Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment No. 1 Thereto, To Adopt FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports), 43528-43547 [2015-17972]

Download as PDF 43528 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices trade through the PBBO. With respect to trading halts, the Exchange believes that proposed Rule 7.18P would promote price discovery and liquidity on the primary listing market for re-opening auctions following a halt, suspension, or trading pause, thereby supporting competition. The proposed nonsubstantive differences would be to use new Pillar terminology, which would promote consistent use of terminology to support the Pillar trading platform making the Exchange’s rules easier to navigate. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others No written comments were solicited or received with respect to the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 45 days of the date of publication of this notice in the Federal Register or up to 90 days (i) as the Commission may designate if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will: (A) By order approve or disapprove the proposed rule change, or (B) institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: tkelley on DSK3SPTVN1PROD with NOTICES Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number SR– NYSEARCA–2015–58 on the subject line. Paper Comments • Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NYSEARCA–2015–58. This file number should be included on the subject line if email is used. To help the Commission process and review your VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission’s Public Reference Room, 100 F Street NE., Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing will also be available for inspection and copying at the NYSE’s principal office and on its Internet Web site at www.nyse.com. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR– NYSEARCA–2015–58 and should be submitted on or before August 12, 2015. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.53 Robert W. Errett, Deputy Secretary. [FR Doc. 2015–17895 Filed 7–21–15; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–75472; File No. SR–FINRA– 2014–048] Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment No. 1 Thereto, To Adopt FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) July 16, 2015. I. Introduction On November 14, 2014, Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’), pursuant to section 19(b)(1) of the Securities Exchange Act PO 00000 53 17 CFR 200.30–3(a)(12). Frm 00143 Fmt 4703 Sfmt 4703 of 1934 (‘‘Act’’ or ‘‘Exchange Act’’) 1 and Rule 19b–4 thereunder,2 a proposed rule to adopt new FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) to address conflicts of interest relating to the publication and distribution of debt research reports. The proposal was published for comment in the Federal Register on November 24, 2014.3 The Commission received five comments on the proposal.4 On February 19, 2015, FINRA filed Amendment No. 1 responding to the comments received to the proposal as well as to propose amendments in response to these comments. The proposal, as amended by Amendment No. 1, was published for comment in the Federal Register on March 18, 2015.5 On February 20, 2015, the Commission issued an order instituting proceedings pursuant to section 19(b)(2)(B) of the Act 6 to determine whether to approve or disapprove the proposal. The order was published for comment in the Federal Register on February 26, 2015.7 The Commission received a further four comments regarding the proceedings or in response 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 Exchange Act Release No. 73623 (Nov. 18, 2014); 79 FR 69905 (Nov. 24, 2014) (‘‘Notice’’). On January 6, 2015, FINRA consented to extending the time period for the Commission to either approve or disapprove the proposed rule change, or to institute proceedings to determine whether to approve or disapprove the proposed rule change, to February 20, 2015. 4 See Letter from Kevin Zambrowicz, Associate General Counsel & Managing Director and Sean Davy, Managing Director, SIFMA, dated Dec. 15, 2014 (‘‘SIFMA’’), Letter from Hugh D. Berkson, President-Elect, Public Investors Arbitration Bar Association, dated Dec. 15, 2014 (‘‘PIABA Debt’’), Letter from Yoon-Young Lee, WilmerHale, dated Dec. 16, 2014 (‘‘WilmerHale Debt One’’), Letter from William Beatty, President and Washington (State) Securities Administrator, North American Securities Administrators Association, Inc., dated Dec. 19, 2014 (‘‘NASAA Debt One’’), and Letter from Kurt N. Schacht, CFA, Managing Director, Standards and Financial Market Integrity and Linda L. Rittenhouse, Director, Capital Markets Policy, CFA Institute, dated Feb. 9, 2015 (‘‘CFA Institute One’’). 5 Exchange Act Release No. 74490 (Mar. 12, 2015); 80 FR 14198 (Mar. 18, 2015) (‘‘Amendment Notice’’). 6 15 U.S.C. 78s(b)(2)(B). 7 Exchange Act Release No. 74340 (Feb. 20, 2015); 80 FR 10538 (Feb. 26, 2015). Specifically, the Commission instituted proceedings to allow for additional analysis of the proposed rule change’s consistency with section 15A(b)(9) of the Act, which requires that FINRA’s rules be designed to, among other things, promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest. See id. 2 17 E:\FR\FM\22JYN1.SGM 22JYN1 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices to Amendment No. 1,8 to which FINRA responded via letter on May 5, 2015.9 This order approves the proposed rule change. II. Description of the Proposed Rule Change tkelley on DSK3SPTVN1PROD with NOTICES As described more fully in the Notice, FINRA proposed to adopt FINRA Rule 2242 to address conflicts of interest relating to the publication and distribution of debt research reports. Proposed FINRA Rule 2242 would adopt a tiered approach that FINRA believed, in general, would provide retail debt research recipients with extensive protections similar to those provided to recipients of equity research under current and proposed FINRA rules,10 with modifications to reflect differences in the trading of debt securities. As stated above, the Commission received five comments on the proposal. All of the relevant commenters expressed general support for the proposal. Of the four comments received in regards to the proceedings or Amendment No. 1, one was supportive of the proposal as amended by Amendment No. 1 with certain specific comments,11 one stated that Amendment No. 1 addressed their specific comments,12 one reiterated prior concerns regarding the principlesbased nature of the proposal,13 and one did not seem to be related to the proposed rule change.14 8 Letter from Stephanie R. Nicholas, WilmerHale, dated Apr. 6, 2015 (‘‘WilmerHale Debt Two’’), Letter from Kurt N. Schacht, Managing Director, Standards and Financial Market Integrity, and Linda L. Rittenhouse, Director, Capital Markets Policy, CFA Institute, to Brent J. Fields, Secretary, SEC, dated Apr. 7, 2015 (‘‘CFA Institute Two’’), an anonymous comment dated Apr. 8, 2015 (‘‘Anonymous’’), and Letter from William Beatty, President and Washington (State) Securities Administrator, North American Securities Administrators Association, Inc., dated Apr. 17, 2015 (‘‘NASAA Debt Two’’). 9 Letter from Philip Shaikun, Vice President and Associate General Counsel, FINRA, dated May 5, 2015 (‘‘FINRA Response’’). 10 See Exchange Act Release No. 73622 (Nov. 18, 2014); 79 FR 69939 (Nov. 24, 2014) (SR–FINRA– 2014–047) (proposing amendments to current SRO rules relating to equity research). 11 WilmerHale Debt Two. 12 CFA Institute Two. 13 NASAA Debt Two. 14 Anonymous. The comment, in total, was: ‘‘[I]s this a due diligence report where numbers amounts are fabricated? Is a qualified professional ‘valuing’ as a way of adjusting the amounts[?] I believe individuals should be leery of using ‘debt’ excessively when processing accounting matters. Especially with the prevalence of automated software and attitude of today[’]s workers.’’ Id. Neither we nor FINRA see any issues raised by this comment relevant to the proposed rule change. See FINRA Response. VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 A. Definitions FINRA represented that most of the defined terms closely follow the defined terms for equity research in NASD Rule 2711, as amended by the equity research filing, with minor changes to reflect their application to debt research. The proposed definitions are set forth below. Under the proposed rule change, the term ‘‘debt research analyst’’ would mean an associated person who is primarily responsible for, and any associated person who reports directly or indirectly to a debt research analyst in connection with, the preparation of the substance of a debt research report, whether or not any such person has the job title of ‘‘research analyst.’’ 15 The term ‘‘debt research analyst account’’ would mean any account in which a debt research analyst or member of the debt research analyst’s household has a financial interest, or over which such analyst has discretion or control. It would not, however, include an investment company registered under the Investment Company Act of 1940 over which the debt research analyst or a member of the debt research analyst’s household has discretion or control, provided that the debt research analyst or member of a debt research analyst’s household has no financial interest in such investment company, other than a performance or management fee. The term also would not include a ‘‘blind trust’’ account that is controlled by a person other than the debt research analyst or member of the debt research analyst’s household where neither the debt research analyst nor a member of the debt research analyst’s household knows of the account’s investments or investment transactions.16 The proposed rule change would define the term ‘‘debt research report’’ as any written (including electronic) communication that includes an analysis of a debt security or an issuer of a debt security and that provides information reasonably sufficient upon which to base an investment decision, excluding communications that solely constitute an equity research report as defined in proposed Rule 2241(a)(11).17 proposed FINRA Rule 2242(a)(1). 16 See proposed FINRA Rule 2242(a)(2). The exclusion for a registered investment company over which a research analyst has discretion or control in the proposed definition mirrors proposed changes to the definition of ‘‘research analyst account’’ in the equity research rules. 17 See proposed FINRA Rule 2242(a)(3). FINRA explained that the proposed rule change did not need to, similar to the equity proposal, explicitly exclude communications concerning open-end registered investment companies that are not listed or traded on an exchange (‘‘mutual funds’’) from the proposed rule as they would not be captured by the rule in the first place. See proposed FINRA Rule PO 00000 15 See Frm 00144 Fmt 4703 Sfmt 4703 43529 The proposed definition and exceptions noted below would, in FINRA’s view, generally align with the definition of ‘‘research report’’ in NASD Rule 2711, while incorporating aspects of the Regulation AC definition of ‘‘research report.’’ 18 Communications that constitute statutory prospectuses that are filed as part of the registration statement would not be included in the definition of a debt research report. Further, communications that constitute private placement memoranda and comparable offering-related documents, other than those that purport to be research, would not be included in the definition of a debt research report. In general, the term debt research report also would not include communications that are limited to the following, if they do not include an analysis of, or recommend or rate, individual debt securities or issuers: • Discussions of broad-based indices; • Commentaries on economic, political, or market conditions; • Commentaries on or analyses of particular types of debt securities or characteristics of debt securities; • Technical analyses concerning the demand and supply for a sector, index, or industry based on trading volume and price; • Recommendations regarding increasing or decreasing holdings in particular industries or sectors or types of debt securities; or • Notices of ratings or price target changes, provided that the member simultaneously directs the readers of the notice to the most recent debt research report on the subject company that includes all current applicable disclosures required by the rule and that such debt research report does not contain materially misleading disclosures, including disclosures that are outdated or no longer applicable. The term debt research report also, in general, would not include the following communications, even if they include an analysis of an individual debt security or issuer and information 2242(a)(4) (defining ‘‘debt securities’’ as not including ‘‘equity securities’’ as defined in the Act). See also Exchange Act Release No. 74488 (Mar. 12, 2015); 80 FR 14174 (Mar. 18, 2015) (explaining the equity proposal as amended). 18 In aligning the proposed definition with the Regulation AC definition of research report, FINRA pointed out that the proposed definition differs in minor respects from the definition of ‘‘research report’’ in NASD Rule 2711. For example, the proposed definition of ‘‘debt research report’’ would apply to a communication that includes an analysis of a debt security or an issuer of a debt security, while the definition of ‘‘research report’’ in NASD Rule 2711 applies to an analysis of equity securities of individual companies or industries. E:\FR\FM\22JYN1.SGM 22JYN1 43530 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices tkelley on DSK3SPTVN1PROD with NOTICES reasonably sufficient upon which to base an investment decision: • Statistical summaries of multiple companies’ financial data, including listings of current ratings that do not include an analysis of individual companies’ data; • An analysis prepared for a specific person or a limited group of fewer than 15 persons; • Periodic reports or other communications prepared for investment company shareholders or discretionary investment account clients that discuss individual debt securities in the context of a fund’s or account’s past performance or the basis for previously made discretionary investment decisions; or • Internal communications that are not given to current or prospective customers. The proposed rule change would define the term ‘‘debt security’’ as any ‘‘security’’ as defined in section 3(a)(10) of the Exchange Act,19 except for any ‘‘equity security’’ as defined in section 3(a)(11) of the Exchange Act,20 any ‘‘municipal security’’ as defined in section 3(a)(29) of the Exchange Act,21 any ‘‘security-based swap’’ as defined in section 3(a)(68) of the Exchange Act,22 and any ‘‘U.S. Treasury Security’’ as defined in paragraph (p) of FINRA Rule 6710.23 The proposed rule change would define the term ‘‘debt trader’’ as a person, with respect to transactions in debt securities, who is engaged in proprietary trading or the execution of transactions on an agency basis.24 The proposed rule change would provide that the term ‘‘independent third-party debt research report’’ means a third-party debt research report, in which the person producing the report both (1) has no affiliation or business or contractual relationship with the distributing member or that member’s affiliates that is reasonably likely to inform the content of its research reports, and (2) makes content determinations without any input from the distributing member or that member’s affiliates.25 The proposed rule change would define the term ‘‘investment banking department’’ as any department or division, whether or not identified as such, that performs any investment banking service on behalf of a member.26 The term ‘‘investment banking services’’ would include, without limitation, acting as an underwriter, participating in a selling group in an offering for the issuer or otherwise acting in furtherance of a public offering of the issuer; acting as a financial adviser in a merger or acquisition; providing venture capital or equity lines of credit or serving as placement agent for the issuer or otherwise acting in furtherance of a private offering of the issuer.27 The proposed rule change would define the term ‘‘member of a debt research analyst’s household’’ as any individual whose principal residence is the same as the debt research analyst’s principal residence.28 The proposed rule change would define ‘‘public appearance’’ as any participation in a conference call, seminar, forum (including an interactive electronic forum) or other public speaking activity before fifteen or more persons or before one or more representatives of the media, a radio, television or print media interview, or the writing of a print media article, in which a debt research analyst makes a recommendation or offers an opinion concerning a debt security or an issuer of a debt security.29 Under the proposed rule change the term ‘‘qualified institutional buyer’’ has the same meaning as under Rule 144A of the Securities Act.30 The proposed rule change would define ‘‘research department’’ as any department or division, whether or not identified as such, that is principally responsible for preparing the substance of a debt research report on behalf of a member.31 The proposed rule change would define the term ‘‘subject company’’ as the issuer whose debt securities are the subject of a debt research report or a public appearance.32 Finally, the proposed rule change would define the term ‘‘thirdparty debt research report’’ as a debt research report that is produced by a person or entity other than the member.33 B. Identifying and Managing Conflicts of Interest Similar to the proposed equity research rule, the proposed rule change contains an overarching provision that would require members to establish, 26 See proposed FINRA Rule 2242(a)(8). proposed FINRA Rule 2242(a)(9). 28 See proposed FINRA Rule 2242(a)(10). 29 See proposed FINRA Rule 2242(a)(11). 30 See proposed FINRA Rule 2242(a)(12). 31 See proposed FINRA Rule 2242(a)(14). 32 See proposed FINRA Rule 2242(a)(15). 33 See proposed FINRA Rule 2242(a)(16). 19 15 U.S.C. 78c(a)(10). 20 15 U.S.C. 78c(a)(11). 21 15 U.S.C. 78c(a)(29). 22 15 U.S.C. 78c(a)(68). 23 See proposed FINRA Rule 2242(a)(4). 24 See proposed FINRA Rule 2242(a)(5). 25 See proposed FINRA Rule 2242(a)(6). VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 27 See PO 00000 Frm 00145 Fmt 4703 Sfmt 4703 maintain, and enforce written policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to the preparation, content, and distribution of debt research reports; public appearances by debt research analysts; and the interaction between debt research analysts and persons outside of the research department, including investment banking, sales and trading and principal trading personnel, subject companies, and customers.34 The written policies and procedures would be required to be reasonably designed to promote objective and reliable debt research that reflects the truly held opinions of debt research analysts and to prevent the use of debt research reports or debt research analysts to manipulate or condition the market or favor the interests of the firm or current or prospective customers or class of customers.35 The proposed rule change would introduce a distinction between sales and trading personnel and persons engaged in principal trading activities, where, in FINRA’s opinion, the conflicts addressed by the proposal are of most concern. 1. Prepublication Review FINRA proposed that the required policies and procedures would be required to prohibit prepublication review, clearance or approval of debt research by persons involved in investment banking, sales and trading, or principal trading, and either restrict or prohibit such review, clearance, and approval by other non-research personnel other than legal and compliance.36 The policies and procedures also would be required to prohibit prepublication review of a debt research report by a subject company, other than for verification of facts.37 The proposed rule change would allow sections of a draft debt research report to be provided to non-investment banking personnel, non-principal trading personnel, non-sales and trading personnel, or to the subject company for factual review, so long as: (1) The sections of the draft debt research report submitted do not contain the research summary, recommendation or rating; (2) A complete draft of the debt research report is provided to legal or compliance personnel before sections of the report are submitted to noninvestment banking personnel, non34 See proposed FINRA Rule 2242(b)(1). proposed FINRA Rule 2242(b)(2). 36 See proposed FINRA Rule 2242(b)(2)(A) and (B). 37 See proposed FINRA Rule 2242(b)(2)(N). 35 See E:\FR\FM\22JYN1.SGM 22JYN1 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices principal trading personnel, non-sales and trading personnel or the subject company; and (3) If, after submitting sections of the draft debt research report to non-investment banking personnel, non-principal trading personnel, nonsales and trading personnel or the subject company, the research department intends to change the proposed rating or recommendation, it would be required to first provide written justification to, and receive written authorization from, legal or compliance personnel for the change. The member would be required to retain copies of any draft and the final version of such debt research report for three years after publication. 38 tkelley on DSK3SPTVN1PROD with NOTICES 2. Coverage Decisions With respect to coverage decisions, a member’s written policies and procedures would be required under the proposal to restrict or limit input by investment banking, sales and trading and principal trading personnel to ensure that research management independently makes all final decisions regarding the research coverage plan.39 However, the provision would not preclude personnel from these or any other department from conveying customer interests and coverage needs, so long as final decisions regarding the coverage plan are made by research management. 3. Solicitation and Marketing of Investment Banking Transactions A member’s written policies and procedures also would be required under the proposal to restrict or limit activities by debt research analysts that can reasonably be expected to compromise their objectivity.40 This would include prohibiting participation in pitches and other solicitations of investment banking services transactions and road shows and other marketing on behalf of issuers related to such transactions. The proposed rule change would adopt Supplementary Material that incorporates an existing FINRA interpretation for the equity research rules that prohibits in pitch materials any information about a member’s debt research capacity in a manner that suggests, directly or indirectly, that the member might provide favorable debt research coverage.41 By way of example, the Supplementary Material explains that 38 See proposed FINRA Rule 2242.05 (Submission of Sections of a Draft Research Report for Factual Review). 39 See proposed FINRA Rule 2242(b)(2)(C). 40 See proposed FINRA Rule 2242(b)(2)(L). 41 See proposed FINRA Rule 2242.01 (Efforts to Solicit Investment Banking Business). VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 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. The proposed rule change also would prohibit investment banking personnel from directing debt research analysts to engage in sales or marketing efforts related to an investment banking services transaction or any communication with a current or prospective customer about an investment banking services transaction.42 In addition, the proposed rule change would adopt Supplementary Material to provide that, consistent with this requirement, no debt research analyst may engage in any communication with a current or prospective customer in the presence of investment banking department personnel or company management about an investment banking services transaction.43 4. Supervision A member’s written policies and procedures would be required under the proposal to limit the supervision of debt research analysts to persons not engaged in investment banking, sales and trading or principal trading activities.44 In addition, the member would further be required under the proposal to establish information barriers or other institutional safeguards reasonably designed to ensure that debt research analysts are insulated from the review, pressure or oversight by persons engaged in investment banking services, principal trading or sales and trading activities or others who might be biased in their judgment or supervision.45 5. Budget and Compensation A member’s written policies and procedures also would be required under the proposal to limit the determination of a firm’s debt research department budget to senior management, excluding senior management engaged in investment banking or principal trading activities, and without regard to specific revenues proposed FINRA Rule 2242(b)(2)(M). proposed FINRA Rule 2242.02(a) (Restrictions on Communications with Customers and Internal Personnel). 44 See proposed FINRA Rule 2242(b)(2)(D). 45 See proposed FINRA Rule 2242(b)(2)(H). PO 00000 42 See 43531 or results derived from investment banking.46 However, the proposed rule change would expressly permit all persons to provide input to senior management regarding the demand for and quality of debt research, including product trends and customer interests. It further would allow consideration by senior management of a firm’s overall revenues and results in determining the debt research budget and allocation of expenses. With respect to compensation determinations, a member’s written policies and procedures would be required under the proposal to prohibit compensation based on specific investment banking services or trading transactions or contributions to a firm’s investment banking or principal trading activities and prohibit investment banking and principal trading personnel from input into the compensation of debt research analysts.47 Further, the firm’s written policies and procedures would be required under the proposal to require that the compensation of a debt research analyst who is primarily responsible for the substance of a research report be reviewed and approved at least annually by a committee that reports to a member’s board of directors or, if the member has no board of directors, a senior executive officer of the member.48 This committee would be required under the proposal to not have representation from investment banking personnel or persons engaged in principal trading activities and would be required to consider certain factors when reviewing a debt research analyst’s compensation. Specifically, the proposal would require that the committee consider the debt research analyst’s individual performance, including the analyst’s productivity and the quality of the debt research analyst’s research as well as the overall ratings received from customers and peers (independent of the member’s investment banking department and persons engaged in principal trading activities) and other independent ratings services. Neither investment banking personnel nor persons engaged in principal trading activities would be required under the proposal to give input with respect to the compensation determination for debt research analysts. However, sales and trading personnel would be permitted to give input to debt research management as part of the evaluation process in order to convey customer 43 See Frm 00146 Fmt 4703 Sfmt 4703 46 See 47 See proposed FINRA Rule 2242(b)(2)(E). proposed FINRA Rule 2242(b)(2)(D) and (F). 48 See E:\FR\FM\22JYN1.SGM proposed FINRA Rule 2242(b)(2)(G). 22JYN1 43532 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices feedback, provided that final compensation determinations are made by research management, subject to review and approval by the compensation committee.49 The committee, which would not be permitted to have representation from investment banking or persons engaged in principal trading activities, would be required to document the basis for each debt research analyst’s compensation, including any input from sales and trading personnel. tkelley on DSK3SPTVN1PROD with NOTICES 6. Personal Trading Restrictions Under the proposed rule change, a member’s written policies and procedures would be required to restrict or limit trading by a ‘‘debt research analyst account’’ in securities, derivatives and funds whose performance is materially dependent upon the performance of securities covered by the debt research analyst.50 The procedures would be required under the proposal to ensure that those accounts, supervisors of debt research analysts, and associated persons with the ability to influence the content of debt research reports do not benefit in their trading from knowledge of the content or timing of debt research reports before the intended recipients of such research have had a reasonable opportunity to act on the information in the report.51 Furthermore, the procedures would be required under the proposal to generally prohibit a debt research analyst account from purchasing or selling any security or any option or derivative of such security in a manner inconsistent with the debt research analyst’s most recently published recommendation, except that the procedures would be permitted to define circumstances of financial hardship (e.g., unanticipated significant change in the personal financial circumstances of the beneficial owner of the research analyst account) in which the firm would permit a debt research analyst account to trade contrary to that recommendation. In determining whether a particular trade is contrary to an existing recommendation, firms would be permitted to take into account the context of a given trade, including the extent of coverage of the subject security. While the proposed rule change does not include a recordkeeping requirement, FINRA stated it expects members to evidence compliance with their policies and 49 See procedures and retain any related documentation in accordance with FINRA Rule 4511. The proposed rule change includes Supplementary Material .10, which would provide that FINRA would not consider a research analyst account to have traded in a manner inconsistent with a research analyst’s recommendation where a member has instituted a policy that prohibits any research analyst from holding securities, or options on or derivatives of such securities, of the companies in the research analyst’s coverage universe, provided that the member establishes a reasonable plan to liquidate such holdings consistent with the principles in paragraph (b)(2)(J)(i) and such plan is approved by the member’s legal or compliance department.52 7. Retaliation and Promises of Favorable Research A member’s written policies and procedures would be required to prohibit direct or indirect retaliation or threat of retaliation against debt research analysts by any employee of the firm for publishing research or making a public appearance that may adversely affect the member’s current or prospective business interests.53 The policies and procedures would also be required to prohibit explicit or implicit promises of favorable debt research, specific research content or a specific rating or recommendation as inducement for the receipt of business or compensation.54 8. Joint Due Diligence with Investment Banking Personnel The proposed rule change would establish limitations regarding joint due diligence activities—i.e., due diligence by the debt research analyst in the presence of investment banking department personnel—during a specified time period. Specifically, the proposed rule change states that FINRA would interpret the overarching principle which would, under the proposal, require members to, among other things, establish, maintain, and enforce written policies and procedures that address the interaction between debt research analysts and those outside the research department, including investment banking department personnel, sales and trading personnel, principal trading personnel, subject companies, and customers,55 to prohibit the performance of joint due diligence proposed FINRA Rule 2242(b)(2)(D) and 52 See (G). 50 See proposed FINRA Rule 2242(b)(2)(J). 51 See proposed FINRA Rule 2242.07 (Ability to Influence the Content of a Research Report). VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 PO 00000 proposed FINRA Rule 2242.10. proposed FINRA Rule 2242(b)(2)(I). 54 See proposed FINRA Rule 2242(b)(2)(K). 55 See proposed FINRA Rule 2242(b)(1)(C). 53 See Frm 00147 Fmt 4703 Sfmt 4703 prior to the selection of underwriters for the investment banking services transaction.56 9. Communications Between Debt Research Analysts and Trading Personnel The proposed rule change delineates what would be the prohibited and permissible interactions between debt research analysts and sales and trading and principal trading personnel. The proposed rule change would require members to establish, maintain and enforce written policies and procedures reasonably designed to prohibit sales and trading and principal trading personnel from attempting to influence a debt research analyst’s opinions or views for the purpose of benefiting the trading position of the firm, a customer or a class of customers.57 It would further prohibit debt research analysts from identifying or recommending specific potential trading transactions to sales and trading or principal trading personnel that are inconsistent with such debt research analyst’s currently published debt research reports or from disclosing the timing of, or material investment conclusions in, a pending debt research report.58 The proposed rule change would permit sales and trading and principal trading personnel to communicate customers’ interests to a debt research analyst, so long as the debt research analyst does not respond by publishing debt research for the purpose of benefiting the trading position of the firm, a customer or a class of customers.59 In addition, debt research analysts would be permitted to provide customized analysis, recommendations or trade ideas to sales and trading and principal trading personnel and customers, provided that any such communications are not inconsistent with the analyst’s currently published or pending debt research, and that any subsequently published debt research is not for the purpose of benefiting the trading position of the firm, a customer or a class of customers.60 The proposed rule change also would permit sales and trading and principal 56 See proposed FINRA Rule 2242.09 (Joint Due Diligence). 57 See proposed FINRA Rule 2242.03(a)(1) (Information Barriers between Research Analysts and Trading Desk Personnel). 58 See proposed FINRA Rule 2242.03(a)(2) (Information Barriers between Research Analysts and Trading Desk Personnel). 59 See proposed FINRA Rule 2242.03(b)(1) (Information Barriers between Research Analysts and Trading Desk Personnel). 60 See proposed FINRA Rule 2242.03(b)(2) (Information Barriers between Research Analysts and Trading Desk Personnel). E:\FR\FM\22JYN1.SGM 22JYN1 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices trading personnel to seek the views of debt research analysts regarding the creditworthiness of the issuer of a debt security and other information regarding an issuer of a debt security that is reasonably related to the price or performance of the debt security, so long as, with respect to any covered issuer, such information is consistent with the debt research analyst’s published debt research report and consistent in nature with the types of communications that a debt research analyst might have with customers. In determining what is consistent with the debt research analyst’s published debt research, FINRA stated that a member would be permitted to consider the context, including that the investment objectives or time horizons being discussed differ from those underlying the debt research analyst’s published views.61 Finally, FINRA also stated that debt research analysts would be permitted to seek information from sales and trading and principal trading personnel regarding a particular debt instrument, current prices, spreads, liquidity, and similar market information relevant to the debt research analyst’s valuation of a particular debt security.62 The proposed rule change clarifies that communications between debt research analysts and sales and trading or principal trading personnel that are not related to sales and trading, principal trading or debt research activities would be permitted to take place without restriction, unless otherwise prohibited.63 10. Restrictions on Communications With Customers and Internal Sales Personnel tkelley on DSK3SPTVN1PROD with NOTICES The proposed rule change would apply standards to communications with customers and internal sales personnel. Any written or oral communication by a debt research analyst with a current or prospective customer or internal personnel related to an investment banking services transaction would be required to be fair, balanced and not misleading, taking into consideration the overall context in which the communication is made.64 61 See proposed FINRA Rule 2242.03(b)(3) (Information Barriers between Research Analysts and Trading Desk Personnel). 62 See proposed FINRA Rule 2242.03(b)(4) (Information Barriers between Research Analysts and Trading Desk Personnel). 63 See proposed FINRA Rule 2242.03(c) (Information Barriers between Research Analysts and Trading Desk Personnel). 64 See proposed FINRA Rule 2242.02(b) (Restrictions on Communications with Customers and Internal Personnel). VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 Consistent with the proposed prohibition on investment banking department personnel directly or indirectly directing a debt research analyst to engage in sales or marketing efforts related to an investment banking services transaction or directing a debt research analyst to engage in any communication with a current or prospective customer about an investment banking services transaction, no debt research analyst would be permitted to engage in any communication with a current or prospective customer in the presence of investment banking department personnel or company management about an investment banking services transaction. C. Content and Disclosure in Debt Research Reports The proposed rule change would, in general, adopt the disclosures in the equity research rule for debt research, with modifications to reflect the different characteristics of the debt market. The proposed rule change would require members to establish, maintain and enforce written policies and procedures reasonably designed to ensure that purported facts in their debt research reports are based on reliable information.65 In addition, the policies and procedures would be required to be reasonably designed to ensure that any recommendation or rating has a reasonable basis and is accompanied by a clear explanation of any valuation method used and a fair presentation of the risks that may impede achievement of the recommendation or rating.66 While there would be no obligation to employ a rating system under the proposed rule, members that choose to employ a rating system would be required to clearly define in each debt research report the meaning of each rating in the system, including the time horizon and any benchmarks on which a rating is based. In addition, the definition of each rating would be required to be consistent with its plain meaning.67 Consistent with the equity rules, irrespective of the rating system a member employs, a member would be required to include in each debt research report limited to the analysis of an issuer of a debt security that includes a rating of the subject company the percentage of all subject companies rated by the member to which the member would assign a ‘‘buy,’’ ‘‘hold’’ PO 00000 or ‘‘sell’’ rating.68 In addition, a member would be required to disclose in each debt research report the percentage of subject companies within each of the ‘‘buy,’’ ‘‘hold,’’ and ‘‘sell’’ categories for which the member has provided investment banking services within the previous 12 months.69 All such information would be required to be current as of the end of the most recent calendar quarter or the second most recent calendar quarter if the publication date of the debt research report is less than 15 calendar days after the most recent calendar quarter.70 If a debt research report limited to the analysis of an issuer of a debt security contains a rating for the subject company and the member has assigned a rating to such subject company for at least one year, the debt research report would be required to show each date on which a member has assigned a rating to the debt security and the rating assigned on such date. This information would be required for the period that the member has assigned any rating to the debt security or for a three-year period, whichever is shorter.71 Unlike the equity research rules, the proposed rule change would not require those ratings to be plotted on a price chart because of limits on price transparency, including daily closing price information, with respect to many debt securities. The proposed rule change would require a member to disclose in any debt research report at the time of publication or distribution of the report: 72 • 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 68 See proposed FINRA Rule 2242(c)(2)(A). proposed FINRA Rule 2242(c)(2)(B). 70 See proposed FINRA Rule 2242(c)(2)(C). 71 See proposed FINRA Rule 2242(c)(3). 72 See proposed FINRA Rule 2242(c)(4). 69 See 65 See proposed FINRA Rule 2242(c)(1)(A). proposed FINRA Rule 2242(c)(1)(B). 67 See proposed FINRA Rule 2242(c)(2). 66 See Frm 00148 Fmt 4703 Sfmt 4703 43533 E:\FR\FM\22JYN1.SGM 22JYN1 tkelley on DSK3SPTVN1PROD with NOTICES 43534 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices services from the subject company in the next three months; • If, as of the end of the month immediately preceding the date of publication or distribution of a debt research report (or the end of the second most recent month if the publication date is less than 30 calendar days after the end of the most recent month), the member or its affiliates have received from the subject company any compensation for products or services other than investment banking services in the previous 12 months; 73 • 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, noninvestment banking securities-related services or non-securities services; • If the member trades or may trade as principal in the debt securities (or in related derivatives) that are the subject of the debt research report; • If the debt research analyst received any compensation from the subject company in the previous 12 months; and • Any other material conflict of interest of the debt research analyst or member that the debt research analyst or an associated person of the member with the ability to influence the content of a debt research report knows or has reason to know at the time of the publication or distribution of a debt research report. The proposed rule change would incorporate a proposed amendment to the corresponding provision in the equity research rules that expands the existing ‘‘catch all’’ disclosure to require disclosure of material conflicts known not only by the research analyst, but also by any ‘‘associated person of the member with the ability to influence the content of a research report.’’ The proposed rule change defines a person with the ‘‘ability to influence the content of a research report’’ as an associated person who is required to review the content of the debt research report or has exercised authority to review or change the debt research report prior to publication or distribution. This term would not include legal or compliance personnel who may review a debt research report for compliance purposes but are not authorized to dictate a particular 73 See also discussion of proposed FINRA Rule 2242.04 (Disclosure of Compensation Received by Affiliates) below. VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 recommendation or rating.74 The ‘‘reason to know’’ standard in the provision would not impose a duty of inquiry on the debt research analyst or others who can influence the content of a debt research report. Rather, it would cover disclosure of those conflicts that should reasonably be discovered by those persons in the ordinary course of discharging their functions. The proposed rule change would mandate disclosure of firm ownership of debt securities in research reports or a public appearance to the extent those holdings constitute a material conflict of interest.75 The proposed rule change would adopt an exception for disclosure that would reveal material non-public information regarding specific potential future investment banking transactions.76 Similar to the equity research rules, the proposed rule change would require that disclosures be presented on the front page of debt research reports or the front page must refer to the page on which the disclosures are found. Electronic debt research reports, however, would be permitted to provide a hyperlink directly to the required disclosures. All disclosures and references to disclosures required by the proposed rule would need to be clear, comprehensive and prominent.77 Like the equity research rule, the proposed rule change would permit a member that distributes a debt research report covering six or more companies (compendium report) to direct the reader in a clear manner to the applicable disclosures. Electronic compendium reports would be required to include a hyperlink to the required disclosures. Paper-based compendium reports would be required to provide either a toll-free number or a postal address to request the required disclosures and also may include a web address of the member where the disclosures can be found.78 D. Disclosure of Compensation Received by Affiliates The proposed rule change would provide that a member would not be required to disclose receipt of noninvestment banking services compensation by an affiliate if it has implemented written policies and procedures reasonably designed to prevent the debt research analyst and proposed FINRA Rule 2242.07. proposed FINRA Rules 2242(c)(4)(H) and (d)(1)(E). 76 See proposed FINRA Rule 2242(c)(5). 77 See proposed FINRA Rule 2242(c)(6). 78 See proposed FINRA Rule 2242(c)(7). PO 00000 74 See 75 See Frm 00149 Fmt 4703 Sfmt 4703 associated persons of the member with the ability to influence the content of debt research reports from directly or indirectly receiving information from the affiliate as to whether the affiliate received such compensation.79 In addition, a member would be permitted to satisfy the disclosure requirement with respect to the receipt of investment banking compensation from a foreign sovereign by a non-U.S. affiliate of the member by implementing written policies and procedures reasonably designed to prevent the debt research analyst and associated persons of the member with the ability to influence the content of debt research reports from directly or indirectly receiving information from the non-U.S. affiliate as to whether such non-U.S. affiliate received or expects to receive such compensation from the foreign sovereign. However, a member would be required to disclose receipt of compensation by its affiliates from the subject company (including any foreign sovereign) in the past 12 months when the debt research analyst or an associated person with the ability to influence the content of a debt research report has actual knowledge that an affiliate received such compensation during that time period. E. Disclosure in Public Appearances The proposed rule change closely parallels the equity research rules with respect to disclosure in public appearances. Under the proposed rule, a debt research analyst would be required to disclose in public appearances: 80 • 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 79 See proposed FINRA Rule 2242.04 (Disclosure of Compensation Received by Affiliates). 80 See proposed FINRA Rule 2242(d)(1). E:\FR\FM\22JYN1.SGM 22JYN1 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices types of services provided to the subject company, if known by the debt research analyst; or • Any other material conflict of interest of the debt research analyst or member that the debt research analyst knows or has reason to know at the time of the public appearance. However, a member or debt research analyst would not be required to make any such disclosure to the extent it would reveal material non-public information regarding specific potential future investment banking transactions.81 Unlike in debt research reports, the ‘‘catch-all’’ disclosure requirement in public appearances would apply only to a conflict of interest of the debt research analyst or member that the analyst knows or has reason to know at the time of the public appearance. FINRA stated it understands that supervisors or legal and compliance personnel, who otherwise might be captured by the definition of an associated person ‘‘with the ability to influence,’’ typically do not have the opportunity to review and insist on changes to public appearances, many of which are extemporaneous in nature. The proposed rule change would require members to maintain records of public appearances by debt research analysts sufficient to demonstrate compliance by those debt research analysts with the applicable disclosure requirements for public appearances. Such records would be required to be maintained for at least three years from the date of the public appearance.82 tkelley on DSK3SPTVN1PROD with NOTICES F. Disclosure Required by Other Provisions With respect to both research reports and public appearances, the proposed rule change would require that, in addition to the disclosures required under the proposed rule, members and debt research analysts comply with all applicable disclosure provisions of FINRA Rule 2210 (Communications with the Public) and the federal securities laws.83 G. Distribution of Member Research Reports The proposed rule change would require firms to establish, maintain and enforce written policies and procedures reasonably designed to ensure that a debt research report is not distributed selectively to internal trading personnel or a particular customer or class of customers in advance of other customers that the member has previously determined are entitled to receive the debt research report.84 The proposed rule change includes further guidance to explain that firms would be permitted to provide different debt research products and services to different classes of customers, provided the products are not differentiated based on the timing of receipt of potentially market moving information and the firm discloses its research dissemination practices to all customers that receive a research product.85 In addition, a member that provides different debt research products and services for certain customers would be required to inform its other customers that its alternative debt research products and services may reach different conclusions or recommendations that could impact the price of the debt security.86 H. Distribution of Third-party Debt Research Reports FINRA proposed to apply the supervisory review and disclosure obligations applicable to the distribution of third-party equity research similarly to third-party retail debt research. Moreover, the proposed rule change would incorporate the current standards for third-party equity research, including the distinction between independent and nonindependent third-party research with respect to the review and disclosure requirements. In addition, the proposed rule change would adopt an expanded requirement in the proposed equity research rules that requires members to disclose any other material conflict of interest that can reasonably be expected to have influenced the member’s choice of a third-party research provider or the subject company of a third-party research report. The proposed rule change would prohibit a member from distributing third-party debt research if it knows or has reason to know that such research is not objective or reliable.87 A member would satisfy the standard based on its actual knowledge and reasonable diligence. However, there would be no duty of inquiry to definitively establish that the third-party research is, in fact, objective and reliable. In addition, the proposed rule change would require a member to establish, maintain, and enforce written policies and procedures reasonably designed to 84 See proposed FINRA Rule 2242(f). proposed FINRA Rule 2242.06 (Distribution of Member Research Products). 86 See id. 87 See proposed FINRA Rule 2242(g)(1). ensure that any third-party debt research report it distributes contains no untrue statement of material fact and is otherwise not false or misleading.88 For the purpose of this requirement, a member’s obligation to review a thirdparty debt research report would extend to any untrue statement of material fact or any false or misleading information that should be known from reading the debt research report or is known based on information otherwise possessed by the member. 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 thirdparty debt research report provider or the subject company of a third-party debt research report, including: • If the member or any of its affiliates managed or co-managed a public offering of securities for the subject company in the past 12 months, received compensation for investment banking services from the subject company in the past 12 months, or expects to receive or intends to seek compensation for investment banking services from the subject company in the next three months; • If the member trades or may trade as principal in the debt securities (or in related derivatives) that are the subject of the debt research report; and • Any other material conflict of interest of the debt research analyst or member that the debt research analyst or an associated person of the member with the ability to influence the content of a debt research report knows or has reason to know at the time of the publication or distribution of a debt research report.89 The proposed rule change would not require members to review a third-party debt research report prior to distribution if such debt research report is an independent third-party debt research report.90 For the purposes of the disclosure requirements for third-party research reports, a member would not be considered to have distributed a third-party debt research report where the research is an independent thirdparty 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 85 See 81 See proposed FINRA Rule 2242(d)(2). proposed FINRA Rule 2242(d)(3). 83 See proposed FINRA Rule 2242(e). 82 See VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 PO 00000 Frm 00150 Fmt 4703 Sfmt 4703 43535 88 See proposed FINRA Rule 2242(g)(2). proposed FINRA Rule 2242(g)(3). 90 See proposed FINRA Rule 2242(g)(4). 89 See E:\FR\FM\22JYN1.SGM 22JYN1 43536 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices customer, during the solicitation, of the availability of independent debt research on the solicited debt security and the customer requests such independent debt research.91 The proposed rule would require that members ensure that third-party debt research reports are clearly labeled as such and that there is no confusion on the part of the recipient as to the person or entity that prepared the debt research reports.92 tkelley on DSK3SPTVN1PROD with NOTICES I. Obligations of Persons Associated With a Member The proposed rule change would clarify the obligations of each associated person under those provisions of the proposed rule that require a member to restrict or prohibit certain conduct by establishing, maintaining, and enforcing particular policies and procedures. Specifically, the proposed rule change provides that, consistent with FINRA Rule 0140, persons associated with a member would be required to comply with such member’s written policies and procedures as established pursuant to the proposed rule. In addition, consistent with Rule 0140, the proposed rule states in Supplementary Material .08 that it would be a violation of proposed Rule 2242 for an associated person to engage in the restricted or prohibited conduct to be addressed through the establishment, maintenance, and enforcement of written policies and procedures required by provisions of FINRA Rule 2242, including applicable supplementary material. J. Exemption for Members With Limited Investment Banking Activity Similar to the equity research rule, the proposed rule change would exempt from certain provisions regarding supervision and compensation of debt research analysts those members that over the previous three years, on average per year, have participated in ten or fewer investment banking services transactions as manager or comanager and generated $5 million or less in gross investment banking revenues from those transactions.93 Specifically, members that meet those thresholds would be exempt from the requirement to establish, maintain, and enforce policies and procedures that (1) prohibit prepublication review of debt research reports by investment banking personnel or other persons not directly 91 See proposed FINRA Rule 2242(g)(5). proposed FINRA Rule 2242(g)(6). This requirement would codify guidance in Notice to Members 04–18 (March 2004) related to equity research reports. 93 See proposed FINRA Rule 2242(h). 92 See VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 responsible for the preparation, content, or distribution of debt research reports (but not principal trading or sales and trading personnel, unless the member also qualifies for the limited principal trading activity exemption); (2) restrict or limit investment banking personnel from input into coverage decisions; (3) limit supervision of debt research analysts to persons not engaged in investment banking; (4) limit determination of the research department budget to senior management, excluding senior management engaged in investment banking activities; (5) require that compensation of a debt research analyst be approved by a compensation committee that may not have representation from investment banking personnel; and (6) establish information barriers to insulate debt research analysts from the review or oversight by persons engaged in investment banking services or other persons who might be biased in their judgment or supervision.94 However, the proposed rule would require that members with limited investment banking activity establish information barriers or other institutional safeguards reasonably designed to ensure debt research analysts are insulated from pressure by persons engaged in investment banking services activities or other persons, including persons engaged in principal trading or principal sales and trading activities, who might be biased in their judgment or supervision.95 While small investment banks may need those who supervise debt research analysts under such circumstances also to be involved in the determination of those analysts’ compensation, the proposal would still prohibit these firms from compensating a debt research analyst based upon specific investment banking services transactions or contributions to a member’s investment banking services activities. Members that qualify for this exemption would be required to maintain records sufficient to establish eligibility for the exemption and also maintain for at least three years any communication that, but for this exemption, would be subject to all of the requirements of proposed FINRA Rule 2242(b). 94 See proposed FINRA Rule 2242(b)(2)(A)(i), (b)(2)(B), (b)(2)(C) (with respect to investment banking), (b)(2)(D)(i), (b)(2)(E) (with respect to investment banking), (b)(2)(G) and (b)(2)(H)(i) and (iii). 95 For the purposes of proposed FINRA Rule 2242(h), FINRA clarified that the term ‘‘investment banking services transactions’’ includes the underwriting of both corporate debt and equity securities but not municipal securities. PO 00000 Frm 00151 Fmt 4703 Sfmt 4703 K. Exemption for Limited Principal Trading Activity The proposed rule change includes an exemption from certain provisions regarding supervision and compensation of debt research analysts for members that engage in limited principal trading activity where: (1) In absolute value on an annual basis, the member’s trading gains or losses on principal trades in debt securities are $15 million or less over the previous three years, on average per year; and (2) The member employs fewer than 10 debt traders; provided, however, that such members establish information barriers or other institutional safeguards reasonably designed to ensure debt research analysts are insulated from pressure by persons engaged in principal trading or sales and trading activities or other persons who might be biased in their judgment or supervision.96 Specifically, members that meet those thresholds would be exempt from the requirement to establish, maintain and enforce policies and procedures that: (1) Prohibit prepublication review of debt research reports by principal trading or sales and trading personnel or other persons not directly responsible for the preparation, content or distribution of debt research reports (but not investment banking personnel, unless the firm also qualifies for the limited investment banking activity exemption); (2) Restrict or limit principal trading or sales and trading personnel from input into coverage decisions; (3) Limit supervision of debt research analysts to persons not engaged in sales and trading or principal trading activities, including input into the compensation of debt research analysts; (4) Limit determination of the research department budget to senior management, excluding senior management engaged in principal trading activities; (5) Require that compensation of a debt research analyst be approved by a compensation committee that may not have representation from principal trading personnel; and (6) Establish information barriers to insulate debt research analysts from the review or oversight by persons engaged in principal trading or sales and trading activities or other persons who might be biased in their judgment or supervision.97 As with the limited investment banking activity exemption, members 96 See proposed FINRA Rule 2242(i). 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). 97 See E:\FR\FM\22JYN1.SGM 22JYN1 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices 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). tkelley on DSK3SPTVN1PROD with NOTICES L. Exemption for Debt Research Reports Provided to Institutional Investors Given the debt market and the needs of its participants, the proposed rule change would exempt debt research distributed solely to eligible institutional investors (‘‘institutional debt research’’) from most of the provisions regarding supervision, coverage determinations, budget and compensation determinations, and all of the disclosure requirements applicable to debt research reports distributed to retail investors (‘‘retail debt research’’).98 Under the proposed rule change, the term ‘‘retail investor’’ means any person other than an institutional investor.99 The proposed rule distinguishes between larger and smaller institutions in the manner in which their opt-in decision is obtained. Larger institutions would be permitted to receive institutional debt research based on negative consent, while smaller institutions would be required to affirmatively consent in writing to receive that research. Specifically, the proposed rule would allow firms to distribute institutional debt research by negative consent to a person who meets the definition of a qualified institutional buyer (‘‘QIB’’) 100 and where, pursuant to FINRA Rule 2111(b): (1) The member or associated person has a reasonable basis to believe that the QIB is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies involving a debt security or debt securities; and (2) The QIB has affirmatively indicated that it is exercising independent judgment in evaluating the member’s 98 See proposed FINRA Rule 2242(j)(1). proposed FINRA Rule 2242(a)(13). 100 See proposed FINRA Rule 2242(a)(12) under which a QIB has the same meaning as under Rule 144A of the Securities Act. recommendations pursuant to FINRA Rule 2111 and such affirmation is broad enough to encompass transactions in debt securities. The proposed rule change would require written disclosure to the QIB that the member may provide debt research reports that are intended for institutional investors and are not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. If the QIB does not contact the member and request to receive only retail debt research reports, the member would be permitted to reasonably conclude that the QIB has consented to receiving institutional debt research reports.101 FINRA stated that it would interpret this standard to allow an order placer, e.g., a registered investment adviser, for a QIB that satisfies the FINRA Rule 2111 institutional suitability requirements with respect to debt transactions to agree to receive institutional debt research on behalf of the QIB by negative consent should the rule be approved. Institutional accounts that meet the definition of FINRA Rule 4512(c) but do not satisfy the higher tier requirements described above would still be permitted to affirmatively elect in writing to receive institutional debt research. Specifically, a person that meets the definition of ‘‘institutional account’’ in FINRA Rule 4512(c) would be permitted to receive institutional debt research provided that such person, prior to receipt of a debt research report, has affirmatively notified the member in writing that it wishes to receive institutional debt research and forego treatment as a retail investor for the purposes of the proposed rule. Members would not be permitted to allow retail investors to choose to receive institutional debt research.102 FINRA stated that, to avoid a disruption in the receipt of institutional debt research, the proposed rule change would allow firms to send institutional debt research to any FINRA Rule 4512(c) account, except a natural person, without affirmative or negative consent for a period of up to one year after Commission approval of the proposed rule change while they obtain the necessary consents. Natural persons that qualify as an institutional account under FINRA Rule 4512(c) would be required to provide affirmative consent to receive institutional debt research 43537 during this transition period and thereafter.103 The proposed exemption would permit members that distribute institutional debt research to institutional investors to do so without meeting the proposed requirements to have written policies and procedures for this research with respect to: (1) Restricting or prohibiting prepublication review of institutional debt research by principal trading and sales and trading personnel or others outside the research department, other than investment banking personnel; (2) Input by investment banking, principal trading and sales and trading into coverage decisions; (3) Limiting supervision of debt research analysts to persons not engaged in investment banking, principal trading or sales and trading activities; (4) Limiting determination of the debt research department’s budget to senior management not engaged in investment banking or principal trading activities and without regard to specific revenues derived from investment banking; (5) Determination of debt research analyst compensation; (6) Restricting or limiting debt research analyst account trading; and (7) Information barriers or other institutional safeguards reasonably designed to ensure debt research analysts are insulated from review or oversight by investment banking, sales and trading or principal trading personnel, among others (but members still must have written policies and procedures to guard against those persons pressuring analysts). The exemption further would apply to all disclosure requirements, including content and disclosure requirements for third-party research. Notwithstanding the proposed exemption, some provisions of the proposed rule still would apply to institutional debt research, including the prohibition on prepublication review of debt research reports by investment banking personnel and the restrictions on such review by subject companies. While prepublication review by principal trading and sales and trading personnel would not be prohibited pursuant to the exemption, other provisions of the rule would continue to require management of those conflicts, including the requirement to establish information barriers reasonably designed to insulate debt research analysts from pressure by those persons. Furthermore, the requirements in Supplementary 99 See VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 101 See proposed FINRA Rule 2242(j)(1)(A)(i) and (ii). PO 00000 102 See proposed FINRA Rule 2242(j)(1)(B). Frm 00152 Fmt 4703 Sfmt 4703 103 See proposed FINRA Rule 2242.11 (Distribution of Institutional Debt Research During Transition Period). E:\FR\FM\22JYN1.SGM 22JYN1 tkelley on DSK3SPTVN1PROD with NOTICES 43538 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices Material .05 related to submission of sections of a draft debt research report for factual review would apply to any permitted prepublication review by persons not directly responsible for the preparation, content or distribution of debt research reports. In addition, members would be required to prohibit debt research analysts from participating in the solicitation of investment banking services transactions, road shows, and other marketing on behalf of issuers and further prohibit investment banking personnel from directly or indirectly directing a debt research analyst to engage in sales and marketing efforts related to an investment banking deal or to communicate with a current or prospective customer with respect to such transactions. The provisions regarding retaliation against debt research analysts and promises of favorable debt research also would still apply with respect to research distributed to eligible institutional investors.104 While the proposed rule change would not require institutional debt research to carry the specific disclosures applicable to retail debt research, it would require that such research carry general disclosures prominently on the first page warning that: (1) The report is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports; (2) If applicable, that the views in the report may differ from the views offered in retail debt research reports; and (3) If applicable, that the report may not be independent of the firm’s proprietary interests and that the firm trades the securities covered in the report for its own account and on a discretionary basis on behalf of certain customers, and such trading interests may be contrary to the recommendation in the report.105 FINRA stated that the second and third disclosures described above would be required only if the member produces both retail and institutional debt research reports that sometimes differ in their views or if the member maintains a proprietary trading desk or trades on a discretionary basis on behalf of some customers and those interests sometimes are contrary to recommendations in institutional debt research reports. 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 104 See 105 See proposed FINRA Rule 2242(j)(2). proposed FINRA Rule 2242(j)(3). VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 made available only to eligible institutional investors.106 A member would not be permitted to rely on the proposed exemption with respect to a debt research report that the member has reason to believe will be redistributed to a retail investor. The proposed rule change also states that the proposed exemption would not relieve a member of its obligations to comply with the antifraud provisions of the federal securities laws and FINRA rules.107 M. General Exemptive Authority The proposed rule change would provide FINRA, pursuant to the FINRA Rule 9600 Series, with authority to conditionally or unconditionally grant, in exceptional and unusual circumstances, an exemption from any requirement of the proposed rule for good cause shown, after taking into account all relevant factors and provided that such exemption is consistent with the purposes of the rule, the protection of investors, and the public interest.108 III. Summary of Comment Letters, Discussion, and Commission Findings In response to the proposal as originally proposed by FINRA, the Commission received five comments on the proposal.109 All of the relevant commenters expressed general support for the proposal.110 The specifics of these comments were summarized when the Commission instituted proceedings and again when the Commission noticed Amendment No. 1.111 FINRA filed Amendment No. 1 as a response to these earlier comments as discussed when the amendment was noticed.112 In the time since Amendment No. 1 was filed the Commission has received four comment letters on the proposal.113 FINRA submitted a letter in response to these comments.114 All five of the commenters to the original proposal,115 and all three of the relevant commenters to the proposal in connection with instituting proceedings proposed FINRA Rule 2242(j)(4). proposed FINRA Rule 2242(j)(5). 108 See proposed FINRA Rule 2242(k). 109 See note 4, supra. 110 SIFMA, WilmerHale Debt One, PIABA Debt, NASAA Debt One and CFA Institute One. 111 Exchange Act Release No. 74340 (Feb. 20, 2015); 80 FR 10538 (Feb. 26, 2015) and Amendment Notice. 112 Id. 113 WilmerHale Debt Two, CFA Institute Two, Anonymous, and NASAA Debt Two. 114 FINRA Response. 115 SIFMA, WilmerHale Debt One, PIABA Debt, NASAA Debt One, and CFA Institute One. PO 00000 106 See 107 See Frm 00153 Fmt 4703 Sfmt 4703 or with regards to Amendment No. 1,116 expressed general support for the proposal. The Commission notes this support. A. Comments and Discussion Regarding the Principles-Based Approach of the Proposed Rule Change The rule proposal as originally proposed would have adopted a policies and procedures approach to identification and management of research-related conflicts of interest and require those policies and procedures to, at a minimum, prohibit or restrict particular conduct. Commenters to the original proposal expressed several concerns with the approach. Two of these commenters asserted that the mix of a principles-based approach with prescriptive requirements was confusing in places and posed operational challenges. In particular, the commenters recommended eliminating the minimum standards for the policies and procedures.117 One of those commenters had previously expressed support for the proposed principles-based approach with minimum requirements,118 but asserted that the proposed rule text requiring procedures to ‘‘at a minimum, be reasonably designed to prohibit’’ specified conduct is superfluous or confusing. Another commenter to the original proposal favored utilizing a proscriptive approach similar to the current equity rules and also requiring that firms maintain policies and procedures designed to ensure compliance.119 Another commenter to the original proposal supported the types of communications between debt research analysts and other persons that may be permitted by a firm’s policies and procedures.120 One commenter to the original proposal questioned the necessity of the ‘‘preamble’’ requiring policies and procedures that ‘‘restrict or limit activities by research analysts that can reasonably be expected to compromise their objectivity’’ that precedes specific prohibited activities related to investment banking transactions.121 Finally, some 116 WilmerHale Debt Two, CFA Institute Two, and NASAA Debt Two. As noted above the comment from Anonymous did not seem relevant to the proposed rule change as it seemed to be asking about accounting issues, which were not raised by the proposal. See note 14, supra. 117 SIFMA and WilmerHale Debt One. 118 Letter from Amal Aly, Managing Director and Associate General Counsel, SIFMA, to Marcia E. Asquith, Corporate Secretary, FINRA, dated November 14, 2008 regarding Regulatory Notice 08– 55 (Research Analysts and Research Reports). 119 NASAA Debt One. 120 CFA Institute One. 121 WilmerHale Debt One. E:\FR\FM\22JYN1.SGM 22JYN1 tkelley on DSK3SPTVN1PROD with NOTICES Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices commenters to the original proposal suggested FINRA eliminate language in the supplementary material that provides that the failure of an associated person to comply with the firm’s policies and procedures constitutes a violation of the proposed rule itself.122 These commenters argued that because members may establish policies and procedures that go beyond the requirements set forth in the rule, the provision may have the unintended consequence of discouraging firms from creating standards in their policies and procedures that extend beyond the rule. One of those commenters suggested that the remaining language in the supplementary material adequately holds individuals responsible for engaging in restricted or prohibited conduct covered by the proposals.123 FINRA, in response, stated it believes the framework will maintain the same level of investor protection in the current equity rules (which also would largely apply to retail debt research) while providing both some flexibility for firms to align their compliance systems with their business model and philosophy and imposing additional obligations to proactively identify and manage emerging conflicts. According to FINRA the proposal, even under a policies and procedures approach, ‘‘would effectively maintain, with some modifications, the key proscriptions in the current rules’’ 124 (e.g., prohibitions on prepublication review, supervision of research analysts by investment banking and participation in pitches and road shows). FINRA disagreed that the ‘‘preamble’’ to some of those prohibitions is unnecessary. As with the more general overarching principlesbased requirement to identify and manage conflicts of interest, the introductory principle that requires written policies and procedures to restrict or limit activities by research analysts that can reasonably be expected to compromise their objectivity recognizes that FINRA cannot identify every conflict related to research at every firm and therefore requires proactive monitoring and management of those conflicts. FINRA did not believe this ‘‘preamble’’ language is redundant with the broader overarching principle because it applies more specifically to the activities of research analysts and, unlike the broader principle, would preclude the use of 122 SIFMA and WilmerHale Debt One. Debt One. 124 Presumably FINRA means the current equity research rules that would be carried over to debt research reports under the proposal. 123 WilmerHale VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 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, FINRA clarified that the ‘‘at a minimum’’ language was meant to convey that additional conflicts management policies and procedures may be needed to address emerging conflicts that may arise as the result of business changes, such as new research products, affiliations or distribution methods at a particular firm. As discussed in the Notice, FINRA stated that it intends for firms to proactively identify and manage those conflicts with appropriately designed policies and procedures. FINRA clarified that their inclusion of the ‘‘at a minimum’’ language was not, in their opinion, intended to suggest that firms’ written policies and procedures must go beyond the specified prohibitions and restrictions in the proposal where no new conflicts have been identified. However, FINRA stated it believes the overarching requirement for policies and procedures reasonably designed to identify and effectively manage research-related conflicts suffices to achieve the intended regulatory objective, and therefore to eliminate any confusion, FINRA proposed to amend the proposals to delete the ‘‘at a minimum’’ language in Amendment No. 1. One of the commenters that raised this issue noted their approval of this change in their second letter.125 FINRA stated that it appreciates the commenters’ concerns with respect to language in the supplementary material that would make a violation of a firm’s policies a violation of the underlying rule. They further stated that the supplementary material was intended to hold individuals responsible for engaging in the conduct that the policies and procedures effectively restrict or prohibit. FINRA agreed that purpose is achieved with the language in the supplementary material that states that, consistent with FINRA Rule 0140, ‘‘it shall be a violation of [the Rule] for an associated person to engage in the restricted or prohibited conduct to be addressed through the establishment, maintenance and enforcement of policies and procedures required by [the Rule] or related Supplementary Material.’’ Therefore, FINRA proposed, in Amendment No. 1, to amend the proposals to delete the language stating that a violation of a firm’s policies and PO 00000 125 WilmerHale Frm 00154 Debt Two. Fmt 4703 Sfmt 4703 43539 procedures shall constitute a violation of the rule itself. One of the commenters that raised this issue noted their approval of this change in their second letter.126 Another of the original commenters, in a second letter, repeated their concerns about utilizing a principlesbased method in a rule in this area, noting that a proscriptive approach is known to be generally effective at addressing the types of conflicts of interest that the proposal is designed to address and repeated violations by industry of the current proscriptive equity research rule.127 FINRA disagreed with the commenter noting that the proposed rule change would establish for debt research reports, ‘‘with a few modifications,’’ the key requirements of the current equity rules as mandated policies and procedures members must establish.128 B. Comments and Discussion Regarding the Definitions and Terms Used in the Proposed Rule Change One commenter to the original proposal requested that the proposal define the term ‘‘sales and trading personnel’’ as ‘‘persons who are primarily responsible for performing sales and trading activities, or exercising direct supervisory authority over such persons.’’ 129 The commenter’s proposed definition was intended to clarify that the proposed restrictions on sales and trading personnel activities should not extend to senior management who do not directly supervise those activities but have a reporting line from such personnel or persons who occasionally function in a sales and trading capacity. FINRA stated that it intends for the sales and trading personnel conflict management provisions to apply to individuals who perform sales and trading functions, irrespective of their job title or the frequency of engaging in the activities. As such, FINRA stated it did not intend for the rule to capture as sales and trading personnel senior management, such as the chief executive officer, who do not engage in or supervise day-to-day sales and trading activities. However, FINRA stated it believes the applicable provisions should apply to individuals who may occasionally perform or directly supervise sales and trading activities. Otherwise, FINRA believes, investors could be put at risk with respect to the research or transactions involved when those individuals are 126 WilmerHale Debt Two. Debt Two. 128 FINRA Response. 129 WilmerHale Debt One. 127 NASAA E:\FR\FM\22JYN1.SGM 22JYN1 tkelley on DSK3SPTVN1PROD with NOTICES 43540 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices functioning in those capacities because the conflict management procedures and proscriptions and required disclosures would not apply. Therefore, FINRA proposed to amend the rule as part of Amendment No. 1 to define sales and trading personnel to include ‘‘persons in any department or division, whether or not identified as such, who perform any sales or trading service on behalf of a member.’’ FINRA noted that this proposed definition is more consistent with the definition of ‘‘investment banking department’’ in the proposed rule change. One commenter to the original proposal asked FINRA to include an exclusion from the definition of ‘‘debt research report’’ for private placement memoranda and similar offering-related documents prepared in connection with investment banking services transactions.130 The commenter noted that such offering-related documents typically are prepared by investment banking personnel or non-research personnel on behalf of investment banking personnel. The commenter asserted that absent an express exception, the proposals could turn investment banking personnel into research analysts and make the rule unworkable. The commenter noted that NASD Rule 2711(a) excludes communications that constitute statutory prospectuses that are filed as part of a registration statement and contended that the basis for that exception should apply equally to private placement memoranda and similar offering-related documents. As FINRA had noted with respect to the definition of ‘‘research report’’ in the equity research filing, they also noted that a ‘‘debt research report’’ is generally understood not to include such offeringrelated documents prepared in connection with investment banking services transactions. In the course of administering the filing review programs under FINRA Rules 2210 (Communications with the Public), 5110 (Corporate Financing Rule), 5122 (Member Private Offerings) and 5123 (Private Placements of Securities), FINRA stated it had not received any inquiries or addressed any issues that indicate there is confusion regarding the scope of the research analyst rules as applied to offering-related documents prepared in connection with investment banking activities. Regardless, to provide firms with greater clarity as to the status of such offering-related documents under the proposals, FINRA proposed to amend the proposed rule as part of Amendment No. 1 to exclude private placement memoranda and similar offering-related documents prepared in connection with investment banking services transactions other than those that purport to be research from the definition of ‘‘debt research report.’’ In their second comment letter, the commenter expressed support for this change.131 One commenter to the original proposal asked FINRA to refrain from using the concept of ‘‘reliable’’ research in the proposal as it may inappropriately connote accuracy in the context of a research analyst’s opinions.132 FINRA stated it believes that the term ‘‘reliable’’ is commonly understood and notes that the term is used in certain research-related provisions in the Sarbanes–Oxley Act of 2002 (‘‘Sarbanes-Oxley’’) without definition. FINRA further stated it does not believe the term connotes accuracy of opinions. One commenter to the original proposal asked FINRA to eliminate as redundant the term ‘‘independently’’ from the provisions permitting nonresearch personnel to have input into research coverage, so long as research management ‘‘independently makes all final decisions regarding the research coverage plan.’’ 133 The commenter asserted that inclusion of ‘‘independently’’ is confusing since the proposal would permit input from nonresearch personnel into coverage decisions. FINRA stated it had included ‘‘independently’’ to make clear that research management alone is vested with making final coverage decisions. Thus, for example, a firm could not have a committee that includes a majority of research management personnel but also other individuals make final coverage decisions by a vote. As such, FINRA declined to eliminate the term as suggested. One commenter to the original proposal requested that the proposal define the terms ‘‘principal trading activities,’’ ‘‘principal trading personnel,’’ and ‘‘persons engaged in principal trading activities’’ to exclude traders who are primarily involved in customer accommodation or customer facilitation trading, such as market makers that trade on a principal basis.134 The commenter stated that the exclusion is necessary to allow those traders to provide feedback from clients for the purposes of evaluating debt research analysts for compensation determination. More directly to that 131 WilmerHale VerDate Sep<11>2014 Debt One. 19:59 Jul 21, 2015 Debt One. 134 Id. Jkt 235001 PO 00000 Frm 00155 135 SIFMA and WilmerHale Debt One. FR 69905, 69924. 137 WilmerHale Debt Two. 138 SIFMA. 136 79 133 WilmerHale 130 WilmerHale Debt Two. 132 SIFMA. point, the same commenter and an additional commenter to the original proposal asserted that the proposal should not prohibit those engaged in principal trading activities from providing customer feedback as part of the evaluation and compensation process for a debt research analyst.135 They contended that the fixed income markets operate primarily on a principal basis and prohibiting such input would have a broad impact on research management’s ability to appropriately evaluate and compensate debt research analysts. The proposal would allow sales and trading personnel, but not personnel engaged in principal trading activities, to provide input to debt research management into the evaluation of debt research analysts. As discussed in detail in the Notice in response to the similar comment raised to earlier iterations of the debt proposal,136 given the importance of principal trading operations to the revenues of many firms, FINRA stated it believes there is increased risk that a principal trader could improperly pressure or influence debt research if he or she has a say concerning analyst compensation or can selectively relay customer feedback. FINRA also stated it believes the risk to retail investors—the compensation evaluation restrictions would not apply to institutional debt research— outweighs the benefit of an additional data point for research management to assess the quality of research produced by those that they oversee. FINRA also noted that the proposal would allow sales and trading personnel to provide customer feedback. For these reasons, FINRA declined to define the terms as the commenter suggested. One of the commenters, in their second letter, expressed disappointment in this decision, but noted their acceptance that FINRA has already considered the issue a number of times and did not reiterate the comment.137 Another commenter to the original proposal asked for clarification of the term ‘‘principal trading’’ because it believes the term ‘‘sales and trading’’ already encompasses all agency, principal and proprietary trading activities.138 FINRA clarified in response to this comment that the debt proposal imposes greater restrictions on interaction between debt research analysts and principal trading personnel than between debt research analysts and sales and trading personnel because the Fmt 4703 Sfmt 4703 E:\FR\FM\22JYN1.SGM 22JYN1 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices tkelley on DSK3SPTVN1PROD with NOTICES magnitude of the conflict is greater with respect to the former. According to FINRA, this structure evolved based on extensive consultation and feedback from the industry. Based on those communications, FINRA stated it understands and intends for the term ‘‘sales and trading’’ to exclude principal and proprietary trading activities. FINRA further stated it will consider providing guidance where it is unclear whether a particular job function or activity falls within ‘‘sales and trading’’ or ‘‘principal trading’’ activities. One commenter to the original proposal suggested that FINRA revise the definition of ‘‘subject company’’ to specify that the term means the ‘‘issuer (rather than the ‘‘company’’) whose debt securities are the subject of a debt research report or a public appearance.’’ 139 The commenter noted that, among other things, the proposal would cover debt issued by persons other than corporate entities, such as foreign sovereigns or special purpose vehicles. FINRA agreed that the change is appropriate and proposed to amend the definition accordingly in Amendment No. 1. C. Comments and Discussion Regarding Information Barriers The proposed rule would require written policies and procedures to ‘‘establish information barriers or other institutional safeguards reasonably designed to ensure that research analysts are insulated from review, pressure or oversight by persons engaged in investment banking services activities or other persons, including sales and trading department personnel, who might be biased in their judgment or supervision.’’ Some commenters to the original proposal suggested that ‘‘review’’ was unnecessary in this provision because the review of debt research analysts was addressed sufficiently in other parts of the proposed rule.140 One such commenter further suggested that the terms ‘‘review’’ and ‘‘oversight’’ are redundant.141 FINRA stated it does not agree that the terms ‘‘review’’ and ‘‘oversight’’ are coextensive, as the former may connote informal evaluation, while the latter may signify more formal supervision or authority. FINRA noted that while other provisions of the proposed rule change may address related conduct—for example, the provision that prohibits investment banking personnel, principal trading personnel and sales and trading personnel from supervision or control of debt research analysts—this provision extends to ‘‘other persons’’ who may be biased in their judgment or supervision. Finally, FINRA stated it included the ‘‘review, pressure or oversight’’ language to mirror the requirements for equity rules in Sarbanes-Oxley and therefore promote consistency. For these reasons, FINRA declined to revise the proposed rule change. One commenter to the original proposal asked FINRA to clarify that the information barriers or other institutional safeguards required by the proposed rule are not intended to prohibit or limit activities that would otherwise be permitted under other provisions of the rule.142 In the Amendment Notice, FINRA stated that was their intent. This commenter stated in their comment in response to Amendment No. 1 that they interpreted this to mean that the proposal would permit members to allow persons engaged in sales and trading activities to provide informal and formal feedback on research analysts as one factor to be considered by research management for the purposes of the evaluation of the analyst.143 FINRA stated that, in general, it agreed with the commenter’s interpretation.144 The commenter also asserted that the terms ‘‘bias’’ and ‘‘pressure’’ are broad and ambiguous on their face and requested that FINRA clarify that for purposes of the information barriers requirement that they are intended to address persons who may try to improperly influence research.145 As an example, the commenter asked whether a bias would be present if an analyst was pressured to change the format of a research report to comply with the research department’s standard procedures or the firm’s technology specifications. FINRA stated it believes the terms ‘‘pressure’’ and ‘‘bias’’ are commonly understood, particularly in the context of rules intended to promote analyst independence and objectivity. FINRA further noted that the terms appear in certain research-related provisions of Sarbanes–Oxley without definition. With respect to the commenter’s example, FINRA stated it does not believe a bias would be present simply because someone insists that a research analyst comply with formatting or technology specifications that do not otherwise implicate the rules. Debt One. Debt Two. 144 FINRA Response. 145 WilmerHale Debt One. One commenter to the original proposal asked FINRA to modify the information barriers or other institutional safeguards requirement to conform the provision to FINRA’s ‘‘reasonably designed’’ standard for related policies and procedures.146 FINRA stated it believed the change would be consistent with the standard for policies and procedures elsewhere in the proposal, and therefore proposed to amend the provision as requested in Amendment No. 1. The commenter noted with support this change in their second letter.147 One commenter to the original proposal opposed as overbroad the proposed expansion of the current ‘‘catch-all’’ disclosure requirement to include ‘‘any other material conflict of interest of the research analyst or member that a research analyst or an associated person of the member with the ability to influence the content of a research report knows or has reason to know’’ (emphasis added) at the time of publication or distribution of research report.148 The commenter expressed concern about the emphasized language. FINRA stated it proposed the change to capture material conflicts of interest known by persons other than the research analyst (e.g., a supervisor or the head of research) who are in a position to improperly influence a debt research report. FINRA defined ‘‘ability to influence the content of a debt research report’’ in the proposed rule’s supplementary material as ‘‘an associated person who, in the ordinary course of that person’s duties, has the authority to review the research report and change that research report prior to publication or distribution.’’ The commenter stated that the proposed change could capture individuals (especially legal and compliance personnel) who possess confidential information regarding potential future investment banking transactions and thus mandate disclosure of this confidential information. Further, it was possible that this information would not have been excepted from disclosure by a proposed exception in the original proposal that would have excluded disclosure where it would ‘‘reveal material non-public information regarding specific potential future investment banking transactions of the subject company.’’ This is because, according to the commenter, legal and compliance may be aware of material conflicts of interest relating to the subject company that involve material 142 WilmerHale 139 WilmerHale Debt One. 140 SIFMA and WilmerHale Debt One. 141 WilmerHale Debt One. VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 143 WilmerHale PO 00000 Frm 00156 Fmt 4703 Sfmt 4703 43541 146 WilmerHale Debt One. Debt Two. 148 WilmerHale Debt One. 147 WilmerHale E:\FR\FM\22JYN1.SGM 22JYN1 tkelley on DSK3SPTVN1PROD with NOTICES 43542 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices non-public information regarding specific future investment banking transactions of a competitor of the subject company. The commenter also expressed concern that the provision would slow down dissemination of research to canvass all research supervisors and management for conflicts. The commenter suggested that the change was unnecessary given other objectivity safeguards in the proposals that would guard against improper influence. FINRA stated it continues to believe that the catch-all provision must include persons with the ability to influence the content of a debt research report to avoid creating a gap where a supervisor or other person with the authority to change the content of a research report knows of a material conflict. However, FINRA clarified that it intended for the provision to capture only those individuals who are required to review the content of a particular research report or have exercised their authority to review or change the research report prior to publication or distribution. In addition, FINRA stated it did not intend to capture legal or compliance personnel who may review a research report for compliance purposes but are not authorized to dictate a particular recommendation or rating. FINRA proposed to amend the supplementary material in the proposals consistent with this clarification in Amendment No. 1. In addition, FINRA proposed to modify in Amendment No. 1 the exception in proposed Rules 2242(c)(5) and (d)(2) (applying to public appearances) so as to not require disclosure that would otherwise reveal material non-public information regarding specific potential future investment banking transactions, whether or not the transaction involves the subject company. This commenter in their comment in response to Amendment No. 1, while expressing their support for these changes, asked FINRA to make a modification of the parties who trigger disclosure of any other material conflict of interest. Specifically, the commenter asked FINRA to limit this disclosure to only be required when someone has authority to dictate a particular recommendation, rating, or price target.149 The commenter was seeking to extend this authority requirement to other parities that can trigger the disclosure, specifically persons who review the report and persons who have exercised authority to review or change the report generally. FINRA declined to make further changes, noting that the 149 WilmerHale VerDate Sep<11>2014 change in Amendment No. 1 ‘‘was meant to limit application of the provision where there is a discrete review by [legal or compliance personnel] outside of the research department who do not have primary content review responsibilities’’ and that ‘‘those individuals that a firm requires to review research reports (e.g., a Supervisory Analyst) or who exercise their authority to change a research report (e.g., a Director of Research) by definition have the ability to influence the content of a research report.’’ 150 One commenter to the original proposal requested confirmation that members may rely on hyperlinked disclosures for research reports that are delivered electronically, even if these reports are subsequently printed out by customers.151 As long as a research report delivered electronically contains a hyperlink directly to the required disclosures, FINRA stated that the standard will be satisfied. D. Comments and Discussion Regarding Research Products With Differing Recommendations The proposed rule change would require firms to establish, maintain and enforce written policies and procedures reasonably designed to ensure that a research report is not distributed selectively to internal trading personnel or a particular customer or class of customers in advance of other customers that the firm has previously determined are entitled to receive the research report. The proposals also include supplementary material that explains that firms may provide different research products to different classes of customers—e.g., long term fundamental research to all customers and short-term trading research to certain institutional customers— provided the products are not differentiated based on the timing of receipt of potentially market moving information and the firm discloses, if applicable, that one product may contain a different recommendation or rating from another product. One commenter to the original proposal supported the provisions as proposed with general disclosure,152 while another contended that FINRA should require members to disclose when its research products and services do, in fact, contain a recommendation contrary to the research product or service received by other customers.153 The commenter favoring general Debt Two. 19:59 Jul 21, 2015 Jkt 235001 PO 00000 Response. Debt One. 152 WilmerHale Debt One. 153 PIABA Debt. disclosure asserted that disclosure of specific instances of contrary recommendations would impose significant burdens unjustified by the investor protection benefits. The commenter stated that a specific disclosure requirement would require close tracking and analysis of every research product or service to determine if a contrary recommendation exists. The commenter further stated that the difficulty of complying with such a requirement would be exacerbated in large firms by the number of research reports published and research analysts employed and the differing audiences for research products and services.154 The commenter asserted that some firms may publish tens of thousands of research reports each year and employ hundreds of analysts across various disciplines and that a given research analyst or supervisor could not reasonably be expected to know of all other research products and services that may contain differing views. The opposing commenter stated that they believed that permitting contrary opinions while only disclosing the possibility of this contrary research to investors was insufficient to adequately protect investors because the use of ‘‘may’’ in a disclosure is not the same as disclosing that there actually are opposing opinions. Further, they questioned whether such disclosure was consistent with the Act in that it may contrary to Rule 10b–5 by permitting the omission of a material fact in the research report. They did not believe that the disclosure of actual opposing views would be burdensome on members as they should be aware of contrasting opinions. As a result, FINRA should require specific disclosures.155 Another commenter to the original proposal expressed concern that the proposal raises issues about the parity of information received by retail and institutional investors, and whether research provided to institutional investors could contain views that differ from those in research to retail investors.156 The supplementary material states that products may lead to different recommendations or ratings, provided that each is consistent with the member’s ratings system for each respective product. In other words, according to FINRA, all differing recommendations or ratings must be reconcilable such that they are not truly at odds with one another. As such, the proposed rule change would not, in 150 FINRA 151 WilmerHale Frm 00157 Fmt 4703 Sfmt 4703 154 WilmerHale Debt One. Debt. 156 CFA Institute One. 155 PIABA E:\FR\FM\22JYN1.SGM 22JYN1 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices FINRA’s view, allow research provided to an institutional investor to contain views inconsistent with those offered in retail debt research.157 FINRA provided the following example from the filing regarding equity research: A firm might define a ‘‘buy’’ rating in its long-term research product to mean that a stock will outperform the S&P 500 over the next year, while a ‘‘sell’’ rating in its short-term trading product might mean the stock will underperform its sector index over the next month. In this case, FINRA stated that the firm could, under the proposal, maintain a ‘‘buy’’ in the long-term research and a ‘‘sell’’ in its trading research at the same time if the firm believed the stock would temporarily drop near term based on failing to meet expectations in an earnings report but still outperform the S&P over the next year. One commenter, in their second letter, stated that this clarification addressed their concerns that investor protections were being impacted.158 Since the proposed rule change would not allow inconsistent recommendations that could mislead one or more investors, FINRA stated that it believes general disclosure of alternative products with different objectives and recommendations is appropriate relative to its investor protection benefits. The commenter who supported this approach expressed support for FINRA’s decision in their second letter.159 tkelley on DSK3SPTVN1PROD with NOTICES E. Comments and Discussion Regarding Structural and Procedural Safeguards One commenter to the original proposal asked that FINRA clarify that members that have developed policies and procedures consistent with FINRA Rule 5280 (Trading Ahead of Research Reports) would also be in compliance with the debt proposal’s expectation of structural separation between investment banking and debt research, and between sales and trading and principal trading and debt research.160 FINRA indicated in the proposed rule change that while the proposed rule would not require physical separation, FINRA would expect such physical 157 According to FINRA, the proposed rule change would not require that all investors receive all research products, nor would it preclude a firm from offering, for example, a research product to select customers that includes greater depth of analysis. However, it would not, in FINRA’s view, be consistent with the proposed rule change to provide inconsistent views to different classes of customers or to advantage one class of customers based on the timing of receipt of a recommendation, rating or potentially market moving information. 158 CFA Institute Two. 159 WilmerHale Debt Two. 160 WilmerHale Debt One. VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 separation except in extraordinary circumstances where the costs are unreasonable due to a firm’s size and resource limitations. FINRA Rule 5280 does not, according to FINRA, specify physical separation between all of the persons involved. While similar in design and purpose to some aspects of the proposed requirements in the debt proposal, FINRA clarified that FINRA Rule 5280 is not congruent with the proposal to the point where compliance with the policies and procedures provision of that rule would be deemed compliance with the debt proposal separation requirements. FINRA stated that both FINRA Rule 5280 and the debt proposal require policies and procedures reasonably designed to limit information flow. FINRA also stated it believes that physical separation is an effective component to a reasonably designed compliance system that requires information barriers. The same commenter asked that FINRA modify the prohibition on debt analyst attendance at road shows to permit passive participation since there is less opportunity to meet and assess issuer management than in the equity context.161 FINRA stated it believes that even passive participation by debt research analysts in road shows and other marketing may present conflicts of interest and, therefore, declined to revise the proposal as suggested.162 In their second letter, the commenter reiterated this suggested change because, while they note the need for analysts to maintain their objectivity, unlike equity research analysts who have frequent interactions with issuer management and may assist in the due diligence process for offerings, debt research analysts typically do not participate in due diligence and do not have the same opportunities to meet with issuer management and road shows may present the only opportunity to do so.163 For the same reasons as above, FINRA declined again to make this change.164 F. Comments and Discussion Regarding Communications Between Research Analysts and Trading Desk Personnel A commenter to the original proposal 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 PO 00000 161 WilmerHale Debt One. also Notice. 163 WilmerHale Debt Two. 164 FINRA Response 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.’’ 165 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, FINRA stated that 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 expressed its belief that there are a variety of policies and procedures that could address such attempts, including periodic monitoring of such communications. As such, FINRA declined to delete ‘‘attempting’’ from the provision. The commenter further expressed concern that the term ‘‘pending’’ is vague in the above-cited provision.166 The commenter suggested that FINRA delete the term or confirm that ‘‘pending’’ means ‘‘imminent publication of a debt research report.’’ FINRA stated it 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 stated it considers such research in draft to be pending and therefore declined to delete the term or adopt an ‘‘imminent’’ standard as suggested by the commenter. Proposed Supplementary Material .03(b)(3) would provide 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 162 See Frm 00158 Fmt 4703 Sfmt 4703 43543 165 WilmerHale 166 Id. E:\FR\FM\22JYN1.SGM 22JYN1 Debt One. 43544 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices tkelley on DSK3SPTVN1PROD with NOTICES 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 to the original proposal 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.167 FINRA agreed in the Amendment Notice that context may be considered whenever consistency of research or views is at issue. G. Comments and Discussion Regarding Disclosure Requirements One commenter to the original proposal expressed concern about the proposed 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 twelve 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.168 The commenter asked FINRA to eliminate these provisions because the commenter believes that 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.169 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 167 Id. 168 WilmerHale 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. FINRA stated it believes that, similar to the current equity rules, 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 stated it 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 proposed to amend Rules 2242(c)(2) and (3) in Amendment No. 1 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 expressed belief that 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. In their second letter, the commenter expressed support for this change.170 While FINRA also believes that the disclosures would be valuable to retail investors with respect to debt research on individual debt securities, FINRA stated it 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 stated it 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 proposed in Amendment No. 1 to eliminate for now the requirements with respect to debt research reports on individual debt securities. FINRA stated it will reconsider the appropriateness of the disclosure requirements as applied to research on individual debt securities Debt One. 170 WilmerHale 19:59 Jul 21, 2015 H. Comments and Discussion Regarding the 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 would be permitted to use negative consent where the customer meets the definition of a QIB and satisfies the institutional suitability standards of FINRA Rule 2111 with respect to debt transactions and strategies. Institutional accounts that meet the definition of FINRA Rule 4512(c), but do not satisfy the higher tier standard required for negative consent, would be permitted to affirmatively elect in writing to receive institutional debt research. One commenter to the original proposal opposed providing any exemption for debt research distributed solely to eligible institutional investors, contending that it would deprive the 171 WilmerHale 169 Id. VerDate Sep<11>2014 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.171 The commenter noted that while the Commission has interpreted section 15D(b) of the Exchange Act to require disclosure in each equity report, the law does not apply to debt research.172 FINRA stated it 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 stated it believes the disclosures must be in the research report itself. FINRA also expressed its belief that this will promote consistency between equity and retail debt research. FINRA further noted that institutional debt research would not require the specific disclosures. Jkt 235001 PO 00000 Frm 00159 Debt Two. Fmt 4703 Sfmt 4703 172 See E:\FR\FM\22JYN1.SGM Debt One. 15 U.S.C. 78o–6(b) and (d)(2). 22JYN1 tkelley on DSK3SPTVN1PROD with NOTICES Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices market’s largest participants of the important protections of the proposed rules for retail debt research.173 Another such commenter reiterated concerns expressed in response to an earlier iteration of the debt research proposal that the proposed standard for negative consent would be difficult to implement and would disadvantage institutional investors who are capable of, and in fact, make independent investment decisions about debt transactions and strategies. The commenter suggested as an alternative that the institutional investor standard should be based on only on the institutional suitability standard in Rule 2111.174 Another commenter to the original proposal supported the proposed tiered approach for how institutional investors may receive research reports.175 The commenter stated that a QIB presumably has the sophistication and human and financial resources to evaluate debt research without the disclosures and other protections that accompany reports provided to retail investors. The commenter also supported permitting an institutional investor that does not fall within the higher tier category to receive the debt research without the retail investor protections if it notifies the firm in writing of its election. FINRA stated in the Notice and Amendment Notice that it believes an institutional exemption is appropriate to allow more sophisticated institutional market participants that can assess risks associated with debt trading and are aware of conflicts that may exist between a member’s recommendations and trading interests, to continue to receive the timely flow of analysis and trade ideas that they value. FINRA noted that institutional debt research still would remain subject to several provisions of the rules, including the required separation between debt research and investment banking and the requirements for conflict management policies and procedures to insulate debt analysts from pressure by traders and others. In addition, FINRA noted that no institutional investor will be exposed to this less-protected institutional research without either negative or affirmative consent, as applicable. FINRA noted, with regard to the standard for negative consent, it does not believe that less sophisticated institutional investors should be required to take any additional steps to receive the full protections of the 173 PIABA Debt. proposed rules. To the extent the QIB standard for negative consent is too difficult to implement, the proposal would provide an alternative to obtain a one-time affirmative consent for any Rule 4512(c) institutional account and further provides a one-year grace period to obtain that consent, so as not to disrupt the current flow of debt research to institutional customers. As discussed in the rule filing, FINRA included the alternative methods of consent and the grace period to satisfy the differing industry views on which of two consent options would be most cost effective. Another commenter to the original proposal asked that FINRA confirm that, in distributing debt research reports under the institutional debt research framework to certain non-U.S. institutional investors who are customers of a member’s non-U.S. broker-dealer affiliate, the member may rely on similar classifications in the non-U.S. institutional investors’ home jurisdictions.176 The commenter contended that this is necessary because some global firms distribute their debt research reports to non-U.S. institutional investors who may not have been vetted as QIBs for a variety of reasons. The debt proposal never contemplated recognizing equivalent institutional standards in other jurisdictions, and FINRA stated it does not believe that approach is appropriate or workable. FINRA questioned whether there are standards in other jurisdictions that are truly the equivalent of the QIB standard, and stated that it is impractical for FINRA to survey and assess the institutional standards around the world to determine equivalency, not to mention whether the home jurisdiction adequately examines for and enforces compliance with the standard. FINRA noted that, under the proposal, to the extent non-U.S. institutional investors have not been vetted as QIBs, firms have the option of either vetting them if they wish to send them institutional debt research by negative consent or obtaining affirmative written consent to the extent the institution satisfies the Rule 4212(c) standard. The same commenter asked FINRA to clarify the application of the institutional debt research framework to desk analysts or other personnel who are part of the trading desk and are not ‘‘research department’’ personnel. In particular, the commenter suggested that proposed Rules 2242(b)(2)(H) (with respect to pressuring) and (b)(2)(L) (which would require policies and procedures reasonably designed to, among other things, restrict or limit activities by debt research analysts that can reasonably be expected to compromise their objectivity) should not apply when sales and trading personnel or principal trading personnel publish debt research reports in reliance on the institutional research exemption because the requirements of those provisions cannot be reconciled with the inherent nature of conflicts present.177 Those provisions would require firms to have policies and procedures to both establish information barrier or other institutional safeguards reasonably designed to insulate debt research analysts from pressure by, among others, principal trading or sales and trading personnel and restrict or limit activities by debt research analysts that can reasonably be expected to compromise their objectivity. FINRA disagreed with the commenter. They stated that they believe that minimum objectivity standards should apply to institutional debt research regardless of whether the research is published by research department personnel, sales and trading personnel or principal trading personnel. FINRA further stated it believes that a firm can and should put in place policies and procedures reasonably designed to ensure that other traders or sales and trading personnel do not overtly pressure a trader who produces debt research to express a particular view and to prevent that trader from participating in solicitations of investment banking or road show participation. I. Comments and Discussion Regarding the Exemptions for Limited Investment Banking Activity and Limited Principal Trading Activity The proposed rule change would exempt members with limited principal trading activity or limited investment banking activity from the review, supervision, budget, and compensation provisions in the proposed rule related to principal trading and investment banking personnel, respectively. The limited principal trading exemption would apply to firms that engage in principal trading activity where, 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 the member employs fewer than ten debt traders. The limited investment banking exemption would apply, as it does in the equity rules, to firms that have managed or co-managed ten or fewer investment banking services 174 SIFMA. 175 CFA Institute One. VerDate Sep<11>2014 19:59 Jul 21, 2015 176 WilmerHale Jkt 235001 PO 00000 Frm 00160 Debt One. Fmt 4703 Sfmt 4703 43545 177 Id. E:\FR\FM\22JYN1.SGM 22JYN1 tkelley on DSK3SPTVN1PROD with NOTICES 43546 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices transactions on average per year, over the previous three years and generated $5 million or less in gross investment banking revenues from those transactions. One commenter to the original proposal questioned whether the exemptions could compromise the independence and accuracy of the analysis and opinions provided.178 The commenter further expressed concern that the exemption might allow traders to act on debt research prior to publication and distribution of that research. The commenter noted FINRA’s commitment to monitor firms that avail themselves of the exemptions to evaluate whether the thresholds for the exemptions are appropriate and asked FINRA to publish findings that could help properly weigh the burdens on small firms while ensuring the independence of investment research. The commenter also encouraged FINRA to provide additional guidance as to what specific measures should be taken to ensure that 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. FINRA stated in the Notice and the Amendment Notice that it included the exemptions to balance the burdens of compliance with the level or risk to investors. FINRA stated that it determined the thresholds for each exemption based on data analysis and a survey of firms that engage in principal trading activity or investment banking activity, respectively. FINRA clarified that it has not found abuses with respect to the limited investment banking exemption in the equity context and notes that some important separation requirements would still apply to the eligible firms, such as the prohibition on compensating a debt research analyst based on a specific investment banking transaction or contributions to a member’s investment banking services activities. FINRA clarified that the proposed limited principal trading exemption would apply where, based on the survey and data analysis, it reasonably believes the amount of potential principal trading profits poses appreciably lower risk of pressure on debt research analysts by sales and trading or principal trading personnel and where there would be a significant marginal cost to add a trader dedicated to producing research relative to the increase in investor protection. FINRA further noted that the proposal would still prohibit debt research analysts at exempt firms from being compensated based on specific trading transactions. With respect to both exemptions, as the commenter noted, firms would still 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 investment banking or principal trading activities, among others. FINRA stated it believes a number of policies could be implemented to achieve compliance with this requirement. For example, in the context of principal trading, these measures might include monitoring of communications between debt research analysts and individuals on the trading desk and reviewing published research in relation to transactions executed by the firm in the subject company’s debt securities. FINRA also noted that neither exemption would allow trading ahead of research by firm traders, as FINRA Rule 5280 would continue to apply to both debt and equity research and prohibits such conduct. Finally, as noted by the commenter, FINRA stated it intends to monitor the research produced by firms that avail themselves of the exemptions to assess whether the thresholds to qualify for the exemptions are appropriate or should be modified. The commenter responded in its second letter that, while FINRA addressed their concerns, they still had concerns that the examples given by FINRA in the Amendment Notice were insufficient. They recommended additional guidance by FINRA to help ensure adequate compliance. They also approved of FINRA’s commitment to continue to monitor this issue and urged publication of the results.179 In their response, FINRA noted that the examples were not intended to be exhaustive and that, in light of the principles-based approach of the proposal there will be different ways for members to design policies and procedures reasonably designed to protect against pressure. FINRA stated it will continue to monitor the issue and will consider sharing its findings as appropriate.180 J. Comments and Discussion Regarding the Filing Requirement Exclusion One commenter to the original proposal asked FINRA to consider amending FINRA Rule 2210 to exclude debt research reports from that rule’s filing requirements, since there is an exception from the filing requirements for equity research reports that concern 179 CFA 178 CFA Institute One. VerDate Sep<11>2014 19:59 Jul 21, 2015 Institute Two. Response. 180 FINRA Jkt 235001 PO 00000 Frm 00161 Fmt 4703 Sfmt 4703 only equity securities that trade on an exchange.181 FINRA stated it is willing to separately consider the merits of the request, but does not believe the issue is appropriate for resolution in the context of the debt proposal since it primarily relates to the provisions of a rule that are not the subject of the proposed rule change. K. Comments and Discussion Regarding the Implementation Date One commenter to the original proposal requested that the implementation date be at least twelve months after Commission approval of the proposed rule change and that FINRA sequence the compliance dates of the equity research filing and the proposed rule change in that order.182 Another such commenter requested that FINRA provide a ‘‘grace period’’ of one year or the maximum time permissible, if that is less than one year, between the adoption of the proposed rule and the implementation date.183 FINRA stated that it is sensitive to the time firms will require to update their policies and procedures and systems to comply with the proposed rule change and will take those factors into consideration when establishing implementation dates. As stated in the Amendment Notice, FINRA will announce the effective date of the proposed rule change in a Regulatory Notice to be published no later than 60 days following Commission approval. FINRA further stated that the effective date will be no later than 180 days following publication of the Regulatory Notice announcing Commission approval. J. Summary of Findings and Conclusion The Commission has carefully considered the proposed rule change, all of the comments received, and FINRA’s responses to the comments. Based on its review of the record, the Commission finds that the proposed rule change, as amended by Amendment No. 1, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities association.184 In particular, the Commission finds that the proposed rule change, as amended by Amendment No. 1, is consistent with section 15A(b)(6) of the Act, which requires, among other things, that FINRA’s rules be designed to prevent fraudulent and manipulative acts and 181 WilmerHale Debt One. 182 SIFMA. 183 WilmerHale Debt One. approving this proposed rule change, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 184 In E:\FR\FM\22JYN1.SGM 22JYN1 Federal Register / Vol. 80, No. 140 / Wednesday, July 22, 2015 / Notices practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest.185 FINRA stated in its proposal that it ‘‘believes that the proposed rule change would promote increased quality, objectivity and transparency of debt research distributed to investors by requiring firms to identify and mitigate conflicts in the preparation and distribution of such research’’ and that ‘‘the [proposed] rule will provide investors with more reliable information on which to base investment decisions in debt securities, while maintaining timely flow of information important to institutional market participants and providing those institutional investors with appropriate safeguards.’’ We generally agree with these assertions. The potential abuses spawned by the conflicts of interest between research and the business interests of broker-dealers in the equity space are well-known and wellestablished.186 As FINRA explained in the Notice, debt research is not immune to the challenges that these conflicts create. For example, the Massachusetts Secretary of the Commonwealth in 2008 alleged that a FINRA member ‘‘co-opted its supposedly independent [r]esearch [d]epartment to assist in sales efforts geared towards reducing its inventory’’ of debt instruments.187 These allegations are similar to those raised in the allegations that led to the global research analyst settlement as a result of the abuses found regarding equity research.188 As a result, as noted by the 185 15 U.S.C. 78o–3(b)(6). e.g., ‘‘Ten of Nation’s Top Investment Firms Settle Enforcement Actions Involving Conflicts of Interest Between Research and Investment Banking,’’ Press Release 2003–54 (available at https://www.sec.gov/news/press/200354.htm). As one commenter noted, these conflicts can still influence equity research. NASAA Debt Two. See also ‘‘FINRA Fines 10 Firms a Total of $43.5 Million for Allowing Equity Research Analysts to Solicit Investment Banking Business and for Offering Favorable Research Coverage in Connection With Toys‘R’Us IPO,’’ FINRA News Release (available at https://www.finra.org/ newsroom/2014/finra-fines-10-firms-total-435million). 187 Commonwealth of Massachusetts, Office of the Secretary of the Commonwealth, Securities Division, In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Incorporated, Administrative Complaint, Docket No. 2008–0058 (Jul. 31, 2008) (available at https://archives.lib.state.ma.us/ bitstream/handle/2452/213560/ ocn886547410.pdf?sequence=1&isAllowed=y). 188 See, ‘‘Ten of Nation’s Top Investment Firms Settle Enforcement Actions Involving Conflicts of Interest Between Research and Investment Banking,’’ Press Release 2003–54 (available at https://www.sec.gov/news/press/2003-54.htm) (stating that ‘‘[t]he enforcement actions allege that, from approximately mid-1999 through mid-2001 or later, all of the firms engaged in acts and practices that created or maintained inappropriate influence tkelley on DSK3SPTVN1PROD with NOTICES 186 See, VerDate Sep<11>2014 19:59 Jul 21, 2015 Jkt 235001 U.S. Government Accountability Office, ‘‘until FINRA adopts a fixed-income research rule, investors continue to face a potential risk.’’ 189 The proposed rule change attempts to address this need in a way that seems to effectively balance the public interest in effectively managing debt research conflicts of interest with the ability of members to also effectively provide research, and thus information, to the investing public. We also note that the relevant commenters to the proposal as amended, all of which were commenters to the original proposal, stated in their second comment letters that they generally agree with the proposal as amended.190 Regarding concerns raised by commenters regarding the principlesbased structure of the proposal, we note the proposed rule change establishes the key provisions of NASD Rule 2711 for debt research and includes a number of protections for investors beyond those currently found in that rule, including the requirement that research management make independent decisions regarding research coverage,191 maintenance of information barriers or other institutional safeguards between research and investment banking, sales and trading, and other persons who might be biased in their judgment or supervision including, for certain members, requiring physical separation,192 information barriers between research analysts and trading desk personnel,193 and ensure that purported facts in research reports are by investment banking over research analysts, thereby imposing conflicts of interest on research analysts that the firms failed to manage in an adequate or appropriate manner’’). 189 U.S. Government Accountability Office, GAO– 12–209, Securities Research: Additional Actions Could Improve Regulatory Oversight of Analyst Conflicts of Interest, at 41 (Jan. 12, 2012) (available at https://www.gao.gov/assets/590/587613.pdf). 190 WilmerHale Debt Two, CFA Institute Two, and NASAA Debt Two. 191 Proposed FINRA Rule 2242(b)(2)(B). 192 Proposed FINRA Rule 2242(b)(2)(H) and Notice (‘‘Among the structural safeguards, FINRA believes separation between investment banking and debt research, and between sales and trading and principal trading and debt research, is of particular importance. As such, while the proposed rule change does not mandate physical separation between the debt research department and the investment banking, sales and trading and principal trading departments (or other person who might seek to influence research analysts), FINRA would expect such physical separation except in extraordinary circumstances where the costs are unreasonable due to a firm’s size and resource limitations. In those instances, a firm must implement written policies and procedures, including information barriers, to effectively achieve and monitor separation between debt research and investment banking, sales and trading and principal trading personnel.’’) 193 Proposed FINRA Rule 2242.03. PO 00000 Frm 00162 Fmt 4703 Sfmt 9990 43547 based on reliable information.194 Further, FINRA’s responses to interpretive questions posed by the commenters to the original proposal in the Amendment Notice should help eliminate uncertainty regarding how the proposal will operate. For instance, one commenter noted with approval the clarification regarding the ‘‘at a minimum’’ requirement which seemed to be the source of the commenter’s confusion.195 FINRA also provided further guidance on other issues in the FINRA Response, such as whether sales and trading personnel can provide feedback for purposes of evaluating an analyst. In approving this proposal, however, we expect that FINRA will continue to monitor the effectiveness of the rule proposal, especially with regards to the treatment of research provided to institutional investors, and modify the rule should it prove to be unworkable or fail to provide an appropriate level of protection to investors.196 For the reasons stated above, the Commission finds that the proposed rule change is consistent with the Act and the rules and regulations thereunder. IV. Conclusion IT IS THEREFORE ORDERED, pursuant to section 19(b)(2) of the Act,197 that the proposed rule change (SR–FINRA–2014–048), as modified by Amendment No. 1 thereto, be, and it hereby is, approved. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.198 Brent J. Fields, Secretary. [FR Doc. 2015–17972 Filed 7–21–15; 8:45 am] BILLING CODE 8011–01–P 194 Proposed FINRA Rule 2242(c)(1)(A). Debt Two. 196 We note that, as one commenter to the equity version of this proposal noted, the interpretation of what constitutes ‘‘reasonableness’’ may prove difficult for FINRA and member alike. See Letter from Egidio Mogavero, Managing Director and Chief Compliance Officer, JMP Securities, dated Mar. 19, 2015. 197 15 U.S.C. 78s(b)(2). 198 17 CFR 200.30–3(a)(12). 195 WilmerHale E:\FR\FM\22JYN1.SGM 22JYN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 80, Number 140 (Wednesday, July 22, 2015)]
[Notices]
[Pages 43528-43547]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-17972]


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SECURITIES AND EXCHANGE COMMISSION

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


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

July 16, 2015.

I. Introduction

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

[[Page 43529]]

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

II. Description of the Proposed Rule Change

    As described more fully in the Notice, FINRA proposed to adopt 
FINRA Rule 2242 to address conflicts of interest relating to the 
publication and distribution of debt research reports. Proposed FINRA 
Rule 2242 would adopt a tiered approach that FINRA believed, in 
general, would provide retail debt research recipients with extensive 
protections similar to those provided to recipients of equity research 
under current and proposed FINRA rules,\10\ with modifications to 
reflect differences in the trading of debt securities.
---------------------------------------------------------------------------

    \10\ See Exchange Act Release No. 73622 (Nov. 18, 2014); 79 FR 
69939 (Nov. 24, 2014) (SR-FINRA-2014-047) (proposing amendments to 
current SRO rules relating to equity research).
---------------------------------------------------------------------------

    As stated above, the Commission received five comments on the 
proposal. All of the relevant commenters expressed general support for 
the proposal. Of the four comments received in regards to the 
proceedings or Amendment No. 1, one was supportive of the proposal as 
amended by Amendment No. 1 with certain specific comments,\11\ one 
stated that Amendment No. 1 addressed their specific comments,\12\ one 
reiterated prior concerns regarding the principles-based nature of the 
proposal,\13\ and one did not seem to be related to the proposed rule 
change.\14\
---------------------------------------------------------------------------

    \11\ WilmerHale Debt Two.
    \12\ CFA Institute Two.
    \13\ NASAA Debt Two.
    \14\ Anonymous. The comment, in total, was: ``[I]s this a due 
diligence report where numbers amounts are fabricated? Is a 
qualified professional `valuing' as a way of adjusting the 
amounts[?] I believe individuals should be leery of using `debt' 
excessively when processing accounting matters. Especially with the 
prevalence of automated software and attitude of today[']s 
workers.'' Id. Neither we nor FINRA see any issues raised by this 
comment relevant to the proposed rule change. See FINRA Response.
---------------------------------------------------------------------------

A. Definitions

    FINRA represented that most of the defined terms closely follow the 
defined terms for equity research in NASD Rule 2711, as amended by the 
equity research filing, with minor changes to reflect their application 
to debt research. The proposed definitions are set forth below.
    Under the proposed rule change, the term ``debt research analyst'' 
would mean an associated person who is primarily responsible for, and 
any associated person who reports directly or indirectly to a debt 
research analyst in connection with, the preparation of the substance 
of a debt research report, whether or not any such person has the job 
title of ``research analyst.'' \15\ The term ``debt research analyst 
account'' would mean any account in which a debt research analyst or 
member of the debt research analyst's household has a financial 
interest, or over which such analyst has discretion or control. It 
would not, however, include an investment company registered under the 
Investment Company Act of 1940 over which the debt research analyst or 
a member of the debt research analyst's household has discretion or 
control, provided that the debt research analyst or member of a debt 
research analyst's household has no financial interest in such 
investment company, other than a performance or management fee. The 
term also would not include a ``blind trust'' account that is 
controlled by a person other than the debt research analyst or member 
of the debt research analyst's household where neither the debt 
research analyst nor a member of the debt research analyst's household 
knows of the account's investments or investment transactions.\16\
---------------------------------------------------------------------------

    \15\ See proposed FINRA Rule 2242(a)(1).
    \16\ See proposed FINRA Rule 2242(a)(2). The exclusion for a 
registered investment company over which a research analyst has 
discretion or control in the proposed definition mirrors proposed 
changes to the definition of ``research analyst account'' in the 
equity research rules.
---------------------------------------------------------------------------

    The proposed rule change would define the term ``debt research 
report'' as any written (including electronic) communication that 
includes an analysis of a debt security or an issuer of a debt security 
and that provides information reasonably sufficient upon which to base 
an investment decision, excluding communications that solely constitute 
an equity research report as defined in proposed Rule 2241(a)(11).\17\ 
The proposed definition and exceptions noted below would, in FINRA's 
view, generally align with the definition of ``research report'' in 
NASD Rule 2711, while incorporating aspects of the Regulation AC 
definition of ``research report.'' \18\
---------------------------------------------------------------------------

    \17\ See proposed FINRA Rule 2242(a)(3). FINRA explained that 
the proposed rule change did not need to, similar to the equity 
proposal, explicitly exclude communications concerning open-end 
registered investment companies that are not listed or traded on an 
exchange (``mutual funds'') from the proposed rule as they would not 
be captured by the rule in the first place. See proposed FINRA Rule 
2242(a)(4) (defining ``debt securities'' as not including ``equity 
securities'' as defined in the Act). See also Exchange Act Release 
No. 74488 (Mar. 12, 2015); 80 FR 14174 (Mar. 18, 2015) (explaining 
the equity proposal as amended).
    \18\ In aligning the proposed definition with the Regulation AC 
definition of research report, FINRA pointed out that the proposed 
definition differs in minor respects from the definition of 
``research report'' in NASD Rule 2711. For example, the proposed 
definition of ``debt research report'' would apply to a 
communication that includes an analysis of a debt security or an 
issuer of a debt security, while the definition of ``research 
report'' in NASD Rule 2711 applies to an analysis of equity 
securities of individual companies or industries.
---------------------------------------------------------------------------

    Communications that constitute statutory prospectuses that are 
filed as part of the registration statement would not be included in 
the definition of a debt research report. Further, communications that 
constitute private placement memoranda and comparable offering-related 
documents, other than those that purport to be research, would not be 
included in the definition of a debt research report. In general, the 
term debt research report also would not include communications that 
are limited to the following, if they do not include an analysis of, or 
recommend or rate, individual debt securities or issuers:
     Discussions of broad-based indices;
     Commentaries on economic, political, or market conditions;
     Commentaries on or analyses of particular types of debt 
securities or characteristics of debt securities;
     Technical analyses concerning the demand and supply for a 
sector, index, or industry based on trading volume and price;
     Recommendations regarding increasing or decreasing 
holdings in particular industries or sectors or types of debt 
securities; or
     Notices of ratings or price target changes, provided that 
the member simultaneously directs the readers of the notice to the most 
recent debt research report on the subject company that includes all 
current applicable disclosures required by the rule and that such debt 
research report does not contain materially misleading disclosures, 
including disclosures that are outdated or no longer applicable.
    The term debt research report also, in general, would not include 
the following communications, even if they include an analysis of an 
individual debt security or issuer and information

[[Page 43530]]

reasonably sufficient upon which to base an investment decision:
     Statistical summaries of multiple companies' financial 
data, including listings of current ratings that do not include an 
analysis of individual companies' data;
     An analysis prepared for a specific person or a limited 
group of fewer than 15 persons;
     Periodic reports or other communications prepared for 
investment company shareholders or discretionary investment account 
clients that discuss individual debt securities in the context of a 
fund's or account's past performance or the basis for previously made 
discretionary investment decisions; or
     Internal communications that are not given to current or 
prospective customers.
    The proposed rule change would define the term ``debt security'' as 
any ``security'' as defined in section 3(a)(10) of the Exchange 
Act,\19\ except for any ``equity security'' as defined in section 
3(a)(11) of the Exchange Act,\20\ any ``municipal security'' as defined 
in section 3(a)(29) of the Exchange Act,\21\ any ``security-based 
swap'' as defined in section 3(a)(68) of the Exchange Act,\22\ and any 
``U.S. Treasury Security'' as defined in paragraph (p) of FINRA Rule 
6710.\23\
---------------------------------------------------------------------------

    \19\ 15 U.S.C. 78c(a)(10).
    \20\ 15 U.S.C. 78c(a)(11).
    \21\ 15 U.S.C. 78c(a)(29).
    \22\ 15 U.S.C. 78c(a)(68).
    \23\ See proposed FINRA Rule 2242(a)(4).
---------------------------------------------------------------------------

    The proposed rule change would define the term ``debt trader'' as a 
person, with respect to transactions in debt securities, who is engaged 
in proprietary trading or the execution of transactions on an agency 
basis.\24\
---------------------------------------------------------------------------

    \24\ See proposed FINRA Rule 2242(a)(5).
---------------------------------------------------------------------------

    The proposed rule change would provide that the term ``independent 
third-party debt research report'' means a third-party debt research 
report, in which the person producing the report both (1) has no 
affiliation or business or contractual relationship with the 
distributing member or that member's affiliates that is reasonably 
likely to inform the content of its research reports, and (2) makes 
content determinations without any input from the distributing member 
or that member's affiliates.\25\
---------------------------------------------------------------------------

    \25\ See proposed FINRA Rule 2242(a)(6).
---------------------------------------------------------------------------

    The proposed rule change would define the term ``investment banking 
department'' as any department or division, whether or not identified 
as such, that performs any investment banking service on behalf of a 
member.\26\ The term ``investment banking services'' would include, 
without limitation, acting as an underwriter, participating in a 
selling group in an offering for the issuer or otherwise acting in 
furtherance of a public offering of the issuer; acting as a financial 
adviser in a merger or acquisition; providing venture capital or equity 
lines of credit or serving as placement agent for the issuer or 
otherwise acting in furtherance of a private offering of the 
issuer.\27\
---------------------------------------------------------------------------

    \26\ See proposed FINRA Rule 2242(a)(8).
    \27\ See proposed FINRA Rule 2242(a)(9).
---------------------------------------------------------------------------

    The proposed rule change would define the term ``member of a debt 
research analyst's household'' as any individual whose principal 
residence is the same as the debt research analyst's principal 
residence.\28\
---------------------------------------------------------------------------

    \28\ See proposed FINRA Rule 2242(a)(10).
---------------------------------------------------------------------------

    The proposed rule change would define ``public appearance'' as any 
participation in a conference call, seminar, forum (including an 
interactive electronic forum) or other public speaking activity before 
fifteen or more persons or before one or more representatives of the 
media, a radio, television or print media interview, or the writing of 
a print media article, in which a debt research analyst makes a 
recommendation or offers an opinion concerning a debt security or an 
issuer of a debt security.\29\
---------------------------------------------------------------------------

    \29\ See proposed FINRA Rule 2242(a)(11).
---------------------------------------------------------------------------

    Under the proposed rule change the term ``qualified institutional 
buyer'' has the same meaning as under Rule 144A of the Securities 
Act.\30\
---------------------------------------------------------------------------

    \30\ See proposed FINRA Rule 2242(a)(12).
---------------------------------------------------------------------------

    The proposed rule change would define ``research department'' as 
any department or division, whether or not identified as such, that is 
principally responsible for preparing the substance of a debt research 
report on behalf of a member.\31\ The proposed rule change would define 
the term ``subject company'' as the issuer whose debt securities are 
the subject of a debt research report or a public appearance.\32\ 
Finally, the proposed rule change would define the term ``third-party 
debt research report'' as a debt research report that is produced by a 
person or entity other than the member.\33\
---------------------------------------------------------------------------

    \31\ See proposed FINRA Rule 2242(a)(14).
    \32\ See proposed FINRA Rule 2242(a)(15).
    \33\ See proposed FINRA Rule 2242(a)(16).
---------------------------------------------------------------------------

B. Identifying and Managing Conflicts of Interest

    Similar to the proposed equity research rule, the proposed rule 
change contains an overarching provision that would require members to 
establish, maintain, and enforce written policies and procedures 
reasonably designed to identify and effectively manage conflicts of 
interest related to the preparation, content, and distribution of debt 
research reports; public appearances by debt research analysts; and the 
interaction between debt research analysts and persons outside of the 
research department, including investment banking, sales and trading 
and principal trading personnel, subject companies, and customers.\34\
---------------------------------------------------------------------------

    \34\ See proposed FINRA Rule 2242(b)(1).
---------------------------------------------------------------------------

    The written policies and procedures would be required to be 
reasonably designed to promote objective and reliable debt research 
that reflects the truly held opinions of debt research analysts and to 
prevent the use of debt research reports or debt research analysts to 
manipulate or condition the market or favor the interests of the firm 
or current or prospective customers or class of customers.\35\
---------------------------------------------------------------------------

    \35\ See proposed FINRA Rule 2242(b)(2).
---------------------------------------------------------------------------

    The proposed rule change would introduce a distinction between 
sales and trading personnel and persons engaged in principal trading 
activities, where, in FINRA's opinion, the conflicts addressed by the 
proposal are of most concern.
1. Prepublication Review
    FINRA proposed that the required policies and procedures would be 
required to prohibit prepublication review, clearance or approval of 
debt research by persons involved in investment banking, sales and 
trading, or principal trading, and either restrict or prohibit such 
review, clearance, and approval by other non-research personnel other 
than legal and compliance.\36\ The policies and procedures also would 
be required to prohibit prepublication review of a debt research report 
by a subject company, other than for verification of facts.\37\ The 
proposed rule change would allow sections of a draft debt research 
report to be provided to non-investment banking personnel, non-
principal trading personnel, non-sales and trading personnel, or to the 
subject company for factual review, so long as: (1) The sections of the 
draft debt research report submitted do not contain the research 
summary, recommendation or rating; (2) A complete draft of the debt 
research report is provided to legal or compliance personnel before 
sections of the report are submitted to non-investment banking 
personnel, non-

[[Page 43531]]

principal trading personnel, non-sales and trading personnel or the 
subject company; and (3) If, after submitting sections of the draft 
debt research report to non-investment banking personnel, non-principal 
trading personnel, non-sales and trading personnel or the subject 
company, the research department intends to change the proposed rating 
or recommendation, it would be required to first provide written 
justification to, and receive written authorization from, legal or 
compliance personnel for the change. The member would be required to 
retain copies of any draft and the final version of such debt research 
report for three years after publication. \38\
---------------------------------------------------------------------------

    \36\ See proposed FINRA Rule 2242(b)(2)(A) and (B).
    \37\ See proposed FINRA Rule 2242(b)(2)(N).
    \38\ See proposed FINRA Rule 2242.05 (Submission of Sections of 
a Draft Research Report for Factual Review).
---------------------------------------------------------------------------

2. Coverage Decisions
    With respect to coverage decisions, a member's written policies and 
procedures would be required under the proposal to restrict or limit 
input by investment banking, sales and trading and principal trading 
personnel to ensure that research management independently makes all 
final decisions regarding the research coverage plan.\39\ However, the 
provision would not preclude personnel from these or any other 
department from conveying customer interests and coverage needs, so 
long as final decisions regarding the coverage plan are made by 
research management.
---------------------------------------------------------------------------

    \39\ See proposed FINRA Rule 2242(b)(2)(C).
---------------------------------------------------------------------------

3. Solicitation and Marketing of Investment Banking Transactions
    A member's written policies and procedures also would be required 
under the proposal to restrict or limit activities by debt research 
analysts that can reasonably be expected to compromise their 
objectivity.\40\ This would include prohibiting participation in 
pitches and other solicitations of investment banking services 
transactions and road shows and other marketing on behalf of issuers 
related to such transactions. The proposed rule change would adopt 
Supplementary Material that incorporates an existing FINRA 
interpretation for the equity research rules that prohibits in pitch 
materials any information about a member's debt research capacity in a 
manner that suggests, directly or indirectly, that the member might 
provide favorable debt research coverage.\41\ By way of example, the 
Supplementary Material explains that FINRA would consider the 
publication in a pitch book or related materials of an analyst's 
industry ranking to imply the potential outcome of future research 
because of the manner in which such rankings are compiled. The 
Supplementary Material further notes that a member would be permitted 
to include in the pitch materials the fact of coverage and the name of 
the debt research analyst, since that information alone does not imply 
favorable coverage.
---------------------------------------------------------------------------

    \40\ See proposed FINRA Rule 2242(b)(2)(L).
    \41\ See proposed FINRA Rule 2242.01 (Efforts to Solicit 
Investment Banking Business).
---------------------------------------------------------------------------

    The proposed rule change also would prohibit investment banking 
personnel from directing debt research analysts to engage in sales or 
marketing efforts related to an investment banking services transaction 
or any communication with a current or prospective customer about an 
investment banking services transaction.\42\ In addition, the proposed 
rule change would adopt Supplementary Material to provide that, 
consistent with this requirement, no debt research analyst may engage 
in any communication with a current or prospective customer in the 
presence of investment banking department personnel or company 
management about an investment banking services transaction.\43\
---------------------------------------------------------------------------

    \42\ See proposed FINRA Rule 2242(b)(2)(M).
    \43\ See proposed FINRA Rule 2242.02(a) (Restrictions on 
Communications with Customers and Internal Personnel).
---------------------------------------------------------------------------

4. Supervision
    A member's written policies and procedures would be required under 
the proposal to limit the supervision of debt research analysts to 
persons not engaged in investment banking, sales and trading or 
principal trading activities.\44\ In addition, the member would further 
be required under the proposal to establish information barriers or 
other institutional safeguards reasonably designed to ensure that debt 
research analysts are insulated from the review, pressure or oversight 
by persons engaged in investment banking services, principal trading or 
sales and trading activities or others who might be biased in their 
judgment or supervision.\45\
---------------------------------------------------------------------------

    \44\ See proposed FINRA Rule 2242(b)(2)(D).
    \45\ See proposed FINRA Rule 2242(b)(2)(H).
---------------------------------------------------------------------------

5. Budget and Compensation
    A member's written policies and procedures also would be required 
under the proposal to limit the determination of a firm's debt research 
department budget to senior management, excluding senior management 
engaged in investment banking or principal trading activities, and 
without regard to specific revenues or results derived from investment 
banking.\46\ However, the proposed rule change would expressly permit 
all persons to provide input to senior management regarding the demand 
for and quality of debt research, including product trends and customer 
interests. It further would allow consideration by senior management of 
a firm's overall revenues and results in determining the debt research 
budget and allocation of expenses.
---------------------------------------------------------------------------

    \46\ See proposed FINRA Rule 2242(b)(2)(E).
---------------------------------------------------------------------------

    With respect to compensation determinations, a member's written 
policies and procedures would be required under the proposal to 
prohibit compensation based on specific investment banking services or 
trading transactions or contributions to a firm's investment banking or 
principal trading activities and prohibit investment banking and 
principal trading personnel from input into the compensation of debt 
research analysts.\47\ Further, the firm's written policies and 
procedures would be required under the proposal to require that the 
compensation of a debt research analyst who is primarily responsible 
for the substance of a research report be reviewed and approved at 
least annually by a committee that reports to a member's board of 
directors or, if the member has no board of directors, a senior 
executive officer of the member.\48\ This committee would be required 
under the proposal to not have representation from investment banking 
personnel or persons engaged in principal trading activities and would 
be required to consider certain factors when reviewing a debt research 
analyst's compensation. Specifically, the proposal would require that 
the committee consider the debt research analyst's individual 
performance, including the analyst's productivity and the quality of 
the debt research analyst's research as well as the overall ratings 
received from customers and peers (independent of the member's 
investment banking department and persons engaged in principal trading 
activities) and other independent ratings services.
---------------------------------------------------------------------------

    \47\ See proposed FINRA Rule 2242(b)(2)(D) and (F).
    \48\ See proposed FINRA Rule 2242(b)(2)(G).
---------------------------------------------------------------------------

    Neither investment banking personnel nor persons engaged in 
principal trading activities would be required under the proposal to 
give input with respect to the compensation determination for debt 
research analysts. However, sales and trading personnel would be 
permitted to give input to debt research management as part of the 
evaluation process in order to convey customer

[[Page 43532]]

feedback, provided that final compensation determinations are made by 
research management, subject to review and approval by the compensation 
committee.\49\ The committee, which would not be permitted to have 
representation from investment banking or persons engaged in principal 
trading activities, would be required to document the basis for each 
debt research analyst's compensation, including any input from sales 
and trading personnel.
---------------------------------------------------------------------------

    \49\ See proposed FINRA Rule 2242(b)(2)(D) and (G).
---------------------------------------------------------------------------

6. Personal Trading Restrictions
    Under the proposed rule change, a member's written policies and 
procedures would be required to restrict or limit trading by a ``debt 
research analyst account'' in securities, derivatives and funds whose 
performance is materially dependent upon the performance of securities 
covered by the debt research analyst.\50\ The procedures would be 
required under the proposal to ensure that those accounts, supervisors 
of debt research analysts, and associated persons with the ability to 
influence the content of debt research reports do not benefit in their 
trading from knowledge of the content or timing of debt research 
reports before the intended recipients of such research have had a 
reasonable opportunity to act on the information in the report.\51\ 
Furthermore, the procedures would be required under the proposal to 
generally prohibit a debt research analyst account from purchasing or 
selling any security or any option or derivative of such security in a 
manner inconsistent with the debt research analyst's most recently 
published recommendation, except that the procedures would be permitted 
to define circumstances of financial hardship (e.g., unanticipated 
significant change in the personal financial circumstances of the 
beneficial owner of the research analyst account) in which the firm 
would permit a debt research analyst account to trade contrary to that 
recommendation. In determining whether a particular trade is contrary 
to an existing recommendation, firms would be permitted to take into 
account the context of a given trade, including the extent of coverage 
of the subject security. While the proposed rule change does not 
include a recordkeeping requirement, FINRA stated it expects members to 
evidence compliance with their policies and procedures and retain any 
related documentation in accordance with FINRA Rule 4511.
---------------------------------------------------------------------------

    \50\ See proposed FINRA Rule 2242(b)(2)(J).
    \51\ See proposed FINRA Rule 2242.07 (Ability to Influence the 
Content of a Research Report).
---------------------------------------------------------------------------

    The proposed rule change includes Supplementary Material .10, which 
would provide that FINRA would not consider a research analyst account 
to have traded in a manner inconsistent with a research analyst's 
recommendation where a member has instituted a policy that prohibits 
any research analyst from holding securities, or options on or 
derivatives of such securities, of the companies in the research 
analyst's coverage universe, provided that the member establishes a 
reasonable plan to liquidate such holdings consistent with the 
principles in paragraph (b)(2)(J)(i) and such plan is approved by the 
member's legal or compliance department.\52\
---------------------------------------------------------------------------

    \52\ See proposed FINRA Rule 2242.10.
---------------------------------------------------------------------------

7. Retaliation and Promises of Favorable Research
    A member's written policies and procedures would be required to 
prohibit direct or indirect retaliation or threat of retaliation 
against debt research analysts by any employee of the firm for 
publishing research or making a public appearance that may adversely 
affect the member's current or prospective business interests.\53\ The 
policies and procedures would also be required to prohibit explicit or 
implicit promises of favorable debt research, specific research content 
or a specific rating or recommendation as inducement for the receipt of 
business or compensation.\54\
---------------------------------------------------------------------------

    \53\ See proposed FINRA Rule 2242(b)(2)(I).
    \54\ See proposed FINRA Rule 2242(b)(2)(K).
---------------------------------------------------------------------------

8. Joint Due Diligence with Investment Banking Personnel
    The proposed rule change would establish limitations regarding 
joint due diligence activities--i.e., due diligence by the debt 
research analyst in the presence of investment banking department 
personnel--during a specified time period. Specifically, the proposed 
rule change states that FINRA would interpret the overarching principle 
which would, under the proposal, require members to, among other 
things, establish, maintain, and enforce written policies and 
procedures that address the interaction between debt research analysts 
and those outside the research department, including investment banking 
department personnel, sales and trading personnel, principal trading 
personnel, subject companies, and customers,\55\ to prohibit the 
performance of joint due diligence prior to the selection of 
underwriters for the investment banking services transaction.\56\
---------------------------------------------------------------------------

    \55\ See proposed FINRA Rule 2242(b)(1)(C).
    \56\ See proposed FINRA Rule 2242.09 (Joint Due Diligence).
---------------------------------------------------------------------------

9. Communications Between Debt Research Analysts and Trading Personnel
    The proposed rule change delineates what would be the prohibited 
and permissible interactions between debt research analysts and sales 
and trading and principal trading personnel. The proposed rule change 
would require members to establish, maintain and enforce written 
policies and procedures reasonably designed to prohibit sales and 
trading and principal trading personnel from attempting to influence a 
debt research analyst's opinions or views for the purpose of benefiting 
the trading position of the firm, a customer or a class of 
customers.\57\ It would further prohibit debt research analysts from 
identifying or recommending specific potential trading transactions to 
sales and trading or principal trading personnel that are inconsistent 
with such debt research analyst's currently published debt research 
reports or from disclosing the timing of, or material investment 
conclusions in, a pending debt research report.\58\
---------------------------------------------------------------------------

    \57\ See proposed FINRA Rule 2242.03(a)(1) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
    \58\ See proposed FINRA Rule 2242.03(a)(2) (Information Barriers 
between Research Analysts and Trading Desk Personnel).
---------------------------------------------------------------------------

    The proposed rule change would permit sales and trading and 
principal trading personnel to communicate customers' interests to a 
debt research analyst, so long as the debt research analyst does not 
respond by publishing debt research for the purpose of benefiting the 
trading position of the firm, a customer or a class of customers.\59\ 
In addition, debt research analysts would be permitted to provide 
customized analysis, recommendations or trade ideas to sales and 
trading and principal trading personnel and customers, provided that 
any such communications are not inconsistent with the analyst's 
currently published or pending debt research, and that any subsequently 
published debt research is not for the purpose of benefiting the 
trading position of the firm, a customer or a class of customers.\60\
---------------------------------------------------------------------------

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

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

[[Page 43533]]

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

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

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

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

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

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

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

C. Content and Disclosure in Debt Research Reports

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

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

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

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

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

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

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

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

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

[[Page 43534]]

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

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

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

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

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

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

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

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

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

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

D. Disclosure of Compensation Received by Affiliates

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

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

E. Disclosure in Public Appearances

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

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

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

[[Page 43535]]

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

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

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

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

F. Disclosure Required by Other Provisions

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

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

G. Distribution of Member Research Reports

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

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

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

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

H. Distribution of Third-party Debt Research Reports

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

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

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

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

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

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

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

[[Page 43536]]

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

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

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

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

I. Obligations of Persons Associated With a Member

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

J. Exemption for Members With Limited Investment Banking Activity

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

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

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

K. Exemption for Limited Principal Trading Activity

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

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

    As with the limited investment banking activity exemption, members

[[Page 43537]]

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

L. Exemption for Debt Research Reports Provided to Institutional 
Investors

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

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

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

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

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

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

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

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

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

[[Page 43538]]

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

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

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

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

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

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

M. General Exemptive Authority

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

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

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

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

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

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

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

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

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

[[Page 43539]]

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

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

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

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

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

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

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

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

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

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

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

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

[[Page 43540]]

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

[[Page 43541]]

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

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

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

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

C. Comments and Discussion Regarding Information Barriers

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

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

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

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

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

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

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

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

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

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

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

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

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

[[Page 43542]]

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

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

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

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

D. Comments and Discussion Regarding Research Products With Differing 
Recommendations

    The proposed rule change would require firms to establish, maintain 
and enforce written policies and procedures reasonably designed to 
ensure that a research report is not distributed selectively to 
internal trading personnel or a particular customer or class of 
customers in advance of other customers that the firm has previously 
determined are entitled to receive the research report. The proposals 
also include supplementary material that explains that firms may 
provide different research products to different classes of customers--
e.g., long term fundamental research to all customers and short-term 
trading research to certain institutional customers--provided the 
products are not differentiated based on the timing of receipt of 
potentially market moving information and the firm discloses, if 
applicable, that one product may contain a different recommendation or 
rating from another product.
    One commenter to the original proposal supported the provisions as 
proposed with general disclosure,\152\ while another contended that 
FINRA should require members to disclose when its research products and 
services do, in fact, contain a recommendation contrary to the research 
product or service received by other customers.\153\ The commenter 
favoring general disclosure asserted that disclosure of specific 
instances of contrary recommendations would impose significant burdens 
unjustified by the investor protection benefits. The commenter stated 
that a specific disclosure requirement would require close tracking and 
analysis of every research product or service to determine if a 
contrary recommendation exists. The commenter further stated that the 
difficulty of complying with such a requirement would be exacerbated in 
large firms by the number of research reports published and research 
analysts employed and the differing audiences for research products and 
services.\154\ The commenter asserted that some firms may publish tens 
of thousands of research reports each year and employ hundreds of 
analysts across various disciplines and that a given research analyst 
or supervisor could not reasonably be expected to know of all other 
research products and services that may contain differing views.
---------------------------------------------------------------------------

    \152\ WilmerHale Debt One.
    \153\ PIABA Debt.
    \154\ WilmerHale Debt One.
---------------------------------------------------------------------------

    The opposing commenter stated that they believed that permitting 
contrary opinions while only disclosing the possibility of this 
contrary research to investors was insufficient to adequately protect 
investors because the use of ``may'' in a disclosure is not the same as 
disclosing that there actually are opposing opinions. Further, they 
questioned whether such disclosure was consistent with the Act in that 
it may contrary to Rule 10b-5 by permitting the omission of a material 
fact in the research report. They did not believe that the disclosure 
of actual opposing views would be burdensome on members as they should 
be aware of contrasting opinions. As a result, FINRA should require 
specific disclosures.\155\
---------------------------------------------------------------------------

    \155\ PIABA Debt.
---------------------------------------------------------------------------

    Another commenter to the original proposal expressed concern that 
the proposal raises issues about the parity of information received by 
retail and institutional investors, and whether research provided to 
institutional investors could contain views that differ from those in 
research to retail investors.\156\
---------------------------------------------------------------------------

    \156\ CFA Institute One.
---------------------------------------------------------------------------

    The supplementary material states that products may lead to 
different recommendations or ratings, provided that each is consistent 
with the member's ratings system for each respective product. In other 
words, according to FINRA, all differing recommendations or ratings 
must be reconcilable such that they are not truly at odds with one 
another. As such, the proposed rule change would not, in

[[Page 43543]]

FINRA's view, allow research provided to an institutional investor to 
contain views inconsistent with those offered in retail debt 
research.\157\ FINRA provided the following example from the filing 
regarding equity research: A firm might define a ``buy'' rating in its 
long-term research product to mean that a stock will outperform the S&P 
500 over the next year, while a ``sell'' rating in its short-term 
trading product might mean the stock will underperform its sector index 
over the next month. In this case, FINRA stated that the firm could, 
under the proposal, maintain a ``buy'' in the long-term research and a 
``sell'' in its trading research at the same time if the firm believed 
the stock would temporarily drop near term based on failing to meet 
expectations in an earnings report but still outperform the S&P over 
the next year. One commenter, in their second letter, stated that this 
clarification addressed their concerns that investor protections were 
being impacted.\158\
---------------------------------------------------------------------------

    \157\ According to FINRA, the proposed rule change would not 
require that all investors receive all research products, nor would 
it preclude a firm from offering, for example, a research product to 
select customers that includes greater depth of analysis. However, 
it would not, in FINRA's view, be consistent with the proposed rule 
change to provide inconsistent views to different classes of 
customers or to advantage one class of customers based on the timing 
of receipt of a recommendation, rating or potentially market moving 
information.
    \158\ CFA Institute Two.
---------------------------------------------------------------------------

    Since the proposed rule change would not allow inconsistent 
recommendations that could mislead one or more investors, FINRA stated 
that it believes general disclosure of alternative products with 
different objectives and recommendations is appropriate relative to its 
investor protection benefits. The commenter who supported this approach 
expressed support for FINRA's decision in their second letter.\159\
---------------------------------------------------------------------------

    \159\ WilmerHale Debt Two.
---------------------------------------------------------------------------

E. Comments and Discussion Regarding Structural and Procedural 
Safeguards

    One commenter to the original proposal asked that FINRA clarify 
that members that have developed policies and procedures consistent 
with FINRA Rule 5280 (Trading Ahead of Research Reports) would also be 
in compliance with the debt proposal's expectation of structural 
separation between investment banking and debt research, and between 
sales and trading and principal trading and debt research.\160\ FINRA 
indicated in the proposed rule change that while the proposed rule 
would not require physical separation, FINRA would expect such physical 
separation except in extraordinary circumstances where the costs are 
unreasonable due to a firm's size and resource limitations. FINRA Rule 
5280 does not, according to FINRA, specify physical separation between 
all of the persons involved. While similar in design and purpose to 
some aspects of the proposed requirements in the debt proposal, FINRA 
clarified that FINRA Rule 5280 is not congruent with the proposal to 
the point where compliance with the policies and procedures provision 
of that rule would be deemed compliance with the debt proposal 
separation requirements. FINRA stated that both FINRA Rule 5280 and the 
debt proposal require policies and procedures reasonably designed to 
limit information flow.
---------------------------------------------------------------------------

    \160\ WilmerHale Debt One.
---------------------------------------------------------------------------

    FINRA also stated it believes that physical separation is an 
effective component to a reasonably designed compliance system that 
requires information barriers.
    The same commenter asked that FINRA modify the prohibition on debt 
analyst attendance at road shows to permit passive participation since 
there is less opportunity to meet and assess issuer management than in 
the equity context.\161\ FINRA stated it believes that even passive 
participation by debt research analysts in road shows and other 
marketing may present conflicts of interest and, therefore, declined to 
revise the proposal as suggested.\162\ In their second letter, the 
commenter reiterated this suggested change because, while they note the 
need for analysts to maintain their objectivity, unlike equity research 
analysts who have frequent interactions with issuer management and may 
assist in the due diligence process for offerings, debt research 
analysts typically do not participate in due diligence and do not have 
the same opportunities to meet with issuer management and road shows 
may present the only opportunity to do so.\163\ For the same reasons as 
above, FINRA declined again to make this change.\164\
---------------------------------------------------------------------------

    \161\ WilmerHale Debt One.
    \162\ See also Notice.
    \163\ WilmerHale Debt Two.
    \164\ FINRA Response
---------------------------------------------------------------------------

F. Comments and Discussion Regarding Communications Between Research 
Analysts and Trading Desk Personnel

    A commenter to the original proposal 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.'' \165\ 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, FINRA stated that 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 expressed its 
belief that there are a variety of policies and procedures that could 
address such attempts, including periodic monitoring of such 
communications. As such, FINRA declined to delete ``attempting'' from 
the provision.
---------------------------------------------------------------------------

    \165\ WilmerHale Debt One.
---------------------------------------------------------------------------

    The commenter further expressed concern that the term ``pending'' 
is vague in the above-cited provision.\166\ The commenter suggested 
that FINRA delete the term or confirm that ``pending'' means ``imminent 
publication of a debt research report.'' FINRA stated it 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 stated it 
considers such research in draft to be pending and therefore declined 
to delete the term or adopt an ``imminent'' standard as suggested by 
the commenter.
---------------------------------------------------------------------------

    \166\ Id.
---------------------------------------------------------------------------

    Proposed Supplementary Material .03(b)(3) would provide 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

[[Page 43544]]

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 to the original proposal 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.\167\ 
FINRA agreed in the Amendment Notice that context may be considered 
whenever consistency of research or views is at issue.
---------------------------------------------------------------------------

    \167\ Id.
---------------------------------------------------------------------------

G. Comments and Discussion Regarding Disclosure Requirements

    One commenter to the original proposal expressed concern about the 
proposed 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 twelve 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.\168\ The commenter asked FINRA to 
eliminate these provisions because the commenter believes that 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.\169\ 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.
---------------------------------------------------------------------------

    \168\ WilmerHale Debt One.
    \169\ Id.
---------------------------------------------------------------------------

    FINRA stated it believes that, similar to the current equity rules, 
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 stated it 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 proposed to amend Rules 
2242(c)(2) and (3) in Amendment No. 1 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 expressed belief that 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. In their second letter, the 
commenter expressed support for this change.\170\
---------------------------------------------------------------------------

    \170\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    While FINRA also believes that the disclosures would be valuable to 
retail investors with respect to debt research on individual debt 
securities, FINRA stated it 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 stated it 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 
proposed in Amendment No. 1 to eliminate for now the requirements with 
respect to debt research reports on individual debt securities. FINRA 
stated it 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.\171\ The commenter noted that while the Commission has 
interpreted section 15D(b) of the Exchange Act to require disclosure in 
each equity report, the law does not apply to debt research.\172\ FINRA 
stated it 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 stated it believes the disclosures must be in the research report 
itself. FINRA also expressed its belief that this will promote 
consistency between equity and retail debt research. FINRA further 
noted that institutional debt research would not require the specific 
disclosures.
---------------------------------------------------------------------------

    \171\ WilmerHale Debt One.
    \172\ See 15 U.S.C. 78o-6(b) and (d)(2).
---------------------------------------------------------------------------

H. Comments and Discussion Regarding the 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 would be permitted 
to use negative consent where the customer meets the definition of a 
QIB and satisfies the institutional suitability standards of FINRA Rule 
2111 with respect to debt transactions and strategies. Institutional 
accounts that meet the definition of FINRA Rule 4512(c), but do not 
satisfy the higher tier standard required for negative consent, would 
be permitted to affirmatively elect in writing to receive institutional 
debt research.
    One commenter to the original proposal opposed providing any 
exemption for debt research distributed solely to eligible 
institutional investors, contending that it would deprive the

[[Page 43545]]

market's largest participants of the important protections of the 
proposed rules for retail debt research.\173\ Another such commenter 
reiterated concerns expressed in response to an earlier iteration of 
the debt research proposal that the proposed standard for negative 
consent would be difficult to implement and would disadvantage 
institutional investors who are capable of, and in fact, make 
independent investment decisions about debt transactions and 
strategies. The commenter suggested as an alternative that the 
institutional investor standard should be based on only on the 
institutional suitability standard in Rule 2111.\174\
---------------------------------------------------------------------------

    \173\ PIABA Debt.
    \174\ SIFMA.
---------------------------------------------------------------------------

    Another commenter to the original proposal supported the proposed 
tiered approach for how institutional investors may receive research 
reports.\175\ The commenter stated that a QIB presumably has the 
sophistication and human and financial resources to evaluate debt 
research without the disclosures and other protections that accompany 
reports provided to retail investors. The commenter also supported 
permitting an institutional investor that does not fall within the 
higher tier category to receive the debt research without the retail 
investor protections if it notifies the firm in writing of its 
election.
---------------------------------------------------------------------------

    \175\ CFA Institute One.
---------------------------------------------------------------------------

    FINRA stated in the Notice and Amendment Notice that it believes an 
institutional exemption is appropriate to allow more sophisticated 
institutional market participants that can assess risks associated with 
debt trading and are aware of conflicts that may exist between a 
member's recommendations and trading interests, to continue to receive 
the timely flow of analysis and trade ideas that they value. FINRA 
noted that institutional debt research still would remain subject to 
several provisions of the rules, including the required separation 
between debt research and investment banking and the requirements for 
conflict management policies and procedures to insulate debt analysts 
from pressure by traders and others. In addition, FINRA noted that no 
institutional investor will be exposed to this less-protected 
institutional research without either negative or affirmative consent, 
as applicable.
    FINRA noted, with regard to the standard for negative consent, it 
does not believe that less sophisticated institutional investors should 
be required to take any additional steps to receive the full 
protections of the proposed rules. To the extent the QIB standard for 
negative consent is too difficult to implement, the proposal would 
provide an alternative to obtain a one-time affirmative consent for any 
Rule 4512(c) institutional account and further provides a one-year 
grace period to obtain that consent, so as not to disrupt the current 
flow of debt research to institutional customers. As discussed in the 
rule filing, FINRA included the alternative methods of consent and the 
grace period to satisfy the differing industry views on which of two 
consent options would be most cost effective.
    Another commenter to the original proposal asked that FINRA confirm 
that, in distributing debt research reports under the institutional 
debt research framework to certain non-U.S. institutional investors who 
are customers of a member's non-U.S. broker-dealer affiliate, the 
member may rely on similar classifications in the non-U.S. 
institutional investors' home jurisdictions.\176\ The commenter 
contended that this is necessary because some global firms distribute 
their debt research reports to non-U.S. institutional investors who may 
not have been vetted as QIBs for a variety of reasons. The debt 
proposal never contemplated recognizing equivalent institutional 
standards in other jurisdictions, and FINRA stated it does not believe 
that approach is appropriate or workable. FINRA questioned whether 
there are standards in other jurisdictions that are truly the 
equivalent of the QIB standard, and stated that it is impractical for 
FINRA to survey and assess the institutional standards around the world 
to determine equivalency, not to mention whether the home jurisdiction 
adequately examines for and enforces compliance with the standard. 
FINRA noted that, under the proposal, to the extent non-U.S. 
institutional investors have not been vetted as QIBs, firms have the 
option of either vetting them if they wish to send them institutional 
debt research by negative consent or obtaining affirmative written 
consent to the extent the institution satisfies the Rule 4212(c) 
standard.
---------------------------------------------------------------------------

    \176\ WilmerHale Debt One.
---------------------------------------------------------------------------

    The same commenter asked FINRA to clarify the application of the 
institutional debt research framework to desk analysts or other 
personnel who are part of the trading desk and are not ``research 
department'' personnel. In particular, the commenter suggested that 
proposed Rules 2242(b)(2)(H) (with respect to pressuring) and (b)(2)(L) 
(which would require policies and procedures reasonably designed to, 
among other things, restrict or limit activities by debt research 
analysts that can reasonably be expected to compromise their 
objectivity) should not apply when sales and trading personnel or 
principal trading personnel publish debt research reports in reliance 
on the institutional research exemption because the requirements of 
those provisions cannot be reconciled with the inherent nature of 
conflicts present.\177\ Those provisions would require firms to have 
policies and procedures to both establish information barrier or other 
institutional safeguards reasonably designed to insulate debt research 
analysts from pressure by, among others, principal trading or sales and 
trading personnel and restrict or limit activities by debt research 
analysts that can reasonably be expected to compromise their 
objectivity. FINRA disagreed with the commenter. They stated that they 
believe that minimum objectivity standards should apply to 
institutional debt research regardless of whether the research is 
published by research department personnel, sales and trading personnel 
or principal trading personnel. FINRA further stated it believes that a 
firm can and should put in place policies and procedures reasonably 
designed to ensure that other traders or sales and trading personnel do 
not overtly pressure a trader who produces debt research to express a 
particular view and to prevent that trader from participating in 
solicitations of investment banking or road show participation.
---------------------------------------------------------------------------

    \177\ Id.
---------------------------------------------------------------------------

I. Comments and Discussion Regarding the Exemptions for Limited 
Investment Banking Activity and Limited Principal Trading Activity

    The proposed rule change would exempt members with limited 
principal trading activity or limited investment banking activity from 
the review, supervision, budget, and compensation provisions in the 
proposed rule related to principal trading and investment banking 
personnel, respectively. The limited principal trading exemption would 
apply to firms that engage in principal trading activity where, 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 the member employs fewer 
than ten debt traders. The limited investment banking exemption would 
apply, as it does in the equity rules, to firms that have managed or 
co-managed ten or fewer investment banking services

[[Page 43546]]

transactions on average per year, over the previous three years and 
generated $5 million or less in gross investment banking revenues from 
those transactions.
    One commenter to the original proposal questioned whether the 
exemptions could compromise the independence and accuracy of the 
analysis and opinions provided.\178\ The commenter further expressed 
concern that the exemption might allow traders to act on debt research 
prior to publication and distribution of that research. The commenter 
noted FINRA's commitment to monitor firms that avail themselves of the 
exemptions to evaluate whether the thresholds for the exemptions are 
appropriate and asked FINRA to publish findings that could help 
properly weigh the burdens on small firms while ensuring the 
independence of investment research. The commenter also encouraged 
FINRA to provide additional guidance as to what specific measures 
should be taken to ensure that 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.
---------------------------------------------------------------------------

    \178\ CFA Institute One.
---------------------------------------------------------------------------

    FINRA stated in the Notice and the Amendment Notice that it 
included the exemptions to balance the burdens of compliance with the 
level or risk to investors. FINRA stated that it determined the 
thresholds for each exemption based on data analysis and a survey of 
firms that engage in principal trading activity or investment banking 
activity, respectively. FINRA clarified that it has not found abuses 
with respect to the limited investment banking exemption in the equity 
context and notes that some important separation requirements would 
still apply to the eligible firms, such as the prohibition on 
compensating a debt research analyst based on a specific investment 
banking transaction or contributions to a member's investment banking 
services activities.
    FINRA clarified that the proposed limited principal trading 
exemption would apply where, based on the survey and data analysis, it 
reasonably believes the amount of potential principal trading profits 
poses appreciably lower risk of pressure on debt research analysts by 
sales and trading or principal trading personnel and where there would 
be a significant marginal cost to add a trader dedicated to producing 
research relative to the increase in investor protection. FINRA further 
noted that the proposal would still prohibit debt research analysts at 
exempt firms from being compensated based on specific trading 
transactions.
    With respect to both exemptions, as the commenter noted, firms 
would still 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 investment 
banking or principal trading activities, among others. FINRA stated it 
believes a number of policies could be implemented to achieve 
compliance with this requirement. For example, in the context of 
principal trading, these measures might include monitoring of 
communications between debt research analysts and individuals on the 
trading desk and reviewing published research in relation to 
transactions executed by the firm in the subject company's debt 
securities. FINRA also noted that neither exemption would allow trading 
ahead of research by firm traders, as FINRA Rule 5280 would continue to 
apply to both debt and equity research and prohibits such conduct. 
Finally, as noted by the commenter, FINRA stated it intends to monitor 
the research produced by firms that avail themselves of the exemptions 
to assess whether the thresholds to qualify for the exemptions are 
appropriate or should be modified.
    The commenter responded in its second letter that, while FINRA 
addressed their concerns, they still had concerns that the examples 
given by FINRA in the Amendment Notice were insufficient. They 
recommended additional guidance by FINRA to help ensure adequate 
compliance. They also approved of FINRA's commitment to continue to 
monitor this issue and urged publication of the results.\179\ In their 
response, FINRA noted that the examples were not intended to be 
exhaustive and that, in light of the principles-based approach of the 
proposal there will be different ways for members to design policies 
and procedures reasonably designed to protect against pressure. FINRA 
stated it will continue to monitor the issue and will consider sharing 
its findings as appropriate.\180\
---------------------------------------------------------------------------

    \179\ CFA Institute Two.
    \180\ FINRA Response.
---------------------------------------------------------------------------

J. Comments and Discussion Regarding the Filing Requirement Exclusion

    One commenter to the original proposal asked FINRA to consider 
amending FINRA Rule 2210 to exclude debt research reports from that 
rule's filing requirements, since there is an exception from the filing 
requirements for equity research reports that concern only equity 
securities that trade on an exchange.\181\ FINRA stated it is willing 
to separately consider the merits of the request, but does not believe 
the issue is appropriate for resolution in the context of the debt 
proposal since it primarily relates to the provisions of a rule that 
are not the subject of the proposed rule change.
---------------------------------------------------------------------------

    \181\ WilmerHale Debt One.
---------------------------------------------------------------------------

K. Comments and Discussion Regarding the Implementation Date

    One commenter to the original proposal requested that the 
implementation date be at least twelve months after Commission approval 
of the proposed rule change and that FINRA sequence the compliance 
dates of the equity research filing and the proposed rule change in 
that order.\182\ Another such commenter requested that FINRA provide a 
``grace period'' of one year or the maximum time permissible, if that 
is less than one year, between the adoption of the proposed rule and 
the implementation date.\183\ FINRA stated that it is sensitive to the 
time firms will require to update their policies and procedures and 
systems to comply with the proposed rule change and will take those 
factors into consideration when establishing implementation dates. As 
stated in the Amendment Notice, FINRA will announce the effective date 
of the proposed rule change in a Regulatory Notice to be published no 
later than 60 days following Commission approval. FINRA further stated 
that the effective date will be no later than 180 days following 
publication of the Regulatory Notice announcing Commission approval.
---------------------------------------------------------------------------

    \182\ SIFMA.
    \183\ WilmerHale Debt One.
---------------------------------------------------------------------------

J. Summary of Findings and Conclusion

    The Commission has carefully considered the proposed rule change, 
all of the comments received, and FINRA's responses to the comments. 
Based on its review of the record, the Commission finds that the 
proposed rule change, as amended by Amendment No. 1, is consistent with 
the requirements of the Act and the rules and regulations thereunder 
applicable to a national securities association.\184\ In particular, 
the Commission finds that the proposed rule change, as amended by 
Amendment No. 1, is consistent with section 15A(b)(6) of the Act, which 
requires, among other things, that FINRA's rules be designed to prevent 
fraudulent and manipulative acts and

[[Page 43547]]

practices, to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest.\185\
---------------------------------------------------------------------------

    \184\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \185\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    FINRA stated in its proposal that it ``believes that the proposed 
rule change would promote increased quality, objectivity and 
transparency of debt research distributed to investors by requiring 
firms to identify and mitigate conflicts in the preparation and 
distribution of such research'' and that ``the [proposed] rule will 
provide investors with more reliable information on which to base 
investment decisions in debt securities, while maintaining timely flow 
of information important to institutional market participants and 
providing those institutional investors with appropriate safeguards.''
    We generally agree with these assertions. The potential abuses 
spawned by the conflicts of interest between research and the business 
interests of broker-dealers in the equity space are well-known and 
well-established.\186\ As FINRA explained in the Notice, debt research 
is not immune to the challenges that these conflicts create. For 
example, the Massachusetts Secretary of the Commonwealth in 2008 
alleged that a FINRA member ``co-opted its supposedly independent 
[r]esearch [d]epartment to assist in sales efforts geared towards 
reducing its inventory'' of debt instruments.\187\ These allegations 
are similar to those raised in the allegations that led to the global 
research analyst settlement as a result of the abuses found regarding 
equity research.\188\ As a result, as noted by the U.S. Government 
Accountability Office, ``until FINRA adopts a fixed-income research 
rule, investors continue to face a potential risk.'' \189\ The proposed 
rule change attempts to address this need in a way that seems to 
effectively balance the public interest in effectively managing debt 
research conflicts of interest with the ability of members to also 
effectively provide research, and thus information, to the investing 
public. We also note that the relevant commenters to the proposal as 
amended, all of which were commenters to the original proposal, stated 
in their second comment letters that they generally agree with the 
proposal as amended.\190\
---------------------------------------------------------------------------

    \186\ See, e.g., ``Ten of Nation's Top Investment Firms Settle 
Enforcement Actions Involving Conflicts of Interest Between Research 
and Investment Banking,'' Press Release 2003-54 (available at https://www.sec.gov/news/press/2003-54.htm). As one commenter noted, these 
conflicts can still influence equity research. NASAA Debt Two. See 
also ``FINRA Fines 10 Firms a Total of $43.5 Million for Allowing 
Equity Research Analysts to Solicit Investment Banking Business and 
for Offering Favorable Research Coverage in Connection With 
Toys`R'Us IPO,'' FINRA News Release (available at https://www.finra.org/newsroom/2014/finra-fines-10-firms-total-435-million).
    \187\ Commonwealth of Massachusetts, Office of the Secretary of 
the Commonwealth, Securities Division, In the Matter of Merrill 
Lynch, Pierce, Fenner & Smith, Incorporated, Administrative 
Complaint, Docket No. 2008-0058 (Jul. 31, 2008) (available at https://archives.lib.state.ma.us/bitstream/handle/2452/213560/ocn886547410.pdf?sequence=1&isAllowed=y).
    \188\ See, ``Ten of Nation's Top Investment Firms Settle 
Enforcement Actions Involving Conflicts of Interest Between Research 
and Investment Banking,'' Press Release 2003-54 (available at https://www.sec.gov/news/press/2003-54.htm) (stating that ``[t]he 
enforcement actions allege that, from approximately mid-1999 through 
mid-2001 or later, all of the firms engaged in acts and practices 
that created or maintained inappropriate influence by investment 
banking over research analysts, thereby imposing conflicts of 
interest on research analysts that the firms failed to manage in an 
adequate or appropriate manner'').
    \189\ U.S. Government Accountability Office, GAO-12-209, 
Securities Research: Additional Actions Could Improve Regulatory 
Oversight of Analyst Conflicts of Interest, at 41 (Jan. 12, 2012) 
(available at https://www.gao.gov/assets/590/587613.pdf).
    \190\ WilmerHale Debt Two, CFA Institute Two, and NASAA Debt 
Two.
---------------------------------------------------------------------------

    Regarding concerns raised by commenters regarding the principles-
based structure of the proposal, we note the proposed rule change 
establishes the key provisions of NASD Rule 2711 for debt research and 
includes a number of protections for investors beyond those currently 
found in that rule, including the requirement that research management 
make independent decisions regarding research coverage,\191\ 
maintenance of information barriers or other institutional safeguards 
between research and investment banking, sales and trading, and other 
persons who might be biased in their judgment or supervision including, 
for certain members, requiring physical separation,\192\ information 
barriers between research analysts and trading desk personnel,\193\ and 
ensure that purported facts in research reports are based on reliable 
information.\194\ Further, FINRA's responses to interpretive questions 
posed by the commenters to the original proposal in the Amendment 
Notice should help eliminate uncertainty regarding how the proposal 
will operate. For instance, one commenter noted with approval the 
clarification regarding the ``at a minimum'' requirement which seemed 
to be the source of the commenter's confusion.\195\ FINRA also provided 
further guidance on other issues in the FINRA Response, such as whether 
sales and trading personnel can provide feedback for purposes of 
evaluating an analyst.
---------------------------------------------------------------------------

    \191\ Proposed FINRA Rule 2242(b)(2)(B).
    \192\ Proposed FINRA Rule 2242(b)(2)(H) and Notice (``Among the 
structural safeguards, FINRA believes separation between investment 
banking and debt research, and between sales and trading and 
principal trading and debt research, is of particular importance. As 
such, while the proposed rule change does not mandate physical 
separation between the debt research department and the investment 
banking, sales and trading and principal trading departments (or 
other person who might seek to influence research analysts), FINRA 
would expect such physical separation except in extraordinary 
circumstances where the costs are unreasonable due to a firm's size 
and resource limitations. In those instances, a firm must implement 
written policies and procedures, including information barriers, to 
effectively achieve and monitor separation between debt research and 
investment banking, sales and trading and principal trading 
personnel.'')
    \193\ Proposed FINRA Rule 2242.03.
    \194\ Proposed FINRA Rule 2242(c)(1)(A).
    \195\ WilmerHale Debt Two.
---------------------------------------------------------------------------

    In approving this proposal, however, we expect that FINRA will 
continue to monitor the effectiveness of the rule proposal, especially 
with regards to the treatment of research provided to institutional 
investors, and modify the rule should it prove to be unworkable or fail 
to provide an appropriate level of protection to investors.\196\
---------------------------------------------------------------------------

    \196\ We note that, as one commenter to the equity version of 
this proposal noted, the interpretation of what constitutes 
``reasonableness'' may prove difficult for FINRA and member alike. 
See Letter from Egidio Mogavero, Managing Director and Chief 
Compliance Officer, JMP Securities, dated Mar. 19, 2015.
---------------------------------------------------------------------------

    For the reasons stated above, the Commission finds that the 
proposed rule change is consistent with the Act and the rules and 
regulations thereunder.

IV. Conclusion

    IT IS THEREFORE ORDERED, pursuant to section 19(b)(2) of the 
Act,\197\ that the proposed rule change (SR-FINRA-2014-048), as 
modified by Amendment No. 1 thereto, be, and it hereby is, approved.
---------------------------------------------------------------------------

    \197\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\198\

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

    \198\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Brent J. Fields,
Secretary.
[FR Doc. 2015-17972 Filed 7-21-15; 8:45 am]
BILLING CODE 8011-01-P

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