[Federal Register Volume 80, Number 52 (Wednesday, March 18, 2015)]
[Notices]
[Pages 14198-14215]
[FR Doc No: 2015-06094]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74490; File No. SR-FINRA-2014-048]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Amendment No. 1 to a Proposed Rule
Change To Adopt FINRA Rule 2242 (Debt Research Analysts and Debt
Research Reports)

March 12, 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. On February 20, 2015,
the Commission issued an order instituting proceedings pursuant to
Section 19(b)(2)(B) of the Act \5\ to determine whether to approve or
disapprove the proposal. The order was published for comment in the
Federal Register on February 26, 2015.\6\
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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 infra note 10.
    \5\ 15 U.S.C. 78s(b)(2)(B).
    \6\ Exchange Act Release No. 74340 (Feb. 20, 2015); 80 FR 10538
(Feb. 26, 2015). The comment period closes on March 19, 2015.
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    The proposed rule change, as modified by Amendment No. 1, is
described in Items II and III below, which Items have been
substantially prepared by FINRA.\7\ The Commission is publishing this
notice to solicit comments from interested persons on the proposal as
amended by Amendment No. 1.
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    \7\ For a comparison of the changes of the rule text between the
proposal as originally noticed and the proposal as amended by
Amendment No. 1, see Exhibit 4 to SR-FINRA-2014-048.
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II. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    FINRA is proposing Amendment No. 1 to SR-FINRA-2014-048, a proposed
rule change to adopt 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 text of the proposed rule change is available on FINRA's Web
site at http://www.finra.org, at the principal office of FINRA and at
the Commission's Public Reference Room.

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

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

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

1. Purpose
    Rule Filing History
    On November 14, 2014, FINRA filed with the Securities and Exchange
Commission (``Commission'') SR-FINRA-2014-048,\8\ a proposed rule
change to adopt in the consolidated FINRA rulebook (``Consolidated
FINRA Rulebook'') \9\ Rule 2242 (Debt Research Analysts and Debt
Research Reports) to address conflicts of interest relating to the
publication and distribution of debt research reports.
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    \8\ See Securities Exchange Act Release No. 73623 (November 18,
2014), 79 FR 69905 (November 24, 2014) (Notice of Filing File No.
SR-FINRA-2014-048) (``Proposing Release''). The comment period
closed on December 15, 2014.
    \9\ The current FINRA rulebook includes, in addition to FINRA
Rules, (1) NASD Rules and (2) rules incorporated from NYSE
(``Incorporated NYSE Rules'') (together, the NASD Rules and
Incorporated NYSE Rules are referred to as the ``Transitional
Rulebook''). While the NASD Rules generally apply to all FINRA
members, the Incorporated NYSE Rules apply only to those members of
FINRA that are also members of the NYSE (``Dual Members''). For more
information about the rulebook consolidation process, see
Information Notice, March 12, 2008 (Rulebook Consolidation Process).
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    The Commission published the proposed rule change for public
comment in the Federal Register on November 24, 2014. The Commission
received five comment letters directed to the filing.\10\ Based on
comments received, FINRA is filing this Amendment No. 1 to respond to
the comments and to propose amendments, where appropriate. The
Amendment also includes a few technical, non-substantive changes.
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    \10\ See Letter from Hugh D. Berkson, Executive Vice President
and President-Elect, Public Investors Arbitration Bar Association,
to Brent J. Fields, Secretary, SEC, dated December 15, 2014 (``PIABA
Debt''); Letter from Kevin Zambrowicz, Associate General Counsel and
Managing Director, and Sean Davy, Managing Director, Securities
Industry and Financial Markets Association, to Brent J. Fields,
Secretary, SEC, dated December 15, 2014 (``SIFMA''); Letter from
Yoon-Young Lee, Wilmer Cutler Pickering Hale and Dorr LLP, to Brent
J. Fields, Secretary, SEC, dated December 16, 2014 (``WilmerHale
Debt''); Letter from William Beatty, President, North American
Securities Administrators Association, Inc., Brent J. Fields,
Secretary, SEC, dated December 19, 2014 (``NASAA Debt''); and 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 February 9, 2015 (``CFA Institute'').
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Proposal
    As described in greater detail in the Proposing Release, the
proposed rule change would adopt a tiered approach that, 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, with modifications to reflect
the different nature and trading of debt securities,\11\ while
exempting from many of the provisions debt research distributed solely
to eligible institutional investors.
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    \11\ The proposed rule change reflects proposed amendments to
FINRA's equity research rules set forth in a companion filing to the
proposed rule change (the ``equity research filing''). See
Securities Exchange Act Release No. 73622 (November 18, 2014), 79 FR
69939 (November 24, 2014) (Notice of Filing File No. SR-FINRA-2014-
047). See also Amendment No. 1 to SR-FINRA-2014-047.
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Definitions
    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.'' \12\ 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;
provided, however, it would not include an investment company
registered under the Investment Company Act 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.\13\
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    \12\ See proposed FINRA Rule 2242(a)(1).
    \13\ 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).\14\
The proposed definition and exceptions noted below would generally
align with the definition of ``research report'' in NASD Rule 2711,
while incorporating aspects of the Regulation AC definition of
``research report.'' \15\
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    \14\ See proposed FINRA Rule 2242(a)(3). The proposed rule
change does not incorporate a proposed exclusion from the equity
research rule's definition of ``research report'' of communications
concerning open-end registered investment companies that are not
listed or traded on an exchange (``mutual funds'') because it is not
necessary since mutual fund securities are equity securities under
Section 3(a)(11) of the Exchange Act and therefore would not be
captured by the proposed definition of ``debt research report'' in
the proposed rule change.
    \15\ In aligning the proposed definition with the Regulation AC
definition of research report, 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 disclosure,
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,
except for any ``equity security'' as defined in Section 3(a)(11) of
the Exchange Act, any ``municipal security'' as defined in Section
3(a)(29) of the Exchange Act, any ``security-based swap'' as defined in
Section 3(a)(68) of the Exchange Act, and any ``U.S. Treasury
Security'' as defined in paragraph (p) of FINRA Rule 6710.\16\
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    \16\ 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.\17\
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    \17\ 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 respect of which the person producing the report: (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.\18\
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    \18\ 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.\19\ 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.\20\
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    \19\ See proposed FINRA Rule 2242(a)(8).
    \20\ 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.\21\
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    \21\ 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
15 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.\22\
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    \22\ 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.\23\
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    \23\ 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.\24\ 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.\25\
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.\26\
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    \24\ See proposed FINRA Rule 2242(a)(14).
    \25\ See proposed FINRA Rule 2242(a)(15).
    \26\ See proposed FINRA Rule 2242(a)(16).
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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.\27\
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    \27\ See proposed FINRA Rule 2242(b)(1).
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    The proposed rule change introduces a distinction between sales and
trading personnel and persons engaged in principal trading activities,
where the conflicts addressed by the proposal are of most concern.
    The written policies and procedures must 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.\28\
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    \28\ See proposed FINRA Rule 2242(b)(2).
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Prepublication Review
    FINRA is proposing that the required policies and procedures must
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.\29\ The policies and procedures also must prohibit
prepublication review of a debt research report by a subject company,
other than for verification of facts.\30\ The proposed rule change
allows 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: (a) The sections of the draft debt research report
submitted do not contain the research summary, recommendation or
rating; (b) 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
(c) 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
must first provide written justification to, and receive written
authorization from, legal or compliance personnel for the change. The
member must retain copies of any draft and the final version of such
debt research report for three years after publication.\31\
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    \29\ See proposed FINRA Rule 2242(b)(2)(A) and (B).
    \30\ See proposed FINRA Rule 2242(b)(2)(N).
    \31\ See proposed FINRA Rule 2242.05 (Submission of Sections of
a Draft Research Report for Factual Review).
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Coverage Decisions
    With respect to coverage decisions, a member's written policies and
procedures must 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.\32\ However, the provision does 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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    \32\ See proposed FINRA Rule 2242(b)(2)(C).
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Solicitation and Marketing of Investment Banking Transactions
    A member's written policies and procedures also must restrict or
limit activities by debt research analysts that can reasonably be
expected to compromise their objectivity.\33\ This includes 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 adopts
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.\34\ 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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    \33\ See proposed FINRA Rule 2242(b)(2)(L).
    \34\ 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.\35\ In
addition, the proposed rule change adopts 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.\36\
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    \35\ See proposed FINRA Rule 2242(b)(2)(M).
    \36\ See proposed FINRA Rule 2242.02(a) (Restrictions on
Communications with Customers and Internal Personnel).
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Supervision
    A member's written policies and procedures must limit the
supervision of debt research analysts to persons not engaged in
investment banking, sales and trading or principal trading
activities.\37\ In addition, they further must 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.\38\
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    \37\ See proposed FINRA Rule 2242(b)(2)(D).
    \38\ See proposed FINRA Rule 2242(b)(2)(H).
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Budget and Compensation
    A member's written policies and procedures also must 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.\39\ 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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    \39\ See proposed FINRA Rule 2242(b)(2)(E).
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    With respect to compensation determinations, a member's written
policies and procedures must 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.\40\ Further, the
firm's written policies and procedures must 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.\41\ This committee may not have
representation from investment banking personnel or persons engaged in
principal trading activities and must consider the following factors
when reviewing a debt research analyst's compensation, if applicable:
the debt research analyst's individual performance, including the
analyst's productivity and the quality of the debt research analyst's
research; and 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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    \40\ See proposed FINRA Rule 2242(b)(2)(D) and (F).
    \41\ See proposed FINRA Rule 2242(b)(2)(G).
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    Neither investment banking personnel nor persons engaged in
principal trading activities may give input with respect to the
compensation determination for debt research analysts. However, sales
and trading personnel may 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.\42\ The committee, which may not have representation from
investment banking or persons engaged in principal trading activities,
must document the basis for each debt research analyst's compensation,
including any input from sales and trading personnel.
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    \42\ See proposed FINRA Rule 2242(b)(2)(D) and (G).
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Personal Trading Restrictions
    Under the proposed rule change, a member's written policies and
procedures must 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.\43\ The procedures must 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.\44\ Furthermore, the procedures must 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 they may 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 will permit trading contrary to that recommendation.
In determining whether a particular trade is contrary to an existing
recommendation, firms may 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 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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    \43\ See proposed FINRA Rule 2242(b)(2)(J).
    \44\ 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
provides that FINRA would not consider a research analyst account to
have traded in a manner inconsistent with a research analyst's
recommendation where a member has instituted a policy that prohibits
any research analyst from holding securities, or options on or
derivatives of such securities, of the companies in the research
analyst's coverage universe, provided that the member establishes a
reasonable plan to liquidate such holdings consistent with the
principles in paragraph (b)(2)(J)(i) and such plan is approved by the
member's legal or compliance department.\45\
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    \45\ See proposed FINRA Rule 2242.10.
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Retaliation and Promises of Favorable Research
    A member's written policies and procedures must 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.\46\ The policies and procedures also
must 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.\47\
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    \46\ See proposed FINRA Rule 2242(b)(2)(I).
    \47\ See proposed FINRA Rule 2242(b)(2)(K).
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Joint Due Diligence With Investment Banking Personnel
    The proposed rule change establishes a proscription with respect to
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 interprets the overarching principle
requiring 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,\48\ to prohibit the performance of joint due diligence
prior to the selection of underwriters for the investment banking
services transaction.\49\
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    \48\ See proposed FINRA Rule 2242(b)(1)(C).
    \49\ See proposed FINRA Rule 2242.09 (Joint Due Diligence).
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Communications Between Debt Research Analysts and Trading Personnel
    The proposed rule change delineates 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.\50\
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.\51\
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    \50\ See proposed FINRA Rule 2242.03(a)(1) (Information Barriers
between Research Analysts and Trading Desk Personnel).
    \51\ 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.\52\
In addition, debt research analysts may 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.\53\
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    \52\ See proposed FINRA Rule 2242.03(b)(1) (Information Barriers
between Research Analysts and Trading Desk Personnel).
    \53\ See proposed FINRA Rule 2242.03(b)(2) (Information Barriers
between Research Analysts and Trading Desk Personnel).
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    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, a
member may consider the context, including that the investment
objectives or time horizons being discussed differ from those
underlying the debt research analyst's published views.\54\ Finally,
debt research analysts may 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.\55\
---------------------------------------------------------------------------

    \54\ See proposed FINRA Rule 2242.03(b)(3) (Information Barriers
between Research Analysts and Trading Desk Personnel).
    \55\ 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 may take place without restriction, unless
otherwise prohibited.\56\
---------------------------------------------------------------------------

    \56\ See proposed FINRA Rule 2242.03(c) (Information Barriers
between Research Analysts and Trading Desk Personnel).
---------------------------------------------------------------------------

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 must be fair, balanced and not misleading, taking
into consideration the overall context in which the communication is
made.\57\
---------------------------------------------------------------------------

    \57\ See proposed FINRA Rule 2242.02(b) (Restrictions on
Communications with Customers and Internal Personnel).
---------------------------------------------------------------------------

    Consistent with the 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 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.
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.\58\ In addition, the policies and procedures must 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.\59\ While there is no
obligation to employ a rating system under the proposed rule, members
that choose to employ a rating system must 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 must be consistent with its
plain meaning.\60\
---------------------------------------------------------------------------

    \58\ See proposed FINRA Rule 2242(c)(1)(A).
    \59\ See proposed FINRA Rule 2242(c)(1)(B).
    \60\ See proposed FINRA Rule 2242(c)(2).
---------------------------------------------------------------------------

    Consistent with the equity rules, irrespective of the rating system
a member employs, a member must 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.\61\ In addition, a member must 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.\62\ All such information must 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.\63\
---------------------------------------------------------------------------

    \61\ See proposed FINRA Rule 2242(c)(2)(A).
    \62\ See proposed FINRA Rule 2242(c)(2)(B).
    \63\ 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 must 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.\64\ Unlike the equity research rules, the
proposed rule change does 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.
---------------------------------------------------------------------------

    \64\ See proposed FINRA Rule 2242(c)(3).
---------------------------------------------------------------------------

    The proposed rule change would require \65\ a member to disclose in
any debt research report at the time of publication or distribution of
the report:
---------------------------------------------------------------------------

    \65\ 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; \66\
---------------------------------------------------------------------------

    \66\ 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 does 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.\67\ 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.
---------------------------------------------------------------------------

    \67\ See proposed FINRA Rule 2242.07.
---------------------------------------------------------------------------

    The proposed rule change requires 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.\68\
---------------------------------------------------------------------------

    \68\ See proposed FINRA Rules 2242(c)(4)(H) and (d)(1)(E).
---------------------------------------------------------------------------

    The proposed rule change adopts an exception for disclosure that
would reveal material non-public information regarding specific
potential future investment banking transactions.\69\ 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, may provide a
hyperlink directly to the required disclosures. All disclosures and
references to disclosures required by the proposed rule must be clear,
comprehensive and prominent.\70\
---------------------------------------------------------------------------

    \69\ See proposed FINRA Rule 2242(c)(5).
    \70\ 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 must include a
hyperlink to the required disclosures. Paper-based compendium reports
must 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.\71\
---------------------------------------------------------------------------

    \71\ See proposed FINRA Rule 2242(c)(7).
---------------------------------------------------------------------------

Disclosure of Compensation Received by Affiliates
    The proposed rule change would provide that a member may satisfy
the disclosure requirement with respect to receipt of non-investment
banking services compensation by an affiliate 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 affiliate as to whether the
affiliate received such compensation.\72\ In addition, a member may
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 must 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.
---------------------------------------------------------------------------

    \72\ See proposed FINRA Rule 2242.04 (Disclosure of Compensation
Received by Affiliates).
---------------------------------------------------------------------------

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 must disclose in public
appearances: \73\
---------------------------------------------------------------------------

    \73\ 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 will 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.\74\ Unlike in debt research reports, the ``catch-
all'' disclosure requirement in public appearances applies 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 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.
---------------------------------------------------------------------------

    \74\ 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
must be maintained for at least three years from the date of the public
appearance.\75\
---------------------------------------------------------------------------

    \75\ See proposed FINRA Rule 2242(d)(3).
---------------------------------------------------------------------------

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
must comply with all applicable disclosure provisions of FINRA Rule
2210 (Communications with the Public) and the federal securities
laws.\76\
---------------------------------------------------------------------------

    \76\ See proposed FINRA Rule 2242(e).
---------------------------------------------------------------------------

Distribution of Member Research Reports
    The proposed rule change requires 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.\77\ The proposed rule
change includes further guidance to explain that firms may 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.\78\
---------------------------------------------------------------------------

    \77\ See proposed FINRA Rule 2242(f).
    \78\ 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 must 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.\79\
---------------------------------------------------------------------------

    \79\ See proposed FINRA Rule 2242.06 (Distribution of Member
Research Products).
---------------------------------------------------------------------------

Distribution of Third-party Debt Research Reports
    FINRA is proposing 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 adopts
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.\80\ 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.
---------------------------------------------------------------------------

    \80\ 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.\81\ For the purpose of this
requirement, a member's obligation to review a third-party debt
research report extends 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.
---------------------------------------------------------------------------

    \81\ 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.\82\
---------------------------------------------------------------------------

    \82\ 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.\83\
For the purposes of the disclosure requirements for third-party
research reports, a member shall 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.\84\
---------------------------------------------------------------------------

    \83\ See proposed FINRA Rule 2242(g)(4).
    \84\ 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.\85\
---------------------------------------------------------------------------

    \85\ See proposed FINRA Rule 2242(g)(6). This requirement
codifies guidance in Notice to Members 04-18 (March 2004) related to
equity research reports.
---------------------------------------------------------------------------

Obligations of Persons Associated With a Member
    The proposed rule change clarifies 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 must
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 shall 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.
Exemption for Members With Limited Investment Banking Activity
    Similar to the equity research rule, the proposed rule change
exempts 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 10 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.\86\ Specifically, members that meet those thresholds
would be exempt from the requirement to establish, maintain and enforce
policies and procedures that: 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); restrict or limit investment banking
personnel from input into coverage decisions; limit supervision of debt
research analysts to persons not engaged in investment banking; limit
determination of the research department budget to senior management,
excluding senior management engaged in investment banking activities;
require that compensation of a debt research analyst be approved by a
compensation committee that may not have representation from investment
banking personnel; and 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.\87\ 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.\88\
---------------------------------------------------------------------------

    \86\ See proposed FINRA Rule 2242(h).
    \87\ 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).
    \88\ For the purposes of proposed FINRA Rule 2242(h), 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 still
prohibits 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
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).
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, such
members must 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.\89\ Specifically, members that meet
those thresholds would be exempt from the requirement to establish,
maintain and enforce policies and procedures that: 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); restrict or
limit principal trading or sales and trading personnel from input into
coverage decisions; 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; limit determination of the research department budget to
senior management, excluding senior management engaged in principal
trading activities; require that compensation of a debt research
analyst be approved by a compensation committee that may not have
representation from principal trading personnel; and 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.\90\
---------------------------------------------------------------------------

    \89\ See proposed FINRA Rule 2242(i).
    \90\ 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).
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'').\91\ Under the proposed rule
change, the term ``retail investor'' means any person other than an
institutional investor.\92\
---------------------------------------------------------------------------

    \91\ See proposed FINRA Rule 2242(j)(1).
    \92\ 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.
The larger may receive institutional debt research based on negative
consent, while the smaller must 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'') \93\ 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 may reasonably conclude that the QIB has consented to receiving
institutional debt research reports.\94\ FINRA interprets 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.
---------------------------------------------------------------------------

    \93\ See proposed FINRA Rule 2242(a)(12) under which a QIB has
the same meaning as under Rule 144A of the Securities Act.
    \94\ 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
may still affirmatively elect in writing to receive institutional debt
research. Specifically, a person that meets the definition of
``institutional account'' in FINRA Rule 4512(c) may 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. Retail investors may not choose to receive institutional debt
research.\95\
---------------------------------------------------------------------------

    \95\ See proposed FINRA Rule 2242(j)(1)(B).
---------------------------------------------------------------------------

    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 SEC approval while they obtain the necessary
consents. Natural persons that qualify as an institutional account
under FINRA Rule 4512(c) must provide

affirmative consent to receive institutional debt research during this
transition period and thereafter.\96\
---------------------------------------------------------------------------

    \96\ See proposed FINRA Rule 2242.11 (Distribution of
Institutional Debt Research During Transition Period).
---------------------------------------------------------------------------

    The proposed exemption relieves members that distribute
institutional debt research to institutional investors from the
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 again
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 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 must 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 still
apply with respect to research distributed to eligible institutional
investors.\97\
---------------------------------------------------------------------------

    \97\ See proposed FINRA Rule 2242(j)(2).
---------------------------------------------------------------------------

    While the proposed rule change does not require institutional debt
research to carry the specific disclosures applicable to retail debt
research, it does 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.\98\ Thus, 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.
---------------------------------------------------------------------------

    \98\ 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.\99\ A member may not 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 does not relieve a member of its obligations to comply with
the antifraud provisions of the federal securities laws and FINRA
rules.\100\
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    \99\ See proposed FINRA Rule 2242(j)(4).
    \100\ See proposed FINRA Rule 2242(j)(5).
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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.\101\
---------------------------------------------------------------------------

    \101\ See proposed FINRA Rule 2242(k).
---------------------------------------------------------------------------

Response to Comments
General Support
    All of the commenters to the proposal expressed general support for
the proposal.\102\
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    \102\ SIFMA, WilmerHale Debt, PIABA Debt, NASAA Debt and CFA
Institute.
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Definitions and Terms
    One commenter 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.'' \103\ The commenter's
proposed definition is intended to clarify that the proposed
restrictions on sales and trading personnel activities should not
extend to: (1) Senior management who do not directly supervise those
activities but have a reporting line from such personnel; or (2)
persons who occasionally function in a sales and trading capacity.
FINRA 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 does 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 believes the applicable
provisions should apply to individuals who may occasionally perform or
directly

supervise sales and trading activities; otherwise, 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 has proposed to amend the
rule 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 notes that
this proposed definition is more consistent with the definition of
``investment banking department'' in the proposed rule change.
---------------------------------------------------------------------------

    \103\ WilmerHale Debt.
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    One commenter 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.\104\ 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.
---------------------------------------------------------------------------

    \104\ WilmerHale Debt.
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    As noted with respect to the definition of ``research report'' in
the equity research filing, 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 has 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. Nonetheless, to provide firms with
greater clarity as to the status of such offering-related documents
under the proposals, FINRA proposes to amend the proposed rule 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.''
    One commenter 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.\105\ FINRA
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 does not believe the term connotes accuracy of opinions.
---------------------------------------------------------------------------

    \105\ SIFMA.
---------------------------------------------------------------------------

    One commenter 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.'' \106\ The commenter asserted that inclusion of
``independently'' is confusing since the proposal would permit input
from non-research personnel into coverage decisions. FINRA has 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 declines to eliminate the term as
suggested.
---------------------------------------------------------------------------

    \106\ WilmerHale Debt.
---------------------------------------------------------------------------

    One commenter 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.\107\ 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 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.\108\ 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.
---------------------------------------------------------------------------

    \107\ WilmerHale Debt.
    \108\ SIFMA and WilmerHale Debt.
---------------------------------------------------------------------------

    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 Item 5 of the Proposing Release in response
to the same comment raised to earlier iterations of the debt proposal,
given the importance of principal trading operations to the revenues of
many firms, FINRA believes there is increased risk that a principal
trader could improperly pressure or influence debt research if he or
she has a say into analyst compensation or can selectively relay
customer feedback. FINRA 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 notes that the proposal would allow sales
and trading personnel to provide customer feedback. Accordingly, FINRA
declines to define the terms as the commenter suggested.
    Another commenter 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.\109\ 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. This structure evolved based on extensive consultation
and feedback from the industry. Based on those communications, FINRA
understands and intends for the term ``sales and trading'' to exclude
principal and proprietary trading activities. FINRA will consider
providing guidance where it is unclear whether a particular job
function or activity falls within ``sales and trading'' or ``principal
trading'' activities.
---------------------------------------------------------------------------

    \109\ SIFMA.
---------------------------------------------------------------------------

    One commenter 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.'' \110\ 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 agrees that the change is appropriate and therefore
proposes to amend the definition accordingly.
---------------------------------------------------------------------------

    \110\ WilmerHale Debt.
---------------------------------------------------------------------------

Policies and Procedures
    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 expressed several concerns with the approach.
    Two 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.\111\
One of those commenters had previously expressed support for the
proposed policies-based approach with minimum requirements,\112\ but
asserted that the proposed rule text requiring procedures to ``at a
minimum, be reasonably designed to prohibit'' specified conduct is
either superfluous or confusing. Another commenter favored retaining
the proscriptive approach in the current equity rules and also
requiring that firms maintain policies and procedures designed to
ensure compliance.\113\ Another commenter supported the types of
communications between debt research analysts and other persons that
may be permitted by a firm's policies and procedures.\114\ One
commenter 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.\115\ Finally, some commenters
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.\116\ 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.\117\
---------------------------------------------------------------------------

    \111\ SIFMA and WilmerHale Debt.
    \112\ 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).
    \113\ NASAA Debt.
    \114\ CFA Institute.
    \115\ WilmerHale Debt.
    \116\ SIFMA and WilmerHale Debt.
    \117\ WilmerHale Debt.
---------------------------------------------------------------------------

    As discussed in more detail in the proposed rule change, FINRA
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. Even under a policies and procedures
approach, the proposal would effectively maintain, with some
modifications, the key proscriptions in the current rules--e.g.,
prohibitions on prepublication review, supervision of research analysts
by investment banking and participation in pitches and road shows.
FINRA disagrees 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 does 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.
    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, 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 Proposing Release,
FINRA intends for firms to proactively identify and manage those
conflicts with appropriately designed policies and procedures. FINRA's
inclusion of the ``at a minimum'' language was not 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 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 proposes to amend the proposals to delete the ``at a
minimum'' language.
    FINRA 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. The supplementary material
was intended to hold individuals responsible for engaging in the
conduct that the policies and procedures effectively restrict or
prohibit. FINRA agrees 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 proposes 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.
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 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.\118\ One commenter further suggested that the terms ``review''
and ``oversight'' are redundant.\119\ FINRA 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. And while other provisions of the proposed
rule change may address related conduct--e.g., 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 included the
``review, pressure or oversight'' language to mirror the requirements
for equity rules in Sarbanes-Oxley and therefore promote consistency.
Accordingly, FINRA declines to revise the proposed rule change.
---------------------------------------------------------------------------

    \118\ SIFMA and WilmerHale Debt.
    \119\ WilmerHale Debt.
---------------------------------------------------------------------------

    One commenter 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.\120\ That was clearly
FINRA's intent, and FINRA believes that the rules of statutory
construction would compel that result.
---------------------------------------------------------------------------

    \120\ WilmerHale Debt.
---------------------------------------------------------------------------

    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.\121\ 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 believes the
terms ``pressure'' and ``bias'' are commonly understood, particularly
in the context of rules intended to promote analyst independence and
objectivity. To that end, FINRA notes that the terms appear in certain
research-related provisions of Sarbanes-Oxley without definition. Thus,
with respect to the commenter's example, FINRA 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.
---------------------------------------------------------------------------

    \121\ WilmerHale Debt.
---------------------------------------------------------------------------

    One commenter 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.\122\ FINRA believes the change would be consistent with the
standard for policies and procedures elsewhere in the proposal, and
therefore proposes to amend the provision as requested.
---------------------------------------------------------------------------

    \122\ WilmerHale Debt.
---------------------------------------------------------------------------

    One commenter 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'' at the time of publication or distribution of research
report.\123\ (emphasis added) The commenter expressed concern about the
emphasized language.
---------------------------------------------------------------------------

    \123\ WilmerHale Debt.
---------------------------------------------------------------------------

    FINRA 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 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 might be required to disclose
confidential information that is not covered by the exception in the
proposals that would not require 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 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 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 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 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 proposes to amend the supplementary material in the
proposals consistent with this clarification. In addition, FINRA
proposes to modify the exception in proposed Rules 2242(c)(5) and
(d)(2) (applying to public appearances) not to 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.
    One commenter 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.\124\ As long as a research report delivered electronically
contains a hyperlink directly to the required disclosures, the standard
will be satisfied.
---------------------------------------------------------------------------

    \124\ WilmerHale Debt.
---------------------------------------------------------------------------

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 supported the provisions as proposed with general
disclosure,\125\ 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.\126\ 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.\127\ 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.
---------------------------------------------------------------------------

    \125\ WilmerHale Debt.
    \126\ PIABA Debt.
    \127\ WilmerHale Debt.
---------------------------------------------------------------------------

    Another commenter 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.\128\
---------------------------------------------------------------------------

    \128\ CFA Institute.
---------------------------------------------------------------------------

    Importantly, 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, 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 allow research provided to
an institutional investor to contain views inconsistent with those
offered in retail debt research.\129\ An example in the equity rule
filing is illustrative. 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 12 months, while a ``sell'' rating in its short-term
trading product might mean the stock will underperform its sector index
over the next month. The firm could 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 12 months.
---------------------------------------------------------------------------

    \129\ 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 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.
---------------------------------------------------------------------------

    Since the proposed rule change would not allow inconsistent
recommendations that could mislead one or more investors, FINRA
believes general disclosure of alternative products with different
objectives and recommendations is appropriate relative to its investor
protection benefits.
Structural and Procedural Safeguards
    One commenter 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.\130\ 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. Among other things, Rule 5280
requires members to establish, maintain and enforce policies and
procedures reasonably designed to restrict or limit the information
flow between research department personnel, or other persons with
knowledge of the content or timing of a research report, and trading
department personnel, so as to prevent trading department personnel
from utilizing non-public advance knowledge of the issuance or content
of a research report for the benefit of the member or any other person.
The rule does not 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, 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. Both Rule
5280 and the debt proposal require policies and procedures reasonably
designed to limit information flow. FINRA believes that physical
separation is an effective component to a reasonably designed
compliance system that requires information barriers.
---------------------------------------------------------------------------

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

    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.\131\ FINRA discussed this same comment in detail in
Item 5 of the Proposing Release. In short, FINRA believes that even
passive participation by debt research analysts in road shows and other
marketing may present conflicts of interest and, therefore, declines to
revise the proposal as suggested.
---------------------------------------------------------------------------

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

Communications Between Research Analysts and Trading Desk Personnel
    The commenter also asked FINRA to delete the term ``attempting'' in
the proposed Supplementary Material .03(a)(1), which would require
members to have policies and procedures reasonably designed to prohibit
sales and trading and principal trading personnel from ``attempting to
influence a debt research analyst's opinion or views for the purpose of
benefitting the trading position of the firm, a customer, or a class of
customers.'' \132\ The commenter stated that it is unclear how a firm
should enforce a prohibition on attempts to influence. FINRA notes that
Supplementary Material .03(b)(2) sets forth permissible communications
between debt research analysts and sales and trading and principal
trading personnel, including, for example, allowing a debt research
analyst to provide ``customized analysis, recommendations or trade
ideas'' to customers or traders upon request, provided that the
communications are ``not inconsistent with the analyst's current or
pending debt research, and that any subsequently published debt
research is not for the purpose of

benefitting the trading position of the firm, a customer or a class of
customers.'' In the context of such a request, it is not hard to
envision the possibility that a trader, for example, might attempt to
influence the analyst's view by emphasizing that a particular
recommendation would be beneficial to the firm. FINRA believes there
are a variety of policies and procedures that could address such
attempts, including periodic monitoring of such communications. As
such, FINRA declines to delete ``attempting'' from the provision.
---------------------------------------------------------------------------

    \132\ WilmerHale Debt.
---------------------------------------------------------------------------

    The commenter further expressed concern that the term ``pending''
is vague in the above-cited provision.\133\ The commenter suggested
that FINRA delete the term or confirm that ``pending'' means ``imminent
publication of a debt research report.'' FINRA believes it is important
that any customized analysis, recommendations or trade ideas be
consistent not only with published research, but also any research
being drafted in anticipation of publication or distribution that may
contain changed or additional view or opinions. FINRA considers such
research in draft to be pending and therefore declines to delete the
term or adopt an ``imminent'' standard.
---------------------------------------------------------------------------

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

    Supplementary Material .03(b)(3) provides that in determining what
is consistent with a debt research analyst's published debt research
for purposes of sharing certain views with sales and trading and
principal trading personnel, members may consider the context,
including that the investment objectives or time horizons being
discussed may differ from those underlying the debt analyst's published
views. One commenter asked FINRA to clarify that the standard may be
applied wherever consistency with a debt research analyst's views may
be assessed under the proposed debt rule, such as with respect to debt
research analyst account trading or providing customized analysis,
recommendations, or trade ideas to sales and trading, principal
trading, and customers.\134\ FINRA agrees that context may be
considered whenever consistency of research or views is at issue.
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    \134\ WilmerHale Debt.
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Disclosure Requirements
    One commenter expressed concern about the requirements that a
member disclose in retail debt research reports its distribution of all
debt security ratings (and the percentage of subject companies in each
buy/hold/sell category for which the member has provided investment
banking services within the previous 12 months) and historical ratings
information on the debt securities that are the subject of the debt
research report for a period of three years or the time during which
the member has assigned a rating, whichever is shorter.\135\ The
commenter asked FINRA to eliminate these provisions because they are
impractical and provide minimal benefit to investors in the context of
debt research, even though they may be very useful in the equity
context.\136\ The commenter stated that the large number of bond issues
followed by analysts make the provisions especially burdensome and do
not allow for helpful comparisons for investors across debt securities
or issuers. With respect to the ratings distribution requirements, the
commenter asserted that in some cases, a debt analyst may assign a
rating to the issuer that applies to all of that issuer's bonds,
thereby skewing the distribution because those issuers will be
overrepresented in the distribution. The commenter also stated that the
tracking requirements for these provisions would be particularly
burdensome, given the numerous bonds issued by the same subject company
and the fact that bonds are constantly being replaced with newer ones.
Finally, the commenter stated that the three-year look back period is
too long and suggested instead a one-year period if FINRA retains the
historical rating table requirement.
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    \135\ WilmerHale Debt.
    \136\ WilmerHale Debt.
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    Similar to the current equity rules, FINRA believes that to the
extent that a firm produces retail debt research that assigns a rating
to an issuer--i.e., a credit analysis--these disclosure provisions
would provide value to retail investors to quickly gauge any apparent
bias toward more or less favorable ratings or investment banking
clients and to assess the accuracy of past ratings. Moreover, FINRA
understands that the burden to comply with the requirements with
respect to this limited subset of debt research would be manageable for
firms. Therefore, FINRA is proposing to amend Rules 2242(c)(2) and (3)
to apply the ratings distribution requirement and historical rating
table requirement only to each debt research report limited to the
analysis of an issuer of a debt security that includes a rating of the
subject company. Since the proposal would be limited to these issuer
credit analyses and would not apply to individual bonds, FINRA believes
many of the commenter's burden concerns would be alleviated and that it
would be reasonable and appropriate to maintain the proposed three-year
look back period with respect to the historical rating provision.
    While FINRA also believes that the disclosures would be valuable to
retail investors with respect to debt research on individual debt
securities, FINRA recognizes the additional complexity and cost
associated with compliance, particularly where a retail debt research
report may include multiple ratings of individual debt securities, some
of which may be positive and others negative or neutral. FINRA believes
it would be beneficial to obtain additional information about the array
of debt research products that are now being distributed to retail
investors, as well as the operational challenges and costs to apply
these disclosure provisions to debt research on individual debt
securities. Accordingly, FINRA is proposing to eliminate for now the
requirements with respect to debt research reports on individual debt
securities. FINRA will reconsider the appropriateness of the disclosure
requirements as applied to research on individual debt securities after
obtaining and assessing the additional information.
    The same commenter also requested that FINRA allow members to
provide a hyperlink or web address to web-based disclosures in all debt
research reports, rather than requiring the disclosures within a
printed report.\137\ The commenter noted that while the SEC has
interpreted Sarbanes-Oxley to require disclosure in each equity report,
the law does not apply to debt research. FINRA believes that
disclosures in retail debt research reports should be proximate to the
content of those reports and easily available to recipients of the
research without requiring any substantive additional steps. Therefore,
to the extent a debt research report is not delivered electronically
with hyperlinked disclosures, FINRA believes the disclosures must be in
the research report itself. FINRA also believes this will promote
consistency between equity and retail debt research. Finally, FINRA
notes that institutional debt research would not require the specific
disclosures.
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    \137\ WilmerHale Debt.
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Institutional Debt Research Exemption
    The proposed rule change would exempt debt research provided solely
to certain eligible institutional investors from many of the proposed
rule's provisions, provided that a member obtains consent from the
institutional investor to receive that research and the research
reports contain specified

disclosure to alert recipients that the reports do not carry the same
protections as retail debt research. The proposal distinguishes between
larger and smaller institutions in the manner in which the consent must
be obtained. Firms may use negative consent where the customer meets
the definition of QIB and satisfies the institutional suitability
standards of FINRA Rule 2111 with respect to debt transactions and