responsible for, and
any associated person who reports directly or indirectly to a debt
research analyst in connection with, the preparation of the substance
of a debt research report, whether or not any such person has the job
title of ``research analyst.'' \15\ The term ``debt research analyst
account'' would mean any account in which a debt research analyst or
member of the debt research analyst's household has a financial
interest, or over which such analyst has discretion or control. It
would not, however, include an investment company registered under the
Investment Company Act of 1940 over which the debt research analyst or
a member of the debt research analyst's household has discretion or
control, provided that the debt research analyst or member of a debt
research analyst's household has no financial interest in such
investment company, other than a performance or management fee. The
term also would not include a ``blind trust'' account that is
controlled by a person other than the debt research analyst or member
of the debt research analyst's household where neither the debt
research analyst nor a member of the debt research analyst's household
knows of the account's investments or investment transactions.\16\
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    \15\ See proposed FINRA Rule 2242(a)(1).
    \16\ See proposed FINRA Rule 2242(a)(2). The exclusion for a
registered investment company over which a research analyst has
discretion or control in the proposed definition mirrors proposed
changes to the definition of ``research analyst account'' in the
equity research rules.
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    The proposed rule change would define the term ``debt research
report'' 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 proposed Rule 2241(a)(11).\17\
The proposed definition and exceptions noted below would, in FINRA's
view, generally align with the definition of ``research report'' in
NASD Rule 2711, while incorporating aspects of the Regulation AC
definition of ``research report.'' \18\
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    \17\ See proposed FINRA Rule 2242(a)(3). FINRA explained that
the proposed rule change did not need to, similar to the equity
proposal, explicitly exclude communications concerning open-end
registered investment companies that are not listed or traded on an
exchange (``mutual funds'') from the proposed rule as they would not
be captured by the rule in the first place. See proposed FINRA Rule
2242(a)(4) (defining ``debt securities'' as not including ``equity
securities'' as defined in the Act). See also Exchange Act Release
No. 74488 (Mar. 12, 2015); 80 FR 14174 (Mar. 18, 2015) (explaining
the equity proposal as amended).
    \18\ In aligning the proposed definition with the Regulation AC
definition of research report, FINRA pointed out that the proposed
definition differs in minor respects from the definition of
``research report'' in NASD Rule 2711. For example, the proposed
definition of ``debt research report'' would apply to a
communication that includes an analysis of a debt security or an
issuer of a debt security, while the definition of ``research
report'' in NASD Rule 2711 applies to an analysis of equity
securities of individual companies or industries.
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    Communications that constitute statutory prospectuses that are
filed as part of the registration statement would not be included in
the definition of a debt research report. Further, communications that
constitute private placement memoranda and comparable offering-related
documents, other than those that purport to be research, would not be
included in the definition of a debt research report. In general, the
term debt research report also would not include communications that
are limited to the following, if they do not include an analysis of, or
recommend or rate, individual debt securities or issuers:
     Discussions of broad-based indices;
     Commentaries on economic, political, or market conditions;
     Commentaries on or analyses of particular types of debt
securities or characteristics of debt securities;
     Technical analyses concerning the demand and supply for a
sector, index, or industry based on trading volume and price;
     Recommendations regarding increasing or decreasing
holdings in particular industries or sectors or types of debt
securities; or
     Notices of ratings or price target changes, provided that
the member simultaneously directs the readers of the notice to the most
recent debt research report on the subject company that includes all
current applicable disclosures required by the rule and that such debt
research report does not contain materially misleading disclosures,
including disclosures that are outdated or no longer applicable.
    The term debt research report also, in general, would not include
the following communications, even if they include an analysis of an
individual debt security or issuer and information

reasonably sufficient upon which to base an investment decision:
     Statistical summaries of multiple companies' financial
data, including listings of current ratings that do not include an
analysis of individual companies' data;
     An analysis prepared for a specific person or a limited
group of fewer than 15 persons;
     Periodic reports or other communications prepared for
investment company shareholders or discretionary investment account
clients that discuss individual debt securities in the context of a
fund's or account's past performance or the basis for previously made
discretionary investment decisions; or
     Internal communications that are not given to current or
prospective customers.
    The proposed rule change would define the term ``debt security'' as
any ``security'' as defined in section 3(a)(10) of the Exchange
Act,\19\ except for any ``equity security'' as defined in section
3(a)(11) of the Exchange Act,\20\ any ``municipal security'' as defined
in section 3(a)(29) of the Exchange Act,\21\ any ``security-based
swap'' as defined in section 3(a)(68) of the Exchange Act,\22\ and any
``U.S. Treasury Security'' as defined in paragraph (p) of FINRA Rule
6710.\23\
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    \19\ 15 U.S.C. 78c(a)(10).
    \20\ 15 U.S.C. 78c(a)(11).
    \21\ 15 U.S.C. 78c(a)(29).
    \22\ 15 U.S.C. 78c(a)(68).
    \23\ See proposed FINRA Rule 2242(a)(4).
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    The proposed rule change would define the term ``debt trader'' as a
person, with respect to transactions in debt securities, who is engaged
in proprietary trading or the execution of transactions on an agency
basis.\24\
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    \24\ See proposed FINRA Rule 2242(a)(5).
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    The proposed rule change would provide that the term ``independent
third-party debt research report'' means a third-party debt research
report, in which the person producing the report both (1) has no
affiliation or business or contractual relationship with the
distributing member or that member's affiliates that is reasonably
likely to inform the content of its research reports, and (2) makes
content determinations without any input from the distributing member
or that member's affiliates.\25\
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    \25\ See proposed FINRA Rule 2242(a)(6).
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    The proposed rule change would define the term ``investment banking
department'' as any department or division, whether or not identified
as such, that performs any investment banking service on behalf of a
member.\26\ The term ``investment banking services'' would include,
without limitation, acting as an underwriter, participating in a
selling group in an offering for the issuer or otherwise acting in
furtherance of a public offering of the issuer; acting as a financial
adviser in a merger or acquisition; providing venture capital or equity
lines of credit or serving as placement agent for the issuer or
otherwise acting in furtherance of a private offering of the
issuer.\27\
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    \26\ See proposed FINRA Rule 2242(a)(8).
    \27\ See proposed FINRA Rule 2242(a)(9).
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    The proposed rule change would define the term ``member of a debt
research analyst's household'' as any individual whose principal
residence is the same as the debt research analyst's principal
residence.\28\
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    \28\ See proposed FINRA Rule 2242(a)(10).
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    The proposed rule change would define ``public appearance'' as any
participation in a conference call, seminar, forum (including an
interactive electronic forum) or other public speaking activity before
fifteen or more persons or before one or more representatives of the
media, a radio, television or print media interview, or the writing of
a print media article, in which a debt research analyst makes a
recommendation or offers an opinion concerning a debt security or an
issuer of a debt security.\29\
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    \29\ See proposed FINRA Rule 2242(a)(11).
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    Under the proposed rule change the term ``qualified institutional
buyer'' has the same meaning as under Rule 144A of the Securities
Act.\30\
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    \30\ See proposed FINRA Rule 2242(a)(12).
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    The proposed rule change would define ``research department'' as
any department or division, whether or not identified as such, that is
principally responsible for preparing the substance of a debt research
report on behalf of a member.\31\ The proposed rule change would define
the term ``subject company'' as the issuer whose debt securities are
the subject of a debt research report or a public appearance.\32\
Finally, the proposed rule change would define the term ``third-party
debt research report'' as a debt research report that is produced by a
person or entity other than the member.\33\
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    \31\ See proposed FINRA Rule 2242(a)(14).
    \32\ See proposed FINRA Rule 2242(a)(15).
    \33\ See proposed FINRA Rule 2242(a)(16).
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B. Identifying and Managing Conflicts of Interest

    Similar to the proposed equity research rule, the proposed rule
change contains an overarching provision that would require members to
establish, maintain, and enforce written policies and procedures
reasonably designed to identify and effectively manage conflicts of
interest related to the preparation, content, and distribution of debt
research reports; public appearances by debt research analysts; and the
interaction between debt research analysts and persons outside of the
research department, including investment banking, sales and trading
and principal trading personnel, subject companies, and customers.\34\
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    \34\ See proposed FINRA Rule 2242(b)(1).
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    The written policies and procedures would be required to be
reasonably designed to promote objective and reliable debt research
that reflects the truly held opinions of debt research analysts and to
prevent the use of debt research reports or debt research analysts to
manipulate or condition the market or favor the interests of the firm
or current or prospective customers or class of customers.\35\
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    \35\ See proposed FINRA Rule 2242(b)(2).
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    The proposed rule change would introduce a distinction between
sales and trading personnel and persons engaged in principal trading
activities, where, in FINRA's opinion, the conflicts addressed by the
proposal are of most concern.
1. Prepublication Review
    FINRA proposed that the required policies and procedures would be
required to prohibit prepublication review, clearance or approval of
debt research by persons involved in investment banking, sales and
trading, or principal trading, and either restrict or prohibit such
review, clearance, and approval by other non-research personnel other
than legal and compliance.\36\ The policies and procedures also would
be required to prohibit prepublication review of a debt research report
by a subject company, other than for verification of facts.\37\ The
proposed rule change would allow sections of a draft debt research
report to be provided to non-investment banking personnel, non-
principal trading personnel, non-sales and trading personnel, or to the
subject company for factual review, so long as: (1) The sections of the
draft debt research report submitted do not contain the research
summary, recommendation or rating; (2) A complete draft of the debt
research report is provided to legal or compliance personnel before
sections of the report are submitted to non-investment banking
personnel, non-

principal trading personnel, non-sales and trading personnel or the
subject company; and (3) If, after submitting sections of the draft
debt research report to non-investment banking personnel, non-principal
trading personnel, non-sales and trading personnel or the subject
company, the research department intends to change the proposed rating
or recommendation, it would be required to first provide written
justification to, and receive written authorization from, legal or
compliance personnel for the change. The member would be required to
retain copies of any draft and the final version of such debt research
report for three years after publication. \38\
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    \36\ See proposed FINRA Rule 2242(b)(2)(A) and (B).
    \37\ See proposed FINRA Rule 2242(b)(2)(N).
    \38\ See proposed FINRA Rule 2242.05 (Submission of Sections of
a Draft Research Report for Factual Review).
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2. Coverage Decisions
    With respect to coverage decisions, a member's written policies and
procedures would be required under the proposal to restrict or limit
input by investment banking, sales and trading and principal trading
personnel to ensure that research management independently makes all
final decisions regarding the research coverage plan.\39\ However, the
provision would not preclude personnel from these or any other
department from conveying customer interests and coverage needs, so
long as final decisions regarding the coverage plan are made by
research management.
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    \39\ See proposed FINRA Rule 2242(b)(2)(C).
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3. Solicitation and Marketing of Investment Banking Transactions
    A member's written policies and procedures also would be required
under the proposal to restrict or limit activities by debt research
analysts that can reasonably be expected to compromise their
objectivity.\40\ This would include prohibiting participation in
pitches and other solicitations of investment banking services
transactions and road shows and other marketing on behalf of issuers
related to such transactions. The proposed rule change would adopt
Supplementary Material that incorporates an existing FINRA
interpretation for the equity research rules that prohibits in pitch
materials any information about a member's debt research capacity in a
manner that suggests, directly or indirectly, that the member might
provide favorable debt research coverage.\41\ By way of example, the
Supplementary Material explains that FINRA would consider the
publication in a pitch book or related materials of an analyst's
industry ranking to imply the potential outcome of future research
because of the manner in which such rankings are compiled. The
Supplementary Material further notes that a member would be permitted
to include in the pitch materials the fact of coverage and the name of
the debt research analyst, since that information alone does not imply
favorable coverage.
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    \40\ See proposed FINRA Rule 2242(b)(2)(L).
    \41\ See proposed FINRA Rule 2242.01 (Efforts to Solicit
Investment Banking Business).
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    The proposed rule change also would prohibit investment banking
personnel from directing debt research analysts to engage in sales or
marketing efforts related to an investment banking services transaction
or any communication with a current or prospective customer about an
investment banking services transaction.\42\ In addition, the proposed
rule change would adopt Supplementary Material to provide that,
consistent with this requirement, no debt research analyst may engage
in any communication with a current or prospective customer in the
presence of investment banking department personnel or company
management about an investment banking services transaction.\43\
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    \42\ See proposed FINRA Rule 2242(b)(2)(M).
    \43\ See proposed FINRA Rule 2242.02(a) (Restrictions on
Communications with Customers and Internal Personnel).
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4. Supervision
    A member's written policies and procedures would be required under
the proposal to limit the supervision of debt research analysts to
persons not engaged in investment banking, sales and trading or
principal trading activities.\44\ In addition, the member would further
be required under the proposal to establish information barriers or
other institutional safeguards reasonably designed to ensure that debt
research analysts are insulated from the review, pressure or oversight
by persons engaged in investment banking services, principal trading or
sales and trading activities or others who might be biased in their
judgment or supervision.\45\
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    \44\ See proposed FINRA Rule 2242(b)(2)(D).
    \45\ See proposed FINRA Rule 2242(b)(2)(H).
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5. Budget and Compensation
    A member's written policies and procedures also would be required
under the proposal to limit the determination of a firm's debt research
department budget to senior management, excluding senior management
engaged in investment banking or principal trading activities, and
without regard to specific revenues or results derived from investment
banking.\46\ However, the proposed rule change would expressly permit
all persons to provide input to senior management regarding the demand
for and quality of debt research, including product trends and customer
interests. It further would allow consideration by senior management of
a firm's overall revenues and results in determining the debt research
budget and allocation of expenses.
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    \46\ See proposed FINRA Rule 2242(b)(2)(E).
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    With respect to compensation determinations, a member's written
policies and procedures would be required under the proposal to
prohibit compensation based on specific investment banking services or
trading transactions or contributions to a firm's investment banking or
principal trading activities and prohibit investment banking and
principal trading personnel from input into the compensation of debt
research analysts.\47\ Further, the firm's written policies and
procedures would be required under the proposal to require that the
compensation of a debt research analyst who is primarily responsible
for the substance of a research report be reviewed and approved at
least annually by a committee that reports to a member's board of
directors or, if the member has no board of directors, a senior
executive officer of the member.\48\ This committee would be required
under the proposal to not have representation from investment banking
personnel or persons engaged in principal trading activities and would
be required to consider certain factors when reviewing a debt research
analyst's compensation. Specifically, the proposal would require that
the committee consider the debt research analyst's individual
performance, including the analyst's productivity and the quality of
the debt research analyst's research as well as the overall ratings
received from customers and peers (independent of the member's
investment banking department and persons engaged in principal trading
activities) and other independent ratings services.
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    \47\ See proposed FINRA Rule 2242(b)(2)(D) and (F).
    \48\ See proposed FINRA Rule 2242(b)(2)(G).
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    Neither investment banking personnel nor persons engaged in
principal trading activities would be required under the proposal to
give input with respect to the compensation determination for debt
research analysts. However, sales and trading personnel would be
permitted to give input to debt research management as part of the
evaluation process in order to convey customer

feedback, provided that final compensation determinations are made by
research management, subject to review and approval by the compensation
committee.\49\ The committee, which would not be permitted to have
representation from investment banking or persons engaged in principal
trading activities, would be required to document the basis for each
debt research analyst's compensation, including any input from sales
and trading personnel.
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    \49\ See proposed FINRA Rule 2242(b)(2)(D) and (G).
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6. Personal Trading Restrictions
    Under the proposed rule change, a member's written policies and
procedures would be required to restrict or limit trading by a ``debt
research analyst account'' in securities, derivatives and funds whose
performance is materially dependent upon the performance of securities
covered by the debt research analyst.\50\ The procedures would be
required under the proposal to ensure that those accounts, supervisors
of debt research analysts, and associated persons with the ability to
influence the content of debt research reports do not benefit in their
trading from knowledge of the content or timing of debt research
reports before the intended recipients of such research have had a
reasonable opportunity to act on the information in the report.\51\
Furthermore, the procedures would be required under the proposal to
generally prohibit a debt research analyst account from purchasing or
selling any security or any option or derivative of such security in a
manner inconsistent with the debt research analyst's most recently
published recommendation, except that the procedures would be permitted
to define circumstances of financial hardship (e.g., unanticipated
significant change in the personal financial circumstances of the
beneficial owner of the research analyst account) in which the firm
would permit a debt research analyst account to trade contrary to that
recommendation. In determining whether a particular trade is contrary
to an existing recommendation, firms would be permitted to take into
account the context of a given trade, including the extent of coverage
of the subject security. While the proposed rule change does not
include a recordkeeping requirement, FINRA stated it expects members to
evidence compliance with their policies and procedures and retain any
related documentation in accordance with FINRA Rule 4511.
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    \50\ See proposed FINRA Rule 2242(b)(2)(J).
    \51\ See proposed FINRA Rule 2242.07 (Ability to Influence the
Content of a Research Report).
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    The proposed rule change includes Supplementary Material .10, which
would provide that FINRA would not consider a research analyst account
to have traded in a manner inconsistent with a research analyst's
recommendation where a member has instituted a policy that prohibits
any research analyst from holding securities, or options on or
derivatives of such securities, of the companies in the research
analyst's coverage universe, provided that the member establishes a
reasonable plan to liquidate such holdings consistent with the
principles in paragraph (b)(2)(J)(i) and such plan is approved by the
member's legal or compliance department.\52\
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    \52\ See proposed FINRA Rule 2242.10.
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7. Retaliation and Promises of Favorable Research
    A member's written policies and procedures would be required to
prohibit direct or indirect retaliation or threat of retaliation
against debt research analysts by any employee of the firm for
publishing research or making a public appearance that may adversely
affect the member's current or prospective business interests.\53\ The
policies and procedures would also be required to prohibit explicit or
implicit promises of favorable debt research, specific research content
or a specific rating or recommendation as inducement for the receipt of
business or compensation.\54\
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    \53\ See proposed FINRA Rule 2242(b)(2)(I).
    \54\ See proposed FINRA Rule 2242(b)(2)(K).
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8. Joint Due Diligence with Investment Banking Personnel
    The proposed rule change would establish limitations regarding
joint due diligence activities--i.e., due diligence by the debt
research analyst in the presence of investment banking department
personnel--during a specified time period. Specifically, the proposed
rule change states that FINRA would interpret the overarching principle
which would, under the proposal, require members to, among other
things, establish, maintain, and enforce written policies and
procedures that address the interaction between debt research analysts
and those outside the research department, including investment banking
department personnel, sales and trading personnel, principal trading
personnel, subject companies, and customers,\55\ to prohibit the
performance of joint due diligence prior to the selection of
underwriters for the investment banking services transaction.\56\
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    \55\ See proposed FINRA Rule 2242(b)(1)(C).
    \56\ See proposed FINRA Rule 2242.09 (Joint Due Diligence).
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9. Communications Between Debt Research Analysts and Trading Personnel
    The proposed rule change delineates what would be the prohibited
and permissible interactions between debt research analysts and sales
and trading and principal trading personnel. The proposed rule change
would require members to establish, maintain and enforce written
policies and procedures reasonably designed to prohibit sales and
trading and principal trading personnel from attempting to influence a
debt research analyst's opinions or views for the purpose of benefiting
the trading position of the firm, a customer or a class of
customers.\57\ It would further prohibit debt research analysts from
identifying or recommending specific potential trading transactions to
sales and trading or principal trading personnel that are inconsistent
with such debt research analyst's currently published debt research
reports or from disclosing the timing of, or material investment
conclusions in, a pending debt research report.\58\
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    \57\ See proposed FINRA Rule 2242.03(a)(1) (Information Barriers
between Research Analysts and Trading Desk Personnel).
    \58\ See proposed FINRA Rule 2242.03(a)(2) (Information Barriers
between Research Analysts and Trading Desk Personnel).
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    The proposed rule change would permit sales and trading and
principal trading personnel to communicate customers' interests to a
debt research analyst, so long as the debt research analyst does not
respond by publishing debt research for the purpose of benefiting the
trading position of the firm, a customer or a class of customers.\59\
In addition, debt research analysts would be permitted to provide
customized analysis, recommendations or trade ideas to sales and
trading and principal trading personnel and customers, provided that
any such communications are not inconsistent with the analyst's
currently published or pending debt research, and that any subsequently
published debt research is not for the purpose of benefiting the
trading position of the firm, a customer or a class of customers.\60\
---------------------------------------------------------------------------

    \59\ See proposed FINRA Rule 2242.03(b)(1) (Information Barriers
between Research Analysts and Trading Desk Personnel).
    \60\ See proposed FINRA Rule 2242.03(b)(2) (Information Barriers
between Research Analysts and Trading Desk Personnel).
---------------------------------------------------------------------------

    The proposed rule change also would permit sales and trading and
principal

trading personnel to seek the views of debt research analysts regarding
the creditworthiness of the issuer of a debt security and other
information regarding an issuer of a debt security that is reasonably
related to the price or performance of the debt security, so long as,
with respect to any covered issuer, such information is consistent with
the debt research analyst's published debt research report and
consistent in nature with the types of communications that a debt
research analyst might have with customers. In determining what is
consistent with the debt research analyst's published debt research,
FINRA stated that a member would be permitted to consider the context,
including that the investment objectives or time horizons being
discussed differ from those underlying the debt research analyst's
published views.\61\ Finally, FINRA also stated that debt research
analysts would be permitted to seek information from sales and trading
and principal trading personnel regarding a particular debt instrument,
current prices, spreads, liquidity, and similar market information
relevant to the debt research analyst's valuation of a particular debt
security.\62\
---------------------------------------------------------------------------

    \61\ See proposed FINRA Rule 2242.03(b)(3) (Information Barriers
between Research Analysts and Trading Desk Personnel).
    \62\ See proposed FINRA Rule 2242.03(b)(4) (Information Barriers
between Research Analysts and Trading Desk Personnel).
---------------------------------------------------------------------------

    The proposed rule change clarifies that communications between debt
research analysts and sales and trading or principal trading personnel
that are not related to sales and trading, principal trading or debt
research activities would be permitted to take place without
restriction, unless otherwise prohibited.\63\
---------------------------------------------------------------------------

    \63\ See proposed FINRA Rule 2242.03(c) (Information Barriers
between Research Analysts and Trading Desk Personnel).
---------------------------------------------------------------------------

10. Restrictions on Communications With Customers and Internal Sales
Personnel
    The proposed rule change would apply standards to communications
with customers and internal sales personnel. Any written or oral
communication by a debt research analyst with a current or prospective
customer or internal personnel related to an investment banking
services transaction would be required to be fair, balanced and not
misleading, taking into consideration the overall context in which the
communication is made.\64\
---------------------------------------------------------------------------

    \64\ See proposed FINRA Rule 2242.02(b) (Restrictions on
Communications with Customers and Internal Personnel).
---------------------------------------------------------------------------

    Consistent with the proposed prohibition on investment banking
department personnel directly or indirectly directing a debt research
analyst to engage in sales or marketing efforts related to an
investment banking services transaction or directing a debt research
analyst to engage in any communication with a current or prospective
customer about an investment banking services transaction, no debt
research analyst would be permitted to engage in any communication with
a current or prospective customer in the presence of investment banking
department personnel or company management about an investment banking
services transaction.

C. Content and Disclosure in Debt Research Reports

    The proposed rule change would, in general, adopt the disclosures
in the equity research rule for debt research, with modifications to
reflect the different characteristics of the debt market. The proposed
rule change would require members to establish, maintain and enforce
written policies and procedures reasonably designed to ensure that
purported facts in their debt research reports are based on reliable
information.\65\ In addition, the policies and procedures would be
required to be reasonably designed to ensure that any recommendation or
rating has a reasonable basis and is accompanied by a clear explanation
of any valuation method used and a fair presentation of the risks that
may impede achievement of the recommendation or rating.\66\ While there
would be no obligation to employ a rating system under the proposed
rule, members that choose to employ a rating system would be required
to clearly define in each debt research report the meaning of each
rating in the system, including the time horizon and any benchmarks on
which a rating is based. In addition, the definition of each rating
would be required to be consistent with its plain meaning.\67\
---------------------------------------------------------------------------

    \65\ See proposed FINRA Rule 2242(c)(1)(A).
    \66\ See proposed FINRA Rule 2242(c)(1)(B).
    \67\ See proposed FINRA Rule 2242(c)(2).
---------------------------------------------------------------------------

    Consistent with the equity rules, irrespective of the rating system
a member employs, a member would be required to include in each debt
research report limited to the analysis of an issuer of a debt security
that includes a rating of the subject company the percentage of all
subject companies rated by the member to which the member would assign
a ``buy,'' ``hold'' or ``sell'' rating.\68\ In addition, a member would
be required to disclose in each debt research report the percentage of
subject companies within each of the ``buy,'' ``hold,'' and ``sell''
categories for which the member has provided investment banking
services within the previous 12 months.\69\ All such information would
be required to be current as of the end of the most recent calendar
quarter or the second most recent calendar quarter if the publication
date of the debt research report is less than 15 calendar days after
the most recent calendar quarter.\70\
---------------------------------------------------------------------------

    \68\ See proposed FINRA Rule 2242(c)(2)(A).
    \69\ See proposed FINRA Rule 2242(c)(2)(B).
    \70\ See proposed FINRA Rule 2242(c)(2)(C).
---------------------------------------------------------------------------

    If a debt research report limited to the analysis of an issuer of a
debt security contains a rating for the subject company and the member
has assigned a rating to such subject company for at least one year,
the debt research report would be required to show each date on which a
member has assigned a rating to the debt security and the rating
assigned on such date. This information would be required for the
period that the member has assigned any rating to the debt security or
for a three-year period, whichever is shorter.\71\ Unlike the equity
research rules, the proposed rule change would not require those
ratings to be plotted on a price chart because of limits on price
transparency, including daily closing price information, with respect
to many debt securities.
---------------------------------------------------------------------------

    \71\ See proposed FINRA Rule 2242(c)(3).
---------------------------------------------------------------------------

    The proposed rule change would require a member to disclose in any
debt research report at the time of publication or distribution of the
report: \72\
---------------------------------------------------------------------------

    \72\ See proposed FINRA Rule 2242(c)(4).
---------------------------------------------------------------------------

     If the debt research analyst or a member of the debt
research analyst's household has a financial interest in the debt or
equity securities of the subject company (including, without
limitation, any option, right, warrant, future, long or short
position), and the nature of such interest;
     If the debt research analyst has received compensation
based upon (among other factors) the member's investment banking, sales
and trading or principal trading revenues;
     If the member or any of its affiliates managed or co-
managed a public offering of securities for the subject company in the
past 12 months, received compensation for investment banking services
from the subject company in the past 12 months, or expects to receive
or intends to seek compensation for investment banking

services from the subject company in the next three months;
     If, as of the end of the month immediately preceding the
date of publication or distribution of a debt research report (or the
end of the second most recent month if the publication date is less
than 30 calendar days after the end of the most recent month), the
member or its affiliates have received from the subject company any
compensation for products or services other than investment banking
services in the previous 12 months; \73\
---------------------------------------------------------------------------

    \73\ See also discussion of proposed FINRA Rule 2242.04
(Disclosure of Compensation Received by Affiliates) below.
---------------------------------------------------------------------------

     If the subject company is, or over the 12-month period
preceding the date of publication or distribution of the debt research
report has been, a client of the member, and if so, the types of
services provided to the issuer. Such services, if applicable, shall be
identified as either investment banking services, non-investment
banking securities-related services or non-securities services;
     If the member trades or may trade as principal in the debt
securities (or in related derivatives) that are the subject of the debt
research report;
     If the debt research analyst received any compensation
from the subject company in the previous 12 months; and
     Any other material conflict of interest of the debt
research analyst or member that the debt research analyst or an
associated person of the member with the ability to influence the
content of a debt research report knows or has reason to know at the
time of the publication or distribution of a debt research report.
    The proposed rule change would incorporate a proposed amendment to
the corresponding provision in the equity research rules that expands
the existing ``catch all'' disclosure to require disclosure of material
conflicts known not only by the research analyst, but also by any
``associated person of the member with the ability to influence the
content of a research report.'' The proposed rule change defines a
person with the ``ability to influence the content of a research
report'' as an associated person who is required to review the content
of the debt research report or has exercised authority to review or
change the debt research report prior to publication or distribution.
This term would not include legal or compliance personnel who may
review a debt research report for compliance purposes but are not
authorized to dictate a particular recommendation or rating.\74\ The
``reason to know'' standard in the provision would not impose a duty of
inquiry on the debt research analyst or others who can influence the
content of a debt research report. Rather, it would cover disclosure of
those conflicts that should reasonably be discovered by those persons
in the ordinary course of discharging their functions.
---------------------------------------------------------------------------

    \74\ See proposed FINRA Rule 2242.07.
---------------------------------------------------------------------------

    The proposed rule change would mandate disclosure of firm ownership
of debt securities in research reports or a public appearance to the
extent those holdings constitute a material conflict of interest.\75\
---------------------------------------------------------------------------

    \75\ See proposed FINRA Rules 2242(c)(4)(H) and (d)(1)(E).
---------------------------------------------------------------------------

    The proposed rule change would adopt an exception for disclosure
that would reveal material non-public information regarding specific
potential future investment banking transactions.\76\ Similar to the
equity research rules, the proposed rule change would require that
disclosures be presented on the front page of debt research reports or
the front page must refer to the page on which the disclosures are
found. Electronic debt research reports, however, would be permitted to
provide a hyperlink directly to the required disclosures. All
disclosures and references to disclosures required by the proposed rule
would need to be clear, comprehensive and prominent.\77\
---------------------------------------------------------------------------

    \76\ See proposed FINRA Rule 2242(c)(5).
    \77\ See proposed FINRA Rule 2242(c)(6).
---------------------------------------------------------------------------

    Like the equity research rule, the proposed rule change would
permit a member that distributes a debt research report covering six or
more companies (compendium report) to direct the reader in a clear
manner to the applicable disclosures. Electronic compendium reports
would be required to include a hyperlink to the required disclosures.
Paper-based compendium reports would be required to provide either a
toll-free number or a postal address to request the required
disclosures and also may include a web address of the member where the
disclosures can be found.\78\
---------------------------------------------------------------------------

    \78\ See proposed FINRA Rule 2242(c)(7).
---------------------------------------------------------------------------

D. Disclosure of Compensation Received by Affiliates

    The proposed rule change would provide that a member would not be
required to disclose receipt of non-investment banking services
compensation by an affiliate if it has implemented written policies and
procedures reasonably designed to prevent the debt research analyst and
associated persons of the member with the ability to influence the
content of debt research reports from directly or indirectly receiving
information from the affiliate as to whether the affiliate received
such compensation.\79\ In addition, a member would be permitted to
satisfy the disclosure requirement with respect to the receipt of
investment banking compensation from a foreign sovereign by a non-U.S.
affiliate of the member by implementing written policies and procedures
reasonably designed to prevent the debt research analyst and associated
persons of the member with the ability to influence the content of debt
research reports from directly or indirectly receiving information from
the non-U.S. affiliate as to whether such non-U.S. affiliate received
or expects to receive such compensation from the foreign sovereign.
However, a member would be required to disclose receipt of compensation
by its affiliates from the subject company (including any foreign
sovereign) in the past 12 months when the debt research analyst or an
associated person with the ability to influence the content of a debt
research report has actual knowledge that an affiliate received such
compensation during that time period.
---------------------------------------------------------------------------

    \79\ See proposed FINRA Rule 2242.04 (Disclosure of Compensation
Received by Affiliates).
---------------------------------------------------------------------------

E. Disclosure in Public Appearances

    The proposed rule change closely parallels the equity research
rules with respect to disclosure in public appearances. Under the
proposed rule, a debt research analyst would be required to disclose in
public appearances: \80\
---------------------------------------------------------------------------

    \80\ See proposed FINRA Rule 2242(d)(1).
---------------------------------------------------------------------------

     If the debt research analyst or a member of the debt
research analyst's household has a financial interest in the debt or
equity securities of the subject company (including, without
limitation, whether it consists of any option, right, warrant, future,
long or short position), and the nature of such interest;
     If, to the extent the debt research analyst knows or has
reason to know, the member or any affiliate received any compensation
from the subject company in the previous 12 months;
     If the debt research analyst received any compensation
from the subject company in the previous 12 months;
     If, to the extent the debt research analyst knows or has
reason to know, the subject company currently is, or during the 12-
month period preceding the date of publication or distribution of the
debt research report, was, a client of the member. In such cases, the
debt research analyst also must disclose the

types of services provided to the subject company, if known by the debt
research analyst; or
     Any other material conflict of interest of the debt
research analyst or member that the debt research analyst knows or has
reason to know at the time of the public appearance.
    However, a member or debt research analyst would not be required to
make any such disclosure to the extent it would reveal material non-
public information regarding specific potential future investment
banking transactions.\81\ Unlike in debt research reports, the ``catch-
all'' disclosure requirement in public appearances would apply only to
a conflict of interest of the debt research analyst or member that the
analyst knows or has reason to know at the time of the public
appearance. FINRA stated it understands that supervisors or legal and
compliance personnel, who otherwise might be captured by the definition
of an associated person ``with the ability to influence,'' typically do
not have the opportunity to review and insist on changes to public
appearances, many of which are extemporaneous in nature.
---------------------------------------------------------------------------

    \81\ See proposed FINRA Rule 2242(d)(2).
---------------------------------------------------------------------------

    The proposed rule change would require members to maintain records
of public appearances by debt research analysts sufficient to
demonstrate compliance by those debt research analysts with the
applicable disclosure requirements for public appearances. Such records
would be required to be maintained for at least three years from the
date of the public appearance.\82\
---------------------------------------------------------------------------

    \82\ See proposed FINRA Rule 2242(d)(3).
---------------------------------------------------------------------------

F. Disclosure Required by Other Provisions

    With respect to both research reports and public appearances, the
proposed rule change would require that, in addition to the disclosures
required under the proposed rule, members and debt research analysts
comply with all applicable disclosure provisions of FINRA Rule 2210
(Communications with the Public) and the federal securities laws.\83\
---------------------------------------------------------------------------

    \83\ See proposed FINRA Rule 2242(e).
---------------------------------------------------------------------------

G. Distribution of Member Research Reports

    The proposed rule change would require firms to establish, maintain
and enforce written policies and procedures reasonably designed to
ensure that a debt research report is not distributed selectively to
internal trading personnel or a particular customer or class of
customers in advance of other customers that the member has previously
determined are entitled to receive the debt research report.\84\ The
proposed rule change includes further guidance to explain that firms
would be permitted to provide different debt research products and
services to different classes of customers, provided the products are
not differentiated based on the timing of receipt of potentially market
moving information and the firm discloses its research dissemination
practices to all customers that receive a research product.\85\
---------------------------------------------------------------------------

    \84\ See proposed FINRA Rule 2242(f).
    \85\ See proposed FINRA Rule 2242.06 (Distribution of Member
Research Products).
---------------------------------------------------------------------------

    In addition, a member that provides different debt research
products and services for certain customers would be required to inform
its other customers that its alternative debt research products and
services may reach different conclusions or recommendations that could
impact the price of the debt security.\86\
---------------------------------------------------------------------------

    \86\ See id.
---------------------------------------------------------------------------

H. Distribution of Third-party Debt Research Reports

    FINRA proposed to apply the supervisory review and disclosure
obligations applicable to the distribution of third-party equity
research similarly to third-party retail debt research. Moreover, the
proposed rule change would incorporate the current standards for third-
party equity research, including the distinction between independent
and non-independent third-party research with respect to the review and
disclosure requirements. In addition, the proposed rule change would
adopt an expanded requirement in the proposed equity research rules
that requires members to disclose any other material conflict of
interest that can reasonably be expected to have influenced the
member's choice of a third-party research provider or the subject
company of a third-party research report.
    The proposed rule change would prohibit a member from distributing
third-party debt research if it knows or has reason to know that such
research is not objective or reliable.\87\ A member would satisfy the
standard based on its actual knowledge and reasonable diligence.
However, there would be no duty of inquiry to definitively establish
that the third-party research is, in fact, objective and reliable.
---------------------------------------------------------------------------

    \87\ See proposed FINRA Rule 2242(g)(1).
---------------------------------------------------------------------------

    In addition, the proposed rule change would require a member to
establish, maintain, and enforce written policies and procedures
reasonably designed to ensure that any third-party debt research report
it distributes contains no untrue statement of material fact and is
otherwise not false or misleading.\88\ For the purpose of this
requirement, a member's obligation to review a third-party debt
research report would extend to any untrue statement of material fact
or any false or misleading information that should be known from
reading the debt research report or is known based on information
otherwise possessed by the member.
---------------------------------------------------------------------------

    \88\ See proposed FINRA Rule 2242(g)(2).
---------------------------------------------------------------------------

    The proposed rule change would require that a member accompany any
third-party debt research report it distributes with, or provide a web
address that directs a recipient to, disclosure of any material
conflict of interest that can reasonably be expected to have influenced
the choice of a third-party debt research report provider or the
subject company of a third-party debt research report, including:
     If the member or any of its affiliates managed or co-
managed a public offering of securities for the subject company in the
past 12 months, received compensation for investment banking services
from the subject company in the past 12 months, or expects to receive
or intends to seek compensation for investment banking services from
the subject company in the next three months;
     If the member trades or may trade as principal in the debt
securities (or in related derivatives) that are the subject of the debt
research report; and
     Any other material conflict of interest of the debt
research analyst or member that the debt research analyst or an
associated person of the member with the ability to influence the
content of a debt research report knows or has reason to know at the
time of the publication or distribution of a debt research report.\89\
---------------------------------------------------------------------------

    \89\ See proposed FINRA Rule 2242(g)(3).
---------------------------------------------------------------------------

    The proposed rule change would not require members to review a
third-party debt research report prior to distribution if such debt
research report is an independent third-party debt research report.\90\
For the purposes of the disclosure requirements for third-party
research reports, a member would not be considered to have distributed
a third-party debt research report where the research is an independent
third-party debt research report and made available by a member upon
request, through a member-maintained Web site, or to a customer in
connection with a solicited order in which the registered
representative has informed the

customer, during the solicitation, of the availability of independent
debt research on the solicited debt security and the customer requests
such independent debt research.\91\
---------------------------------------------------------------------------

    \90\ See proposed FINRA Rule 2242(g)(4).
    \91\ See proposed FINRA Rule 2242(g)(5).
---------------------------------------------------------------------------

    The proposed rule would require that members ensure that third-
party debt research reports are clearly labeled as such and that there
is no confusion on the part of the recipient as to the person or entity
that prepared the debt research reports.\92\
---------------------------------------------------------------------------

    \92\ See proposed FINRA Rule 2242(g)(6). This requirement would
codify guidance in Notice to Members 04-18 (March 2004) related to
equity research reports.
---------------------------------------------------------------------------

I. Obligations of Persons Associated With a Member

    The proposed rule change would clarify the obligations of each
associated person under those provisions of the proposed rule that
require a member to restrict or prohibit certain conduct by
establishing, maintaining, and enforcing particular policies and
procedures. Specifically, the proposed rule change provides that,
consistent with FINRA Rule 0140, persons associated with a member would
be required to comply with such member's written policies and
procedures as established pursuant to the proposed rule. In addition,
consistent with Rule 0140, the proposed rule states in Supplementary
Material .08 that it would be a violation of proposed Rule 2242 for an
associated person to engage in the restricted or prohibited conduct to
be addressed through the establishment, maintenance, and enforcement of
written policies and procedures required by provisions of FINRA Rule
2242, including applicable supplementary material.

J. Exemption for Members With Limited Investment Banking Activity

    Similar to the equity research rule, the proposed rule change would
exempt from certain provisions regarding supervision and compensation
of debt research analysts those members that over the previous three
years, on average per year, have participated in ten or fewer
investment banking services transactions as manager or co-manager and
generated $5 million or less in gross investment banking revenues from
those transactions.\93\ Specifically, members that meet those
thresholds would be exempt from the requirement to establish, maintain,
and enforce policies and procedures that (1) prohibit prepublication
review of debt research reports by investment banking personnel or
other persons not directly responsible for the preparation, content, or
distribution of debt research reports (but not principal trading or
sales and trading personnel, unless the member also qualifies for the
limited principal trading activity exemption); (2) restrict or limit
investment banking personnel from input into coverage decisions; (3)
limit supervision of debt research analysts to persons not engaged in
investment banking; (4) limit determination of the research department
budget to senior management, excluding senior management engaged in
investment banking activities; (5) require that compensation of a debt
research analyst be approved by a compensation committee that may not
have representation from investment banking personnel; and (6)
establish information barriers to insulate debt research analysts from
the review or oversight by persons engaged in investment banking
services or other persons who might be biased in their judgment or
supervision.\94\ However, the proposed rule would require that members
with limited investment banking activity establish information barriers
or other institutional safeguards reasonably designed to ensure debt
research analysts are insulated from pressure by persons engaged in
investment banking services activities or other persons, including
persons engaged in principal trading or principal sales and trading
activities, who might be biased in their judgment or supervision.\95\
---------------------------------------------------------------------------

    \93\ See proposed FINRA Rule 2242(h).
    \94\ See proposed FINRA Rule 2242(b)(2)(A)(i), (b)(2)(B),
(b)(2)(C) (with respect to investment banking), (b)(2)(D)(i),
(b)(2)(E) (with respect to investment banking), (b)(2)(G) and
(b)(2)(H)(i) and (iii).
    \95\ For the purposes of proposed FINRA Rule 2242(h), FINRA
clarified that the term ``investment banking services transactions''
includes the underwriting of both corporate debt and equity
securities but not municipal securities.
---------------------------------------------------------------------------

    While small investment banks may need those who supervise debt
research analysts under such circumstances also to be involved in the
determination of those analysts' compensation, the proposal would still
prohibit these firms from compensating a debt research analyst based
upon specific investment banking services transactions or contributions
to a member's investment banking services activities. Members that
qualify for this exemption would be required to maintain records
sufficient to establish eligibility for the exemption and also maintain
for at least three years any communication that, but for this
exemption, would be subject to all of the requirements of proposed
FINRA Rule 2242(b).

K. Exemption for Limited Principal Trading Activity

    The proposed rule change includes an exemption from certain
provisions regarding supervision and compensation of debt research
analysts for members that engage in limited principal trading activity
where: (1) In absolute value on an annual basis, the member's trading
gains or losses on principal trades in debt securities are $15 million
or less over the previous three years, on average per year; and (2) The
member employs fewer than 10 debt traders; provided, however, that such
members establish information barriers or other institutional
safeguards reasonably designed to ensure debt research analysts are
insulated from pressure by persons engaged in principal trading or
sales and trading activities or other persons who might be biased in
their judgment or supervision.\96\ Specifically, members that meet
those thresholds would be exempt from the requirement to establish,
maintain and enforce policies and procedures that: (1) Prohibit
prepublication review of debt research reports by principal trading or
sales and trading personnel or other persons not directly responsible
for the preparation, content or distribution of debt research reports
(but not investment banking personnel, unless the firm also qualifies
for the limited investment banking activity exemption); (2) Restrict or
limit principal trading or sales and trading personnel from input into
coverage decisions; (3) Limit supervision of debt research analysts to
persons not engaged in sales and trading or principal trading
activities, including input into the compensation of debt research
analysts; (4) Limit determination of the research department budget to
senior management, excluding senior management engaged in principal
trading activities; (5) Require that compensation of a debt research
analyst be approved by a compensation committee that may not have
representation from principal trading personnel; and (6) Establish
information barriers to insulate debt research analysts from the review
or oversight by persons engaged in principal trading or sales and
trading activities or other persons who might be biased in their
judgment or supervision.\97\
---------------------------------------------------------------------------

    \96\ See proposed FINRA Rule 2242(i).
    \97\ See proposed FINRA Rule 2242(b)(2)(A)(ii) and (iii),
(b)(2)(B), (b)(2)(C) (with respect to sales and trading and
principal trading), (b)(2)(D)(ii) and (iii), (b)(2)(E) (with respect
to principal trading), (b)(2)(G) and (b)(2)(H)(ii) and (iii).
---------------------------------------------------------------------------

    As with the limited investment banking activity exemption, members

still would be required to establish information barriers or other
institutional safeguards reasonably designed to ensure debt research
analysts are insulated from pressure by persons engaged in principal
trading or sales and trading activities or other persons who might be
biased in their judgment or supervision. Members that qualify for this
exemption must maintain records sufficient to establish eligibility for
the exemption and also maintain for at least three years any
communication that, but for this exemption, would be subject to all of
the requirements of proposed FINRA Rule 2242(b).

L. Exemption for Debt Research Reports Provided to Institutional
Investors

    Given the debt market and the needs of its participants, the
proposed rule change would exempt debt research distributed solely to
eligible institutional investors (``institutional debt research'') from
most of the provisions regarding supervision, coverage determinations,
budget and compensation determinations, and all of the disclosure
requirements applicable to debt research reports distributed to retail
investors (``retail debt research'').\98\ Under the proposed rule
change, the term ``retail investor'' means any person other than an
institutional investor.\99\
---------------------------------------------------------------------------

    \98\ See proposed FINRA Rule 2242(j)(1).
    \99\ See proposed FINRA Rule 2242(a)(13).
---------------------------------------------------------------------------

    The proposed rule distinguishes between larger and smaller
institutions in the manner in which their opt-in decision is obtained.
Larger institutions would be permitted to receive institutional debt
research based on negative consent, while smaller institutions would be
required to affirmatively consent in writing to receive that research.
    Specifically, the proposed rule would allow firms to distribute
institutional debt research by negative consent to a person who meets
the definition of a qualified institutional buyer (``QIB'') \100\ and
where, pursuant to FINRA Rule 2111(b): (1) The member or associated
person has a reasonable basis to believe that the QIB is capable of
evaluating investment risks independently, both in general and with
regard to particular transactions and investment strategies involving a
debt security or debt securities; and (2) The QIB has affirmatively
indicated that it is exercising independent judgment in evaluating the
member's recommendations pursuant to FINRA Rule 2111 and such
affirmation is broad enough to encompass transactions in debt
securities. The proposed rule change would require written disclosure
to the QIB that the member may provide debt research reports that are
intended for institutional investors and are not subject to all of the
independence and disclosure standards applicable to debt research
reports prepared for retail investors. If the QIB does not contact the
member and request to receive only retail debt research reports, the
member would be permitted to reasonably conclude that the QIB has
consented to receiving institutional debt research reports.\101\ FINRA
stated that it would interpret this standard to allow an order placer,
e.g., a registered investment adviser, for a QIB that satisfies the
FINRA Rule 2111 institutional suitability requirements with respect to
debt transactions to agree to receive institutional debt research on
behalf of the QIB by negative consent should the rule be approved.
---------------------------------------------------------------------------

    \100\ See proposed FINRA Rule 2242(a)(12) under which a QIB has
the same meaning as under Rule 144A of the Securities Act.
    \101\ See proposed FINRA Rule 2242(j)(1)(A)(i) and (ii).
---------------------------------------------------------------------------

    Institutional accounts that meet the definition of FINRA Rule
4512(c) but do not satisfy the higher tier requirements described above
would still be permitted to affirmatively elect in writing to receive
institutional debt research. Specifically, a person that meets the
definition of ``institutional account'' in FINRA Rule 4512(c) would be
permitted to receive institutional debt research provided that such
person, prior to receipt of a debt research report, has affirmatively
notified the member in writing that it wishes to receive institutional
debt research and forego treatment as a retail investor for the
purposes of the proposed rule. Members would not be permitted to allow
retail investors to choose to receive institutional debt research.\102\
---------------------------------------------------------------------------

    \102\ See proposed FINRA Rule 2242(j)(1)(B).
---------------------------------------------------------------------------

    FINRA stated that, to avoid a disruption in the receipt of
institutional debt research, the proposed rule change would allow firms
to send institutional debt research to any FINRA Rule 4512(c) account,
except a natural person, without affirmative or negative consent for a
period of up to one year after Commission approval of the proposed rule
change while they obtain the necessary consents. Natural persons that
qualify as an institutional account under FINRA Rule 4512(c) would be
required to provide affirmative consent to receive institutional debt
research during this transition period and thereafter.\103\
---------------------------------------------------------------------------

    \103\ See proposed FINRA Rule 2242.11 (Distribution of
Institutional Debt Research During Transition Period).
---------------------------------------------------------------------------

    The proposed exemption would permit members that distribute
institutional debt research to institutional investors to do so without
meeting the proposed requirements to have written policies and
procedures for this research with respect to: (1) Restricting or
prohibiting prepublication review of institutional debt research by
principal trading and sales and trading personnel or others outside the
research department, other than investment banking personnel; (2) Input
by investment banking, principal trading and sales and trading into
coverage decisions; (3) Limiting supervision of debt research analysts
to persons not engaged in investment banking, principal trading or
sales and trading activities; (4) Limiting determination of the debt
research department's budget to senior management not engaged in
investment banking or principal trading activities and without regard
to specific revenues derived from investment banking; (5) Determination
of debt research analyst compensation; (6) Restricting or limiting debt
research analyst account trading; and (7) Information barriers or other
institutional safeguards reasonably designed to ensure debt research
analysts are insulated from review or oversight by investment banking,
sales and trading or principal trading personnel, among others (but
members still must have written policies and procedures to guard
against those persons pressuring analysts). The exemption further would
apply to all disclosure requirements, including content and disclosure
requirements for third-party research.
    Notwithstanding the proposed exemption, some provisions of the
proposed rule still would apply to institutional debt research,
including the prohibition on prepublication review of debt research
reports by investment banking personnel and the restrictions on such
review by subject companies. While prepublication review by principal
trading and sales and trading personnel would not be prohibited
pursuant to the exemption, other provisions of the rule would continue
to require management of those conflicts, including the requirement to
establish information barriers reasonably designed to insulate debt
research analysts from pressure by those persons. Furthermore, the
requirements in Supplementary

Material .05 related to submission of sections of a draft debt research
report for factual review would apply to any permitted prepublication
review by persons not directly responsible for the preparation, content
or distribution of debt research reports. In addition, members would be
required to prohibit debt research analysts from participating in the
solicitation of investment banking services transactions, road shows,
and other marketing on behalf of issuers and further prohibit
investment banking personnel from directly or indirectly directing a
debt research analyst to engage in sales and marketing efforts related
to an investment banking deal or to communicate with a current or
prospective customer with respect to such transactions. The provisions
regarding retaliation against debt research analysts and promises of
favorable debt research also would still apply with respect to research
distributed to eligible institutional investors.\104\
---------------------------------------------------------------------------

    \104\ See proposed FINRA Rule 2242(j)(2).
---------------------------------------------------------------------------

    While the proposed rule change would not require institutional debt
research to carry the specific disclosures applicable to retail debt
research, it would require that such research carry general disclosures
prominently on the first page warning that: (1) The report is intended
only for institutional investors and does not carry all of the
independence and disclosure standards of retail debt research reports;
(2) If applicable, that the views in the report may differ from the
views offered in retail debt research reports; and (3) If applicable,
that the report may not be independent of the firm's proprietary
interests and that the firm trades the securities covered in the report
for its own account and on a discretionary basis on behalf of certain
customers, and such trading interests may be contrary to the
recommendation in the report.\105\ FINRA stated that the second and
third disclosures described above would be required only if the member
produces both retail and institutional debt research reports that
sometimes differ in their views or if the member maintains a
proprietary trading desk or trades on a discretionary basis on behalf
of some customers and those interests sometimes are contrary to
recommendations in institutional debt research reports.
---------------------------------------------------------------------------

    \105\ See proposed FINRA Rule 2242(j)(3).
---------------------------------------------------------------------------

    The proposed rule change would require members to establish,
maintain and enforce written policies and procedures reasonably
designed to ensure that institutional debt research is made available
only to eligible institutional investors.\106\ A member would not be
permitted to rely on the proposed exemption with respect to a debt
research report that the member has reason to believe will be
redistributed to a retail investor. The proposed rule change also
states that the proposed exemption would not relieve a member of its
obligations to comply with the antifraud provisions of the federal
securities laws and FINRA rules.\107\
---------------------------------------------------------------------------

    \106\ See proposed FINRA Rule 2242(j)(4).
    \107\ See proposed FINRA Rule 2242(j)(5).
---------------------------------------------------------------------------

M. General Exemptive Authority

    The proposed rule change would provide FINRA, pursuant to the FINRA
Rule 9600 Series, with authority to conditionally or unconditionally
grant, in exceptional and unusual circumstances, an exemption from any
requirement of the proposed rule for good cause shown, after taking
into account all relevant factors and provided that such exemption is
consistent with the purposes of the rule, the protection of investors,
and the public interest.\108\
---------------------------------------------------------------------------

    \108\ See proposed FINRA Rule 2242(k).
---------------------------------------------------------------------------

III. Summary of Comment Letters, Discussion, and Commission Findings

    In response to the proposal as originally proposed by FINRA, the
Commission received five comments on the proposal.\109\ All of the
relevant commenters expressed general support for the proposal.\110\
The specifics of these comments were summarized when the Commission
instituted proceedings and again when the Commission noticed Amendment
No. 1.\111\ FINRA filed Amendment No. 1 as a response to these earlier
comments as discussed when the amendment was noticed.\112\ In the time
since Amendment No. 1 was filed the Commission has received four
comment letters on the proposal.\113\ FINRA submitted a letter in
response to these comments.\114\
---------------------------------------------------------------------------

    \109\ See note 4, supra.
    \110\ SIFMA, WilmerHale Debt One, PIABA Debt, NASAA Debt One and
CFA Institute One.
    \111\ Exchange Act Release No. 74340 (Feb. 20, 2015); 80 FR
10538 (Feb. 26, 2015) and Amendment Notice.
    \112\ Id.
    \113\ WilmerHale Debt Two, CFA Institute Two, Anonymous, and
NASAA Debt Two.
    \114\ FINRA Response.
---------------------------------------------------------------------------

    All five of the commenters to the original proposal,\115\ and all
three of the relevant commenters to the proposal in connection with
instituting proceedings or with regards to Amendment No. 1,\116\
expressed general support for the proposal. The Commission notes this
support.
---------------------------------------------------------------------------

    \115\ SIFMA, WilmerHale Debt One, PIABA Debt, NASAA Debt One,
and CFA Institute One.
    \116\ WilmerHale Debt Two, CFA Institute Two, and NASAA Debt
Two. As noted above the comment from Anonymous did not seem relevant
to the proposed rule change as it seemed to be asking about
accounting issues, which were not raised by the proposal. See note
14, supra.
---------------------------------------------------------------------------

A. Comments and Discussion Regarding the Principles-Based Approach of
the Proposed Rule Change

    The rule proposal as originally proposed would have adopted a
policies and procedures approach to identification and management of
research-related conflicts of interest and require those policies and
procedures to, at a minimum, prohibit or restrict particular conduct.
Commenters to the original proposal expressed several concerns with the
approach.
    Two of these commenters asserted that the mix of a principles-based
approach with prescriptive requirements was confusing in places and
posed operational challenges. In particular, the commenters recommended
eliminating the minimum standards for the policies and procedures.\117\
One of those commenters had previously expressed support for the
proposed principles-based approach with minimum requirements,\118\ but
asserted that the proposed rule text requiring procedures to ``at a
minimum, be reasonably designed to prohibit'' specified conduct is
superfluous or confusing. Another commenter to the original proposal
favored utilizing a proscriptive approach similar to the current equity
rules and also requiring that firms maintain policies and procedures
designed to ensure compliance.\119\ Another commenter to the original
proposal supported the types of communications between debt research
analysts and other persons that may be permitted by a firm's policies
and procedures.\120\ One commenter to the original proposal questioned
the necessity of the ``preamble'' requiring policies and procedures
that ``restrict or limit activities by research analysts that can
reasonably be expected to compromise their objectivity'' that precedes
specific prohibited activities related to investment banking
transactions.\121\ Finally, some

commenters to the original proposal suggested FINRA eliminate language
in the supplementary material that provides that the failure of an
associated person to comply with the firm's policies and procedures
constitutes a violation of the proposed rule itself.\122\ These
commenters argued that because members may establish policies and
procedures that go beyond the requirements set forth in the rule, the
provision may have the unintended consequence of discouraging firms
from creating standards in their policies and procedures that extend
beyond the rule. One of those commenters suggested that the remaining
language in the supplementary material adequately holds individuals
responsible for engaging in restricted or prohibited conduct covered by
the proposals.\123\
---------------------------------------------------------------------------

    \117\ SIFMA and WilmerHale Debt One.
    \118\ Letter from Amal Aly, Managing Director and Associate
General Counsel, SIFMA, to Marcia E. Asquith, Corporate Secretary,
FINRA, dated November 14, 2008 regarding Regulatory Notice 08-55
(Research Analysts and Research Reports).
    \119\ NASAA Debt One.
    \120\ CFA Institute One.
    \121\ WilmerHale Debt One.
    \122\ SIFMA and WilmerHale Debt One.
    \123\ WilmerHale Debt One.
---------------------------------------------------------------------------

    FINRA, in response, stated it believes the framework will maintain
the same level of investor protection in the current equity rules
(which also would largely apply to retail debt research) while
providing both some flexibility for firms to align their compliance
systems with their business model and philosophy and imposing
additional obligations to proactively identify and manage emerging
conflicts. According to FINRA the proposal, even under a policies and
procedures approach, ``would effectively maintain, with some
modifications, the key proscriptions in the current rules'' \124\
(e.g., prohibitions on prepublication review, supervision of research
analysts by investment banking and participation in pitches and road
shows). FINRA disagreed that the ``preamble'' to some of those
prohibitions is unnecessary. As with the more general overarching
principles-based requirement to identify and manage conflicts of
interest, the introductory principle that requires written policies and
procedures to restrict or limit activities by research analysts that
can reasonably be expected to compromise their objectivity recognizes
that FINRA cannot identify every conflict related to research at every
firm and therefore requires proactive monitoring and management of
those conflicts. FINRA did not believe this ``preamble'' language is
redundant with the broader overarching principle because it applies
more specifically to the activities of research analysts and, unlike
the broader principle, would preclude the use of disclosure as a means
of conflict management for those activities.
---------------------------------------------------------------------------

    \124\ Presumably FINRA means the current equity research rules
that would be carried over to debt research reports under the
proposal.
---------------------------------------------------------------------------

    In light of the overarching principle that requires firms to
establish, maintain, and enforce written policies and procedures
reasonably designed to identify and effectively manage research-related
conflicts, FINRA clarified that the ``at a minimum'' language was meant
to convey that additional conflicts management policies and procedures
may be needed to address emerging conflicts that may arise as the
result of business changes, such as new research products, affiliations
or distribution methods at a particular firm. As discussed in the
Notice, FINRA stated that it intends for firms to proactively identify
and manage those conflicts with appropriately designed policies and
procedures. FINRA clarified that their inclusion of the ``at a
minimum'' language was not, in their opinion, intended to suggest that
firms' written policies and procedures must go beyond the specified
prohibitions and restrictions in the proposal where no new conflicts
have been identified. However, FINRA stated it believes the overarching
requirement for policies and procedures reasonably designed to identify
and effectively manage research-related conflicts suffices to achieve
the intended regulatory objective, and therefore to eliminate any
confusion, FINRA proposed to amend the proposals to delete the ``at a
minimum'' language in Amendment No. 1. One of the commenters that
raised this issue noted their approval of this change in their second
letter.\125\
---------------------------------------------------------------------------

    \125\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    FINRA stated that it appreciates the commenters' concerns with
respect to language in the supplementary material that would make a
violation of a firm's policies a violation of the underlying rule. They
further stated that the supplementary material was intended to hold
individuals responsible for engaging in the conduct that the policies
and procedures effectively restrict or prohibit. FINRA agreed that
purpose is achieved with the language in the supplementary material
that states that, consistent with FINRA Rule 0140, ``it shall be a
violation of [the Rule] for an associated person to engage in the
restricted or prohibited conduct to be addressed through the
establishment, maintenance and enforcement of policies and procedures
required by [the Rule] or related Supplementary Material.'' Therefore,
FINRA proposed, in Amendment No. 1, to amend the proposals to delete
the language stating that a violation of a firm's policies and
procedures shall constitute a violation of the rule itself. One of the
commenters that raised this issue noted their approval of this change
in their second letter.\126\
---------------------------------------------------------------------------

    \126\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    Another of the original commenters, in a second letter, repeated
their concerns about utilizing a principles-based method in a rule in
this area, noting that a proscriptive approach is known to be generally
effective at addressing the types of conflicts of interest that the
proposal is designed to address and repeated violations by industry of
the current proscriptive equity research rule.\127\ FINRA disagreed
with the commenter noting that the proposed rule change would establish
for debt research reports, ``with a few modifications,'' the key
requirements of the current equity rules as mandated policies and
procedures members must establish.\128\
---------------------------------------------------------------------------

    \127\ NASAA Debt Two.
    \128\ FINRA Response.
---------------------------------------------------------------------------

B. Comments and Discussion Regarding the Definitions and Terms Used in
the Proposed Rule Change

    One commenter to the original proposal requested that the proposal
define the term ``sales and trading personnel'' as ``persons who are
primarily responsible for performing sales and trading activities, or
exercising direct supervisory authority over such persons.'' \129\ The
commenter's proposed definition was intended to clarify that the
proposed restrictions on sales and trading personnel activities should
not extend to senior management who do not directly supervise those
activities but have a reporting line from such personnel or persons who
occasionally function in a sales and trading capacity. FINRA stated
that it intends for the sales and trading personnel conflict management
provisions to apply to individuals who perform sales and trading
functions, irrespective of their job title or the frequency of engaging
in the activities. As such, FINRA stated it did not intend for the rule
to capture as sales and trading personnel senior management, such as
the chief executive officer, who do not engage in or supervise day-to-
day sales and trading activities. However, FINRA stated it believes the
applicable provisions should apply to individuals who may occasionally
perform or directly supervise sales and trading activities. Otherwise,
FINRA believes, investors could be put at risk with respect to the
research or transactions involved when those individuals are

functioning in those capacities because the conflict management
procedures and proscriptions and required disclosures would not apply.
Therefore, FINRA proposed to amend the rule as part of Amendment No. 1
to define sales and trading personnel to include ``persons in any
department or division, whether or not identified as such, who perform
any sales or trading service on behalf of a member.'' FINRA noted that
this proposed definition is more consistent with the definition of
``investment banking department'' in the proposed rule change.
---------------------------------------------------------------------------

    \129\ WilmerHale Debt One.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to include an
exclusion from the definition of ``debt research report'' for private
placement memoranda and similar offering-related documents prepared in
connection with investment banking services transactions.\130\ The
commenter noted that such offering-related documents typically are
prepared by investment banking personnel or non-research personnel on
behalf of investment banking personnel. The commenter asserted that
absent an express exception, the proposals could turn investment
banking personnel into research analysts and make the rule unworkable.
The commenter noted that NASD Rule 2711(a) excludes communications that
constitute statutory prospectuses that are filed as part of a
registration statement and contended that the basis for that exception
should apply equally to private placement memoranda and similar
offering-related documents.
---------------------------------------------------------------------------

    \130\ WilmerHale Debt One.
---------------------------------------------------------------------------

    As FINRA had noted with respect to the definition of ``research
report'' in the equity research filing, they also noted that a ``debt
research report'' is generally understood not to include such offering-
related documents prepared in connection with investment banking
services transactions. In the course of administering the filing review
programs under FINRA Rules 2210 (Communications with the Public), 5110
(Corporate Financing Rule), 5122 (Member Private Offerings) and 5123
(Private Placements of Securities), FINRA stated it had not received
any inquiries or addressed any issues that indicate there is confusion
regarding the scope of the research analyst rules as applied to
offering-related documents prepared in connection with investment
banking activities. Regardless, to provide firms with greater clarity
as to the status of such offering-related documents under the
proposals, FINRA proposed to amend the proposed rule as part of
Amendment No. 1 to exclude private placement memoranda and similar
offering-related documents prepared in connection with investment
banking services transactions other than those that purport to be
research from the definition of ``debt research report.'' In their
second comment letter, the commenter expressed support for this
change.\131\
---------------------------------------------------------------------------

    \131\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to refrain from
using the concept of ``reliable'' research in the proposal as it may
inappropriately connote accuracy in the context of a research analyst's
opinions.\132\ FINRA stated it believes that the term ``reliable'' is
commonly understood and notes that the term is used in certain
research-related provisions in the Sarbanes-Oxley Act of 2002
(``Sarbanes-Oxley'') without definition. FINRA further stated it does
not believe the term connotes accuracy of opinions.
---------------------------------------------------------------------------

    \132\ SIFMA.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to eliminate as
redundant the term ``independently'' from the provisions permitting
non-research personnel to have input into research coverage, so long as
research management ``independently makes all final decisions regarding
the research coverage plan.'' \133\ The commenter asserted that
inclusion of ``independently'' is confusing since the proposal would
permit input from non-research personnel into coverage decisions. FINRA
stated it had included ``independently'' to make clear that research
management alone is vested with making final coverage decisions. Thus,
for example, a firm could not have a committee that includes a majority
of research management personnel but also other individuals make final
coverage decisions by a vote. As such, FINRA declined to eliminate the
term as suggested.
---------------------------------------------------------------------------

    \133\ WilmerHale Debt One.
---------------------------------------------------------------------------

    One commenter to the original proposal requested that the proposal
define the terms ``principal trading activities,'' ``principal trading
personnel,'' and ``persons engaged in principal trading activities'' to
exclude traders who are primarily involved in customer accommodation or
customer facilitation trading, such as market makers that trade on a
principal basis.\134\ The commenter stated that the exclusion is
necessary to allow those traders to provide feedback from clients for
the purposes of evaluating debt research analysts for compensation
determination. More directly to that point, the same commenter and an
additional commenter to the original proposal asserted that the
proposal should not prohibit those engaged in principal trading
activities from providing customer feedback as part of the evaluation
and compensation process for a debt research analyst.\135\ They
contended that the fixed income markets operate primarily on a
principal basis and prohibiting such input would have a broad impact on
research management's ability to appropriately evaluate and compensate
debt research analysts.
---------------------------------------------------------------------------

    \134\ Id.
    \135\ SIFMA and WilmerHale Debt One.
---------------------------------------------------------------------------

    The proposal would allow sales and trading personnel, but not
personnel engaged in principal trading activities, to provide input to
debt research management into the evaluation of debt research analysts.
As discussed in detail in the Notice in response to the similar comment
raised to earlier iterations of the debt proposal,\136\ given the
importance of principal trading operations to the revenues of many
firms, FINRA stated it believes there is increased risk that a
principal trader could improperly pressure or influence debt research
if he or she has a say concerning analyst compensation or can
selectively relay customer feedback. FINRA also stated it believes the
risk to retail investors--the compensation evaluation restrictions
would not apply to institutional debt research--outweighs the benefit
of an additional data point for research management to assess the
quality of research produced by those that they oversee. FINRA also
noted that the proposal would allow sales and trading personnel to
provide customer feedback. For these reasons, FINRA declined to define
the terms as the commenter suggested. One of the commenters, in their
second letter, expressed disappointment in this decision, but noted
their acceptance that FINRA has already considered the issue a number
of times and did not reiterate the comment.\137\
---------------------------------------------------------------------------

    \136\ 79 FR 69905, 69924.
    \137\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    Another commenter to the original proposal asked for clarification
of the term ``principal trading'' because it believes the term ``sales
and trading'' already encompasses all agency, principal and proprietary
trading activities.\138\ FINRA clarified in response to this comment
that the debt proposal imposes greater restrictions on interaction
between debt research analysts and principal trading personnel than
between debt research analysts and sales and trading personnel because
the

magnitude of the conflict is greater with respect to the former.
According to FINRA, this structure evolved based on extensive
consultation and feedback from the industry. Based on those
communications, FINRA stated it understands and intends for the term
``sales and trading'' to exclude principal and proprietary trading
activities. FINRA further stated it will consider providing guidance
where it is unclear whether a particular job function or activity falls
within ``sales and trading'' or ``principal trading'' activities.
---------------------------------------------------------------------------

    \138\ SIFMA.
---------------------------------------------------------------------------

    One commenter to the original proposal suggested that FINRA revise
the definition of ``subject company'' to specify that the term means
the ``issuer (rather than the ``company'') whose debt securities are
the subject of a debt research report or a public appearance.'' \139\
The commenter noted that, among other things, the proposal would cover
debt issued by persons other than corporate entities, such as foreign
sovereigns or special purpose vehicles. FINRA agreed that the change is
appropriate and proposed to amend the definition accordingly in
Amendment No. 1.
---------------------------------------------------------------------------

    \139\ WilmerHale Debt One.
---------------------------------------------------------------------------

C. Comments and Discussion Regarding Information Barriers

    The proposed rule would require written policies and procedures to
``establish information barriers or other institutional safeguards
reasonably designed to ensure that research analysts are insulated from
review, pressure or oversight by persons engaged in investment banking
services activities or other persons, including sales and trading
department personnel, who might be biased in their judgment or
supervision.'' Some commenters to the original proposal suggested that
``review'' was unnecessary in this provision because the review of debt
research analysts was addressed sufficiently in other parts of the
proposed rule.\140\ One such commenter further suggested that the terms
``review'' and ``oversight'' are redundant.\141\ FINRA stated it does
not agree that the terms ``review'' and ``oversight'' are coextensive,
as the former may connote informal evaluation, while the latter may
signify more formal supervision or authority. FINRA noted that while
other provisions of the proposed rule change may address related
conduct--for example, the provision that prohibits investment banking
personnel, principal trading personnel and sales and trading personnel
from supervision or control of debt research analysts--this provision
extends to ``other persons'' who may be biased in their judgment or
supervision. Finally, FINRA stated it included the ``review, pressure
or oversight'' language to mirror the requirements for equity rules in
Sarbanes-Oxley and therefore promote consistency. For these reasons,
FINRA declined to revise the proposed rule change.
---------------------------------------------------------------------------

    \140\ SIFMA and WilmerHale Debt One.
    \141\ WilmerHale Debt One.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to clarify that
the information barriers or other institutional safeguards required by
the proposed rule are not intended to prohibit or limit activities that
would otherwise be permitted under other provisions of the rule.\142\
In the Amendment Notice, FINRA stated that was their intent.
---------------------------------------------------------------------------

    \142\ WilmerHale Debt One.
---------------------------------------------------------------------------

    This commenter stated in their comment in response to Amendment No.
1 that they interpreted this to mean that the proposal would permit
members to allow persons engaged in sales and trading activities to
provide informal and formal feedback on research analysts as one factor
to be considered by research management for the purposes of the
evaluation of the analyst.\143\ FINRA stated that, in general, it
agreed with the commenter's interpretation.\144\
---------------------------------------------------------------------------

    \143\ WilmerHale Debt Two.
    \144\ FINRA Response.
---------------------------------------------------------------------------

    The commenter also asserted that the terms ``bias'' and
``pressure'' are broad and ambiguous on their face and requested that
FINRA clarify that for purposes of the information barriers requirement
that they are intended to address persons who may try to improperly
influence research.\145\ As an example, the commenter asked whether a
bias would be present if an analyst was pressured to change the format
of a research report to comply with the research department's standard
procedures or the firm's technology specifications. FINRA stated it
believes the terms ``pressure'' and ``bias'' are commonly understood,
particularly in the context of rules intended to promote analyst
independence and objectivity. FINRA further noted that the terms appear
in certain research-related provisions of Sarbanes-Oxley without
definition. With respect to the commenter's example, FINRA stated it
does not believe a bias would be present simply because someone insists
that a research analyst comply with formatting or technology
specifications that do not otherwise implicate the rules.
---------------------------------------------------------------------------

    \145\ WilmerHale Debt One.
---------------------------------------------------------------------------

    One commenter to the original proposal asked FINRA to modify the
information barriers or other institutional safeguards requirement to
conform the provision to FINRA's ``reasonably designed'' standard for
related policies and procedures.\146\ FINRA stated it believed the
change would be consistent with the standard for policies and
procedures elsewhere in the proposal, and therefore proposed to amend
the provision as requested in Amendment No. 1. The commenter noted with
support this change in their second letter.\147\
---------------------------------------------------------------------------

    \146\ WilmerHale Debt One.
    \147\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    One commenter to the original proposal opposed as overbroad the
proposed expansion of the current ``catch-all'' disclosure requirement
to include ``any other material conflict of interest of the research
analyst or member that a research analyst or an associated person of
the member with the ability to influence the content of a research
report knows or has reason to know'' (emphasis added) at the time of
publication or distribution of research report.\148\ The commenter
expressed concern about the emphasized language.
---------------------------------------------------------------------------

    \148\ WilmerHale Debt One.
---------------------------------------------------------------------------

    FINRA stated it proposed the change to capture material conflicts
of interest known by persons other than the research analyst (e.g., a
supervisor or the head of research) who are in a position to improperly
influence a debt research report. FINRA defined ``ability to influence
the content of a debt research report'' in the proposed rule's
supplementary material as ``an associated person who, in the ordinary
course of that person's duties, has the authority to review the
research report and change that research report prior to publication or
distribution.'' The commenter stated that the proposed change could
capture individuals (especially legal and compliance personnel) who
possess confidential information regarding potential future investment
banking transactions and thus mandate disclosure of this confidential
information. Further, it was possible that this information would not
have been excepted from disclosure by a proposed exception in the
original proposal that would have excluded disclosure where it would
``reveal material non-public information regarding specific potential
future investment banking transactions of the subject company.'' This
is because, according to the commenter, legal and compliance may be
aware of material conflicts of interest relating to the subject company
that involve material

non-public information regarding specific future investment banking
transactions of a competitor of the subject company. The commenter also
expressed concern that the provision would slow down dissemination of
research to canvass all research supervisors and management for
conflicts. The commenter suggested that the change was unnecessary
given other objectivity safeguards in the proposals that would guard
against improper influence.
    FINRA stated it continues to believe that the catch-all provision
must include persons with the ability to influence the content of a
debt research report to avoid creating a gap where a supervisor or
other person with the authority to change the content of a research
report knows of a material conflict. However, FINRA clarified that it
intended for the provision to capture only those individuals who are
required to review the content of a particular research report or have
exercised their authority to review or change the research report prior
to publication or distribution. In addition, FINRA stated it did not
intend to capture legal or compliance personnel who may review a
research report for compliance purposes but are not authorized to
dictate a particular recommendation or rating. FINRA proposed to amend
the supplementary material in the proposals consistent with this
clarification in Amendment No. 1. In addition, FINRA proposed to modify
in Amendment No. 1 the exception in proposed Rules 2242(c)(5) and
(d)(2) (applying to public appearances) so as to not require disclosure
that would otherwise reveal material non-public information regarding
specific potential future investment banking transactions, whether or
not the transaction involves the subject company.
    This commenter in their comment in response to Amendment No. 1,
while expressing their support for these changes, asked FINRA to make a
modification of the parties who trigger disclosure of any other
material conflict of interest. Specifically, the commenter asked FINRA
to limit this disclosure to only be required when someone has authority
to dictate a particular recommendation, rating, or price target.\149\
The commenter was seeking to extend this authority requirement to other
parities that can trigger the disclosure, specifically persons who
review the report and persons who have exercised authority to review or
change the report generally. FINRA declined to make further changes,
noting that the change in Amendment No. 1 ``was meant to limit
application of the provision where there is a discrete review by [legal
or compliance personnel] outside of the research department who do not
have primary content review responsibilities'' and that ``those
individuals that a firm requires to review research reports (e.g., a
Supervisory Analyst) or who exercise their authority to change a
research report (e.g., a Director of Research) by definition have the
ability to influence the content of a research report.'' \150\
---------------------------------------------------------------------------

    \149\ WilmerHale Debt Two.
    \150\ FINRA Response.
---------------------------------------------------------------------------

    One commenter to the original proposal requested confirmation that
members may rely on hyperlinked disclosures for research reports that
are delivered electronically, even if these reports are subsequently
printed out by customers.\151\ As long as a research report delivered
electronically contains a hyperlink directly to the required
disclosures, FINRA stated that the standard will be satisfied.
---------------------------------------------------------------------------

    \151\ WilmerHale Debt One.
---------------------------------------------------------------------------

D. Comments and Discussion Regarding Research Products With Differing
Recommendations

    The proposed rule change would require firms to establish, maintain
and enforce written policies and procedures reasonably designed to
ensure that a research report is not distributed selectively to
internal trading personnel or a particular customer or class of
customers in advance of other customers that the firm has previously
determined are entitled to receive the research report. The proposals
also include supplementary material that explains that firms may
provide different research products to different classes of customers--
e.g., long term fundamental research to all customers and short-term
trading research to certain institutional customers--provided the
products are not differentiated based on the timing of receipt of
potentially market moving information and the firm discloses, if
applicable, that one product may contain a different recommendation or
rating from another product.
    One commenter to the original proposal supported the provisions as
proposed with general disclosure,\152\ while another contended that
FINRA should require members to disclose when its research products and
services do, in fact, contain a recommendation contrary to the research
product or service received by other customers.\153\ The commenter
favoring general disclosure asserted that disclosure of specific
instances of contrary recommendations would impose significant burdens
unjustified by the investor protection benefits. The commenter stated
that a specific disclosure requirement would require close tracking and
analysis of every research product or service to determine if a
contrary recommendation exists. The commenter further stated that the
difficulty of complying with such a requirement would be exacerbated in
large firms by the number of research reports published and research
analysts employed and the differing audiences for research products and
services.\154\ The commenter asserted that some firms may publish tens
of thousands of research reports each year and employ hundreds of
analysts across various disciplines and that a given research analyst
or supervisor could not reasonably be expected to know of all other
research products and services that may contain differing views.
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    \152\ WilmerHale Debt One.
    \153\ PIABA Debt.
    \154\ WilmerHale Debt One.
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    The opposing commenter stated that they believed that permitting
contrary opinions while only disclosing the possibility of this
contrary research to investors was insufficient to adequately protect
investors because the use of ``may'' in a disclosure is not the same as
disclosing that there actually are opposing opinions. Further, they
questioned whether such disclosure was consistent with the Act in that
it may contrary to Rule 10b-5 by permitting the omission of a material
fact in the research report. They did not believe that the disclosure
of actual opposing views would be burdensome on members as they should
be aware of contrasting opinions. As a result, FINRA should require
specific disclosures.\155\
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    \155\ PIABA Debt.
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    Another commenter to the original proposal expressed concern that
the proposal raises issues about the parity of information received by
retail and institutional investors, and whether research provided to
institutional investors could contain views that differ from those in
research to retail investors.\156\
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    \156\ CFA Institute One.
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    The supplementary material states that products may lead to
different recommendations or ratings, provided that each is consistent
with the member's ratings system for each respective product. In other
words, according to FINRA, all differing recommendations or ratings
must be reconcilable such that they are not truly at odds with one
another. As such, the proposed rule change would not, in

FINRA's view, allow research provided to an institutional investor to
contain views inconsistent with those offered in retail debt
research.\157\ FINRA provided the following example from the filing
regarding equity research: A firm might define a ``buy'' rating in its
long-term research product to mean that a stock will outperform the S&P
500 over the next year, while a ``sell'' rating in its short-term
trading product might mean the stock will underperform its sector index
over the next month. In this case, FINRA stated that the firm could,
under the proposal, maintain a ``buy'' in the long-term research and a
``sell'' in its trading research at the same time if the firm believed
the stock would temporarily drop near term based on failing to meet
expectations in an earnings report but still outperform the S&P over
the next year. One commenter, in their second letter, stated that this
clarification addressed their concerns that investor protections were
being impacted.\158\
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    \157\ According to FINRA, the proposed rule change would not
require that all investors receive all research products, nor would
it preclude a firm from offering, for example, a research product to
select customers that includes greater depth of analysis. However,
it would not, in FINRA's view, be consistent with the proposed rule
change to provide inconsistent views to different classes of
customers or to advantage one class of customers based on the timing
of receipt of a recommendation, rating or potentially market moving
information.
    \158\ CFA Institute Two.
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    Since the proposed rule change would not allow inconsistent
recommendations that could mislead one or more investors, FINRA stated
that it believes general disclosure of alternative products with
different objectives and recommendations is appropriate relative to its
investor protection benefits. The commenter who supported this approach
expressed support for FINRA's decision in their second letter.\159\
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    \159\ WilmerHale Debt Two.
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E. Comments and Discussion Regarding Structural and Procedural
Safeguards

    One commenter to the original proposal asked that FINRA clarify
that members that have developed policies and procedures consistent
with FINRA Rule 5280 (Trading Ahead of Research Reports) would also be
in compliance with the debt proposal's expectation of structural
separation between investment banking and debt research, and between
sales and trading and principal trading and debt research.\160\ FINRA
indicated in the proposed rule change that while the proposed rule
would not require physical separation, FINRA would expect such physical
separation except in extraordinary circumstances where the costs are
unreasonable due to a firm's size and resource limitations. FINRA Rule
5280 does not, according to FINRA, specify physical separation between
all of the persons involved. While similar in design and purpose to
some aspects of the proposed requirements in the debt proposal, FINRA
clarified that FINRA Rule 5280 is not congruent with the proposal to
the point where compliance with the policies and procedures provision
of that rule would be deemed compliance with the debt proposal
separation requirements. FINRA stated that both FINRA Rule 5280 and the
debt proposal require policies and procedures reasonably designed to
limit information flow.
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    \160\ WilmerHale Debt One.
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    FINRA also stated it believes that physical separation is an
effective component to a reasonably designed compliance system that
requires information barriers.
    The same commenter asked that FINRA modify the prohibition on debt
analyst attendance at road shows to permit passive participation since
there is less opportunity to meet and assess issuer management than in
the equity context.\161\ FINRA stated it believes that even passive
participation by debt research analysts in road shows and other
marketing may present conflicts of interest and, therefore, declined to
revise the proposal as suggested.\162\ In their second letter, the
commenter reiterated this suggested change because, while they note the