Covered Investment Fund Research Reports, 26788-26831 [2018-11497]

Download as PDF 26788 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 230, 242, and 270 [Release Nos. 33–10498; 34–83307; IC– 33106; File No. S7–11–18] RIN 3235–AM24 Covered Investment Fund Research Reports Securities and Exchange Commission. ACTION: Proposed rules. AGENCY: As directed by Congress pursuant to the Fair Access to Investment Research Act of 2017, the Commission is proposing a new rule under the Securities Act of 1933. If adopted, the proposal would establish a safe harbor for an unaffiliated broker or dealer participating in a securities offering of a ‘‘covered investment fund’’ to publish or distribute a ‘‘covered investment fund research report.’’ If the conditions for the safe harbor are satisfied, this publication or distribution would be deemed not to be an offer for sale or offer to sell the covered investment fund’s securities for purposes of sections 2(a)(10) and 5(c) of the Securities Act of 1933. The Commission is also proposing a new rule under the Investment Company Act of 1940. This proposal would exclude a covered investment fund research report from the coverage of section 24(b) of the Investment Company Act (or the rules and regulations thereunder), except to the extent the research report is otherwise not subject to the content standards in self-regulatory organization rules related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards. We are also proposing a conforming amendment. SUMMARY: Comments should be received by July 9, 2018. ADDRESSES: Comments may be submitted by any of the following methods: DATES: amozie on DSK3GDR082PROD with PROPOSALS3 Electronic Comments • Use the Commission’s internet comment forms (https://www.sec.gov/ rules/proposed.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number S7– 11–18 on the subject line. Paper Comments • Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 Street, NE, Washington, DC 20549– 1090. All submissions should refer to File Number S7–11–18. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s website (https:// www.sec.gov/rules/proposed.shtml). Comments also are available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Room 1580, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. Studies, memoranda or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission’s website. To ensure direct electronic receipt of such notifications, sign up through the ‘‘Stay Connected’’ option at www.sec.gov to receive notifications by email. FOR FURTHER INFORMATION CONTACT: Asaf Barouk, Attorney-Adviser, John Lee, Senior Counsel; Amanda Hollander Wagner, Branch Chief; or Brian McLaughlin Johnson, Assistant Director, at (202) 551–6792, Investment Company Regulation Office, Division of Investment Management; Steven G. Hearne, Senior Special Counsel, at (202) 551–3430, Division of Corporation Finance; Laura Gold or Samuel Litz, Attorney-Advisers; or John Guidroz, Branch Chief, at (202) 551–5777, Office of Trading Practices, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–8549. SUPPLEMENTARY INFORMATION: The Commission is proposing for comment new rule 139b [17 CFR 230.139b] under the Securities Act of 1933 [15 U.S.C. 77a et seq.]; new rule 24b–4 [17 CFR 270.24b–4] under the Investment Company Act of 1940 [15 U.S.C. 80a–1 et seq.]; and a conforming amendment to rule 101 [17 CFR 242.101(a)] of Regulation M [17 CFR 242.100– 242.105]. Table of Contents I. Introduction and Background A. Introduction PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 B. FAIR Act II. Discussion A. Scope of Proposed Rule 139b 1. Definition of ‘‘Covered Investment Fund Research Report’’ 2. Definition of ‘‘Research Report’’ 3. Definition of ‘‘Covered Investment Fund’’ 4. Non-Exclusivity of Safe Harbor B. Conditions for the Safe Harbor 1. Issuer-Specific Research Reports 2. Industry Research Reports C. Presentation of Performance Information in Research Reports About Registered Investment Companies D. Role of Self-Regulatory Organizations 1. SRO Content Standards and Filing Requirements for Covered Investment Fund Research Reports 2. SRO Limitations E. Conforming Amendment III. Economic Analysis A. Introduction B. Baseline 1. Market Structure and Market Participants 2. Regulatory Structure C. Costs and Benefits 1. FAIR Act Statutory Mandate 2. Proposed Rule 139b 3. Proposed Rule 24b–4 4. Proposed Amendment to Rule 101 of Regulation M 5. Effects on Efficiency, Competition, and Capital Formation 6. Alternatives Considered IV. Paperwork Reduction Act V. Regulatory Flexibility Act Analysis A. Reasons for, and Objectives of, the Proposed Action B. Legal Basis C. Small Entities Subject to the Proposed Rules D. Reporting, Recordkeeping and Other Compliance Requirements E. Duplicative, Overlapping, or Conflicting Federal Rules F. Significant Alternatives G. General Request for Comment VI. Small Business Regulatory Enforcement Fairness Act VII. Statutory Authority I. Introduction and Background A. Introduction As directed by the Fair Access to Investment Research Act of 2017,1 we are proposing new rule 139b under the Securities Act of 1933 (the ‘‘Securities Act’’).2 Proposed rule 139b includes certain conditions that, if satisfied, would provide that a broker’s or dealer’s (a ‘‘broker-dealer’s’’) publication or distribution of a covered investment fund research report will be deemed for purposes of sections 2(a)(10) and 5(c) of the Securities Act not to constitute an offer for sale or offer to sell a security that is the subject of an offering of the 1 Fair Access to Investment Research Act of 2017, Public Law 115–66, 131 Stat. 1196 (2017) (the ‘‘FAIR Act’’). 2 15 U.S.C. 77a et seq. E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 covered investment fund, even if the broker-dealer is participating or may participate in a registered offering of the covered investment fund’s securities.3 Proposed rule 139b would establish a new safe harbor for unaffiliated brokerdealers’ publication or distribution of covered investment fund research reports similar to the existing safe harbor under rule 139 applicable to research reports about other issuers or their securities.4 We are also proposing new rule 24b– 4 under the Investment Company Act of 1940 (the ‘‘Investment Company Act’’),5 which would exclude a covered investment fund research report from the filing requirements of section 24(b) of the Investment Company Act (or the rules and regulations thereunder), except to the extent that such report is otherwise not subject to the content standards in self-regulatory organization (‘‘SRO’’) rules related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards.6 This proposed rule would have the effect of reducing the filing requirements currently applicable to certain communications that, by operation of the FAIR Act and proposed rule 139b, would now be deemed ‘‘covered investment fund research reports.’’ 7 Additionally, in light of the proposal of rule 139b, we are proposing a conforming amendment to rule 101 of Regulation M. This amendment would permit distribution participants, such as brokers or dealers, to publish or 3 See infra text accompanying notes 32–34 (discussing our general approach in modeling proposed rule 139b after rule 139 [17 CFR 230.139], and noting that we propose this approach in furtherance of the FAIR Act’s directive to revise rule 139 to extend the current safe harbor available under rule 139 to broker-dealers’ publication or distribution of covered investment fund research reports); see also proposed addition to rule 139(a) (‘‘For purposes of the [FAIR Act], a safe harbor has been established for covered investment fund research reports, and the specific terms of that safe harbor are set forth in Rule 139b. . . .’’). 4 See infra notes 11–15 and accompanying text. 5 15 U.S.C. 80a–1 et seq. 6 As discussed below, we are proposing this rule pursuant to section 2(b)(4) of the FAIR Act (mandating that the Commission shall provide that a covered investment fund research report shall not be subject to section 24(b) of the Investment Company Act of 1940 (15 U.S.C. 80a–24(b)) or the rules and regulations thereunder, except that such report may still be subject to such section and the rules and regulations thereunder to the extent that it is otherwise not subject to the content standards in the rules of any self-regulatory organization related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards). See infra section II.D.1. 7 See infra notes 184–187 and accompanying text. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 disseminate any information, opinion, or recommendation relating to a covered security if the conditions of proposed rule 139b (or, alternatively, the conditions of rule 138 8 or rule 139 under the Securities Act) are satisfied.9 The proposed conforming amendment is intended to align the treatment of research under proposed rule 139b with the treatment of research under rules 138 and 139 for purposes of Regulation M.10 Rule 139 currently provides a safe harbor for the publication or distribution of research reports concerning one or more issuers by a broker-dealer participating in a registered offering of one of the covered issuers’ securities.11 Specifically, rule 139 provides that a broker-dealer’s publication or distribution of research reports—whether about a particular issuer or multiple issuers, including within the same industry—that satisfy certain conditions under the rule are ‘‘deemed for purposes of sections 2(a)(10) and 5(c) of the [Securities] Act not to constitute an offer for sale or offer to sell.’’ 12 A broker-dealer’s publication or distribution of a research report in reliance on rule 139 would therefore not be deemed to constitute an offer that 8 17 CFR 230.138. infra section II.E. 10 See id. 11 The term ‘‘research report’’ in rule 139 under the Securities Act is defined as ‘‘a written communication, as defined in Rule 405, that includes information, opinions, or recommendations with respect to securities of an issuer or an analysis of a security or an issuer, whether or not it provides information reasonably sufficient upon which to base an investment decision.’’ 17 CFR 230.139(d); see infra section II.A.2 for a discussion of the term ‘‘research report.’’ There are differences in how other rules and regulations define the term ‘‘research report,’’ including Regulation Analyst Certification (‘‘Regulation AC’’) under the Securities Act and the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’), 15 U.S.C. 78a et seq. Compare 17 CFR 242.500–505 (A ‘‘research report’’ as defined under Regulation AC is limited to an analysis of a security or an issuer, and information within the report must be ‘‘reasonably sufficient upon which to base an investment decision;’’ whereas, under rule 139, a ‘‘research report’’ includes not only an analysis of a security or an issuer, as in Regulation AC, but also, information, opinions, or recommendations regarding securities of an issuer, irrespective of the information within the report being ‘‘reasonably sufficient upon which to base an investment decision.’’); Financial Industry Regulatory Authority (‘‘FINRA’’) rule 2241 (defining ‘‘research report’’); and FINRA rule 2242 (defining ‘‘debt research report’’). See also discussion of Regulation AC infra at notes 57–58. We note that research reports published or distributed by broker-dealers in reliance on the rule 139 safe harbor may also be subject to other rules and regulations under the federal securities laws, including but not limited to Regulation AC, as well as SRO rules governing their content and use, including but not limited to FINRA rules 2210, 2241, and 2242. 12 Rule 139(a) under the Securities Act [17 CFR 230.139(a)]. 9 See PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 26789 otherwise could be a non-conforming prospectus in violation of section 5 of the Securities Act.13 Although the Commission has previously requested comment as to whether to extend rule 139 to cover investment company research reports,14 the rule’s safe harbor currently is not available for a brokerdealer’s publication or distribution of research reports pertaining to specific registered investment companies or business development companies.15 B. FAIR Act The FAIR Act directs us to propose and adopt rule amendments that would extend the current safe harbor available under rule 139 to a ‘‘covered investment fund research report.’’ 16 The FAIR Act also directs that these amendments shall be ‘‘upon such terms, conditions, or requirements as the Commission may determine necessary or appropriate in the public interest, for the protection of 13 Sections 5(a) and 5(c) of the Securities Act generally prohibit any person (including brokerdealers) from using the mails or interstate commerce as a means to sell or offer to sell, either directly or indirectly, any security unless a registration statement is in effect or has been filed with the Commission as to the offer and sale of such security, or an exemption from the registration provisions applies. See 15 U.S.C. 77e(a) and (c). Section 5(b)(1) of the Securities Act requires that any ‘‘prospectus’’ relating to a security to which a registration statement has been filed must comply with the requirements of section 10 of the Securities Act. See 15 U.S.C. 77e(b)(1). Section 5(b)(2) of the Securities Act requires that any sale of securities (or delivery after sale) must be accompanied or preceded by a prospectus meeting the requirements of section 10(a) of the Securities Act. See 15 U.S.C. 77e(b)(2). 14 See Securities Offering Reform, Securities Act Release No. 8501 (Nov. 3, 2004) [69 FR 67391 (Nov. 17, 2004)] (‘‘Securities Offering Reform Proposing Release’’). 15 For example, rule 139 is available for research reports regarding issuers that meet the registrant requirements for securities offerings on Form S–3 or Form F–3. See rule 139(a)(1)(i)(A)(1). To the extent that commodity- or currency-based trusts or funds (as defined in section I.B below) register their securities offering pursuant to the Securities Act and meet the eligibility requirements of Form S–3 or F–3, as well as the other conditions of rule 139, the rule 139 safe harbor would be currently available for a broker-dealer’s publication or distribution of research reports pertaining to these issuers. However, covered investment funds that are registered investment companies and business development companies are not able to register their securities offerings on Form S–3 or Form F– 3. Registered investment companies register their securities offerings on forms such as Forms N–1A, N–2, N–3, N–4, and N–6. Publicly-traded business development companies register their securities offerings on Form N–2. However, section 2(a)(3) of the Securities Act provides a safe harbor for brokerdealers with respect to research reports about ‘‘emerging growth companies,’’ as defined in section 2(a)(19) of the Securities Act. Broker-dealers may therefore currently rely on the section (2)(a)(3) safe harbor with respect to research reports about business development companies that are emerging growth companies. 16 See section 2(a) of the FAIR Act. E:\FR\FM\08JNP3.SGM 08JNP3 26790 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules investors, and for the promotion of capital formation.’’ 17 Under the FAIR Act, a ‘‘covered investment fund research report’’ is generally a research report published or distributed by a broker-dealer about a covered investment fund or any of the covered investment fund’s securities.18 The term ‘‘covered investment fund’’ under the FAIR Act includes registered investment companies and business development companies.19 The term also includes other persons issuing securities in an offering registered under the Securities Act (i) whose securities are listed for trading on a national securities exchange, (ii) whose assets consist primarily of commodities, currencies, or derivative instruments that reference commodities or currencies or interests in the foregoing, and (iii) whose registration statement reflects that its securities are purchased or redeemed, subject to certain conditions or limitations, for a ratable share of its assets (such exchange-listed funds or trusts, ‘‘commodity- or currency-based trusts or funds’’).20 However, a ‘‘covered investment fund research report’’ excludes research reports published or distributed by the covered investment fund itself, any affiliate of the covered investment fund, or any broker-dealer that is an investment adviser (or an affiliated person of the investment adviser) to the covered investment fund.21 17 See id. id. at section 2(f)(3). But see infra note 21 and accompanying text (noting that the definition of ‘‘covered investment fund research report’’ excludes research reports published or distributed by the covered investment fund or any affiliate of the covered investment fund, or any research report published or distributed by any broker or dealer that is an investment adviser (or an affiliated person of an investment adviser) for the covered investment fund). 19 See id. at section 2(f)(2)(A). 20 See id. at section 2(f)(2)(B). 21 The FAIR Act definition of ‘‘covered investment fund research report’’ uses the term ‘‘affiliate’’ in connection with a covered investment fund and ‘‘affiliated person’’ in connection with an investment adviser. See section 2(f)(3) of the FAIR Act. The FAIR Act includes a definition for the term ‘‘affiliated person,’’ but not ‘‘affiliate.’’ Because the FAIR Act directs the Commission to revise rule 139 under the Securities Act, we interpret the reference to the term ‘‘affiliate’’ in the definition of ‘‘covered investment fund research report’’ to refer to the term ‘‘affiliate’’ as it would be interpreted under rule 139, which we believe is by reference to rule 405 under the Securities Act. (We believe this to be the case because, for example, rule 139 is available for research reports regarding issuers that register their securities on Form S–3 or F–3 (or that meet the registrant requirements to register their securities offerings on Form S–3 or Form F–3) and that meet the minimum float provisions of General Instruction I.B.1 of such forms. See rule 139(a)(1)(i)(A)(1)(i). General Instruction I.B.1, in turn, refers to the definition of ‘‘affiliate’’ in amozie on DSK3GDR082PROD with PROPOSALS3 18 See VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 The FAIR Act directs us to address the application of certain aspects of current rule 139 to covered investment fund research reports. For example, one of the conditions for using the rule 139 safe harbor for research reports about a specific issuer is that the broker-dealer’s publication or distribution of the research report must ‘‘not represent the initiation of publication of research reports about such issuer or its securities or reinitiation of such publication following discontinuation of publication of such research reports.’’ 22 Because many covered investment funds continuously offer their shares for sale (as opposed to engaging in an offering over a discrete period of time), it is difficult for a broker-dealer participating in such a continuous offering to satisfy this condition. In light of this, the FAIR Act prescribes that our extension of the rule 139 safe harbor, with respect to research reports in an offering of covered investment funds that are in ‘‘substantially continuous distribution,’’ cannot be conditioned on whether the broker-dealer’s publication or distribution of such research reports constitutes initiation or reinitiation of research about the covered investment fund or its securities.23 The FAIR Act also permits us to impose conditions on covered investment fund research reports that are similar to the conditions imposed under rule 139.24 We may set a minimum public float requirement for covered investment funds but may not require a minimum public float that is greater than what is required under rule Securities Act rule 405.) Under rule 405, the term ‘‘affiliate’’ means an affiliate of, or person affiliated with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified. See rule 405 under the Securities Act [17 CFR 230.405]. The FAIR Act defines ‘‘affiliated person’’ as having the meaning given the term in section 2(a) of the Investment Company Act. See section 2(f)(1) of the FAIR Act. Section 2(a) of the Investment Company Act defines an ‘‘affiliated person’’ as: (A) Any person directly or indirectly owning, controlling, or holding with power to vote, five per centum or more of the outstanding voting securities of such other person; (B) any person five per centum or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote, by such other person; (C) any person directly or indirectly controlling, controlled by, or under common control with, such other person; (D) any officer, director, partner, copartner, or employee of such other person; (E) if such other person is an investment company, any investment adviser thereof or any member of an advisory board thereof; and (F) if such other person is an unincorporated investment company not having a board of directors, the depositor thereof. 22 See rule 139(a)(1)(iii) [17 CFR 230.139(a)(1)(iii)]. 23 See section 2(b)(1) of the FAIR Act. 24 See infra notes 25–27. PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 139 (currently, $75 million).25 Similarly, we may set a reporting history requirement for covered investment funds, but may not require a reporting history period for longer than what is required under rule 139 (currently, the 12 months preceding the time of the broker-dealer’s first reliance on the rule 139 safe harbor).26 Moreover, as noted above, we may impose additional conditions that we determine to be necessary or appropriate in the public interest, for the protection of investors, and for the promotion of capital formation.27 Finally, the FAIR Act includes provisions concerning the ability of SROs to impose requirements on the use and filing of covered investment fund research reports.28 First, the FAIR Act directs us to provide that covered investment fund research reports will not be subject to section 24(b) of the Investment Company Act and the rules and regulations thereunder,29 except to the extent that such reports are otherwise not subject to the content standards in the rules of any SRO related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards.30 The FAIR Act also requires us to provide that SROs: (i) Cannot prohibit the ability of a broker-dealer to publish or distribute a covered investment fund 25 See section 2(b)(2)(B) of the FAIR Act. at section 2(b)(2)(A). 27 See supra note 17 and accompanying text. 28 See sections 2(b)(3)–(4), 2(c)(2) of the FAIR Act; see also discussion at text accompanying notes 29– 31 infra. 29 Section 24(b) of the Investment Company Act makes it unlawful for any registered open-end company (or any registered unit investment trust, any registered face-amount certificate company, or any underwriter of any of the preceding companies), in connection with a public offering of any security of which such company is an issuer, to transmit, among other things, sales literature addressed to or intended for distribution to prospective investors unless the sales literature is filed with the Commission. See 15 U.S.C. 80a–24(b). Rule 24b–3 under the Investment Company Act deems these materials to have been filed with the Commission if filed with FINRA. See 17 CFR 270.24b–3. 30 See section 2(b)(4) of the FAIR Act. However, the FAIR Act also includes a provision clarifying that the Act will not be construed as limiting an SRO’s authority to require the filing of communications with the public ‘‘the purpose of which is not to provide research and analysis of covered investment funds.’’ See section 2(c)(2) of the FAIR Act. In addition, the FAIR Act provides that the Act does not limit SROs’ authority to examine or supervise a member’s practices in connection with its publication or distribution of covered investment fund research reports for compliance with applicable provisions of the federal securities laws and SRO rules related to research reports, including rules governing communications with the public. See section 2(c)(2) of the FAIR Act. 26 Id. E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules research report solely because the broker-dealer is participating in a registered offering or other distribution of any securities of the covered investment fund; and (ii) cannot prohibit the ability of a broker-dealer to participate in a registered offering or other distribution of securities of the covered investment fund solely because the broker-dealer has published or distributed a research report about that covered investment fund or its securities.31 amozie on DSK3GDR082PROD with PROPOSALS3 II. Discussion In the sections that follow, we discuss in detail the scope and conditions of proposed rule 139b, the operation and effect of proposed rule 24b–4,32 and the proposed conforming amendment to rule 101 of Regulation M. Proposed rule 139b’s framework is modeled after and generally tracks rule 139. However, proposed rule 139b differs from rule 139 in certain respects. Some of these differences are specifically directed or contemplated by the FAIR Act.33 Other differences, while not specifically directed by the FAIR Act, clarify and tailor the provisions of rule 139 more directly or specifically to the context of broker-dealers’ publication or distribution of covered investment fund research reports.34 For the reasons described below, we believe that the provisions of proposed rule 139b that differ from the provisions of rule 139, and that are not specifically contemplated in the FAIR Act, are necessary or appropriate in the public interest, for the protection of investors, and for the promotion of capital formation. A. Scope of Proposed Rule 139b Proposed rule 139b would establish a safe harbor for the publication or distribution of ‘‘covered investment fund research reports’’ by unaffiliated broker-dealers (as described below) participating in a securities offering of a ‘‘covered investment fund.’’ Under the safe harbor, such publication or distribution would be deemed not to constitute an offer for sale or offer to sell the covered investment fund’s securities for purposes of sections 2(a)(10) and 5(c) of the Securities Act. The safe harbor would be available even if the brokerdealer is participating or may participate in a registered offering of the covered investment fund’s securities. 31 See section 2(b)(3) of the FAIR Act. discussion appears in section II.D infra. 33 See, e.g., infra section II.A.1 (discussing the ‘‘affiliate exclusion’’ (defined below)). 34 See, e.g., infra section II.B.1.a (discussing reporting history and timeliness requirements for issuer-specific reports). 32 This VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 We are proposing to define the term ‘‘covered investment fund research report,’’ as well as the ‘‘covered investment fund’’ and ‘‘research report’’ components of this definition. 1. Definition of ‘‘Covered Investment Fund Research Report’’ Under the FAIR Act, the term ‘‘covered investment fund research report’’ means a research report published or distributed by a broker or dealer about a covered investment fund or any securities issued by the covered investment fund, but does not include a research report to the extent that the research report is published or distributed by the covered investment fund or any affiliate of the covered investment fund, or any research report published or distributed by any broker or dealer that is an investment adviser (or an affiliated person of an investment adviser) for the covered investment fund (the ‘‘affiliate exclusion’’).35 Proposed rule 139b incorporates the same definition as is set forth in the FAIR Act.36 The FAIR Act’s affiliate exclusion prohibits two separate categories of research reports from being deemed to be ‘‘covered investment fund research reports’’ that a broker-dealer may publish or distribute under the contemplated safe harbor. The first category covers research reports published or distributed by the covered investment fund or any affiliate of the covered investment fund. We believe this exclusion would prevent such persons from indirectly using the safe harbor to avoid the applicability of the Securities Act prospectus requirements and other provisions applicable to written offers by such persons. The second category covers research reports published or distributed by any broker or dealer that is an investment adviser (or an affiliated person of an investment adviser) for the covered investment fund. This second exclusion addresses the concern that a brokerdealer that is a fund’s adviser or an affiliated person of a fund’s adviser may have financial incentives that could give rise to a conflict of interest. For example, a broker-dealer that is an affiliated person of a fund’s adviser may have an incentive to promote the covered investment fund’s securities relative to other securities because sales 35 See section 2(f)(3) of the FAIR Act. proposed rule 139b(c)(3); see also supra note 21 (discussing the terms ‘‘affiliate’’ and ‘‘affiliated person’’ in the FAIR Act definition of ‘‘covered investment fund research report’’); proposed rule 139b(c)(5) (defining the term ‘‘investment adviser’’ for purposes of the proposed rule). 36 See PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 26791 of the covered investment fund’s securities would benefit not only the fund, but also could benefit the brokerdealer.37 This second exclusion therefore helps to establish a certain level of independence in the activity of publishing and distributing covered investment fund research reports and therefore could help mitigate these potential conflicts of interest. We believe that it would be inappropriate for any person covered by the affiliate exclusion, or for any person acting on its behalf, to publish or distribute a research report indirectly that the person could not publish or distribute directly under the proposed rule.38 For example, if a broker-dealer were to publish or distribute a research report that included materials that were specifically authorized or approved by a person covered by the affiliate exclusion, expressly for the purpose of inclusion in a research report, this could inappropriately circumvent the affiliate exclusion in proposed rule 139b. In this case, the person covered by the affiliate exclusion would be publishing or distributing communications indirectly through the third-party broker-dealer that otherwise would have to be included in a statutory prospectus meeting the requirements of section 10 of the Securities Act. One of the factors to consider in evaluating whether a research report has been published or 37 We note that broker-dealers may have incentives to recommend certain covered investment funds to clients even when the brokerdealer is not the fund’s investment adviser (or an affiliated person of the investment adviser). For example, when a covered investment fund’s investment adviser has entered into revenue sharing arrangements with a broker-dealer, the brokerdealer may have incentives to recommend to its clients the purchase of this fund’s securities relative to the securities of other covered investment funds (whose investment advisers have not entered into revenue sharing agreements with the broker-dealer). We also note that certain covered investment fund research reports also may be subject to additional rules and regulations under the federal securities laws, as well as certain SRO rules, that are designed to help address certain conflicts of interest and abuses identified with analyst research. See, e.g., Sarbanes-Oxley Act of 2002, Public Law 107–204, 116 Stat. 745 (2002) (‘‘Sarbanes-Oxley Act’’), Regulation AC, and FINRA rules 2210, 2241, 2242. The Sarbanes-Oxley Act, Regulation AC, and a global research analyst settlement required structural changes and increased disclosures in connection with certain abuses identified with analyst research. See section 501 of the SarbanesOxley Act; Regulation Analyst Certification, Securities Act Release No. 8193 (Feb. 20, 2003) [68 FR 9481 (Feb. 27, 2003)] (‘‘Regulation AC Adopting Release’’); Global Research Analyst Settlement, Litigation Release No. 18438 (Oct. 31, 2003) (‘‘Lit. Rel. No. 18438’’); 2010 Modifications to Global Research Analyst Settlement, Litigation Release No. 21457 (Mar. 19, 2010) (‘‘Lit. Rel. No. 21457’’). 38 See, e.g., section 48(a) of the Investment Company Act [15 U.S.C. 80a–47(a)]; section 208(d) of the Investment Advisers Act of 1940 [15 U.S.C. 80b–8(d)]. E:\FR\FM\08JNP3.SGM 08JNP3 26792 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules distributed by a person covered by the affiliate exclusion is the extent of such person’s involvement in the preparation, distribution, or publication of the research report.39 We request comment on the proposed definition of ‘‘covered investment fund research report.’’ • Should we define ‘‘covered investment fund research report’’ as specified in the FAIR Act, as proposed? Why or why not? What modifications, if any, to this definition do commenters recommend? Solely for purposes of the proposed affiliate exclusion, should we use a definition of ‘‘affiliate’’ that differs from the definition of this term in rule 405 under the Securities Act? If so, should we interpret the term ‘‘affiliate’’ in this context to mean an ‘‘affiliated person’’ as defined in the Investment Company Act? If not, what other definition should we use? • Should we include a provision in rule 139b specifying that the affiliate exclusion would make the safe harbor unavailable if a broker-dealer were to publish or distribute a research report that includes materials that were specifically authorized or approved by a person covered by the affiliate exclusion (or a person acting on its behalf) for purposes of inclusion in a research report? Why or why not? If not, is the guidance discussed above on this point 40 appropriate and helpful to the public in understanding the proposed affiliate exclusion? Is there any other guidance that we should provide that would be helpful to promote clarity with respect to the proposed affiliate exclusion? • Broker-dealers may have incentives—in particular, arising from the compensation arrangements between registered investment companies and their distributing broker- amozie on DSK3GDR082PROD with PROPOSALS3 39 Such determinations would necessarily be based on the extent to which a person covered by the affiliate exclusion, or any person acting on its behalf, has been involved in the preparation of the information or explicitly or implicitly endorsed or approved the information. The Commission has referred to these as the entanglement theory and the adoption theory, respectively, and these are helpful guideposts in establishing whether a research report about a covered investment fund may be deemed published or distributed by the fund. See Securities Offering Reform, Securities Act Release No. 8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)] (‘‘Securities Offering Reform Adopting Release’’) (noting that ‘‘[l]iability under the entanglement theory depends upon the level of pre-publication involvement in the preparation of the information’’). See Use of Electronic Media, Securities Act Release No. 7856 (Apr. 28, 2000) [65 FR 25843 (May 4, 2000)] (interpretive release on the use of electronic media); Asset-Backed Securities, Securities Act Release No. 8518 (Dec. 22, 2004) [70 FR 1506 (Jan. 5, 2005)] (adopting asset-backed securities regulations). 40 See supra paragraph accompanying notes 38– 39. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 dealers—to recommend certain covered investment funds to clients even when the broker-dealer is not the fund’s investment adviser (or an affiliated person of the investment adviser).41 While certain covered investment fund research reports may be subject to additional rules and regulations under the federal securities laws, as well as certain SRO rules, that are designed to help address certain conflicts of interest,42 these additional rules and regulations would not necessarily be applicable with respect to all covered investment fund research reports under proposed rule 139b.43 Moreover, while these rules and regulations address conflicts of interest, certain of the conflicts they address may not be prevalent in the investment company context (e.g., FINRA rules 2241 and 2242 address, among other things, investment-banking-related conflicts). Are we correct that there are conflicts of interest that could arise with respect to broker-dealers’ publication or distribution of covered investment fund research reports (in particular, research reports about registered investment company issuers) that would not be mitigated by proposed rule 139b’s exclusion of research reports published or distributed by a broker-dealer that is an investment adviser for the covered investment fund (or an affiliated person of the adviser)? If not, why not? If so, how should we address these conflicts? Should we add restrictions or conditions to the safe harbor to further mitigate potential conflicts? If so, what types of additional restrictions or conditions would be appropriate? For example, should we require a brokerdealer to describe in a research report the revenue-sharing or other distribution arrangements it has with a covered investment fund as a condition to relying on the proposed safe harbor? Should the existence of a revenuesharing agreement or other particular type of distribution arrangement disqualify a broker-dealer from being able to publish or distribute a research report about a covered investment fund 41 See supra note 37 and accompanying text; see also infra paragraphs accompanying notes 262–269. 42 See id. 43 For example, as discussed above, there are differences in how the FAIR Act and proposed rule 139b, and other rules and regulations, define the term ‘‘research report,’’ and therefore the scope of other rules and regulations that govern brokerdealers’ publication and distribution of research reports does not correspond in every respect to the scope of proposed rule 139b. See infra section II.A.2 (discussing the definition of ‘‘research report’’ in proposed rule 139b); see supra note 11 (discussing the differences in the definition of ‘‘research report’’ in Regulation AC and FINRA rules 2241 and 2242). PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 in reliance on the proposed safe harbor? If so, what types and why? • Alternatively, should we require broker-dealers that rely on proposed rule 139b to maintain policies and procedures designed to mitigate conflicts that are raised by the distribution of covered investment funds (in particular, covered investment funds that are registered investment companies) and not addressed by the Commission’s rules or SRO rules (such as FINRA rules 2241 and 2242)? To the extent that Commission and SRO rules do not require disclosure of conflicts of interest in covered investment fund research reports, should we require broker-dealers that rely on the proposed rule 139b safe harbor to disclose conflicts of interest in a salient way in covered investment fund research reports? If so, what should the content and format requirements be with respect to such disclosure? 2. Definition of ‘‘Research Report’’ We are proposing to define the term ‘‘research report’’ in rule 139b as a written communication, as defined in rule 405 under the Securities Act, that includes information, opinions, or recommendations with respect to securities of an issuer or an analysis of a security or an issuer, whether or not it provides information reasonably sufficient upon which to base an investment decision.44 This definition is identical to the corresponding definition of ‘‘research report’’ in rule 139.45 We are not proposing to include a definition of ‘‘research report’’ in rule 139b that is identical to that in the FAIR Act for two reasons, discussed in more detail below. First, we believe that the definition we propose is consistent with the FAIR Act, because we would interpret it to have 44 See proposed rule 139b(c)(6). Rule 405 defines ‘‘written communication’’ to mean that ‘‘[e]xcept as otherwise specifically provided or the context otherwise requires, a written communication is any communication that is written, printed, a radio or television broadcast, or a graphic communication as defined in [rule 405].’’ 17 CFR 230.405. 45 See rule 139(d) [17 CFR 230.139(d)]. Rule 139 defines ‘‘research report’’ to mean ‘‘a written communication, as defined in Rule 405, that includes information, opinions, or recommendations with respect to securities of an issuer or an analysis of a security or an issuer, whether or not it provides information reasonably sufficient upon which to base an investment decision.’’ See rule 139(d) [17 CFR 230.139(d)]. A ‘‘written communication,’’ as defined in rule 405, includes a ‘‘graphic communication.’’ As further defined in rule 405, a ‘‘graphic communication’’ includes all forms of electronic media, including electronic communications except those, which at the time of the communication, originate in realtime to a live audience and does not originate in recorded form or otherwise as a graphic communication, although it is transmitted through graphic means. See rule 405 [17 CFR 230.405]. E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules the same meaning as the definition of ‘‘research report’’ in the FAIR Act.46 Second, we believe that proposing a definition of ‘‘research report’’ in rule 139b that is identical to the existing definition of ‘‘research report’’ in rule 139 would reduce potential interpretive confusion for market participants who are familiar with the rule 139 definition. The FAIR Act defines the term ‘‘research report’’ as having the meaning given to that term under section 2(a)(3) of the Securities Act but specifies that the term ‘‘shall not include an oral communication.’’ 47 Section 2(a)(3) of the Securities Act, in turn, defines ‘‘research report’’ to mean ‘‘a written, electronic, or oral communication that includes information, opinions, or recommendations with respect to securities of an issuer or an analysis of a security or an issuer, whether or not it provides information reasonably sufficient upon which to base an investment decision.’’ 48 The proposed rule 139b definition of ‘‘research report’’ tracks the FAIR Act definition of ‘‘research report,’’ except that while it does include ‘‘electronic communications,’’ it does not expressly reference that term. For the following reasons, we believe that this difference would have no effect on the types of communications that would qualify as research reports under the proposed safe harbor. Current Commission rules make clear that all electronic communications (other than telephone and other live communications) are graphic and, therefore, written communications for purposes of the Securities Act.49 Therefore, the proposed rule 139b definition’s reference to a ‘‘written communication,’’ as defined in rule 405, would include a ‘‘graphic communication,’’ which in turn would include electronic communications (other than telephone and other live communications).50 46 See infra notes 49–50 and accompanying text. section 2(f)(6) of the FAIR Act. 48 15 U.S.C. 77b(a)(3). 49 See Securities Offering Reform Adopting Release, supra note 39, at nn.96–97 and accompanying text; infra note 50. Among other things, the Securities Offering Reform Adopting Release amended the definition of ‘‘research report’’ in rule 139 to make clear that it continues to apply to information, opinions, or recommendations contained in written communications. See id., at text following n.363. As the Commission noted in the Securities Offering Reform Adopting Release, the intention of addressing electronic communications under the Securities Act is ‘‘to encompass new technologies . . . [and] promote consistent understanding of what constitutes such a communication in view of the technological developments.’’ See Securities Offering Reform Adopting Release, supra note 39, at 44732. 50 See supra note 45 (discussing the current definition of ‘‘research report’’ in rule 139, which amozie on DSK3GDR082PROD with PROPOSALS3 47 See VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 By using the same definition of ‘‘research report’’ in rule 139 and proposed rule 139b we avoid creating ambiguity that may result if market participants are unable to understand, based on the text of the rules, that the term ‘‘research report,’’ though defined in two different ways, would be interpreted identically. We request comment on the proposed definition of ‘‘research report.’’ • Should we use the definition of ‘‘research report’’ in rule 139 as we have proposed rather than as specified in the FAIR Act? Is our proposed approach appropriate? Is defining ‘‘research report’’ as proposed consistent with section 2(f)(6) of the FAIR Act? Would the proposed definition of ‘‘research report’’ have the intended result of assuring that the definitions of ‘‘research report’’ under the FAIR Act and rule 139b would be interpreted identically? Why or why not? • Instead of using the rule 139 definition of ‘‘research report,’’ as proposed, would it be preferable for the Commission to incorporate the FAIR Act definition of ‘‘research report’’ into proposed rule 139b? If so, why? • What, if any, additional modifications to the proposed definition of ‘‘research report’’ would promote clarity? Should we incorporate any additional modifications to the proposed definition for any other purpose? 3. Definition of ‘‘Covered Investment Fund’’ The FAIR Act defines the term ‘‘covered investment fund’’ to include registered investment companies, business development companies, and certain commodity- or currency-based trusts or funds.51 We are proposing to define the term ‘‘covered investment fund’’ in rule 139b in substantially the same manner as the FAIR Act, with the addition that we propose to specify in this definition that the term ‘‘investment company’’ includes ‘‘a series or class thereof.’’ 52 references a ‘‘written communication’’ as defined in rule 405, which definition in turn incorporates the term ‘‘graphic communication’’). 51 See supra notes 19–20 and accompanying text. Based on the definition in section 2(f)(2) of the FAIR Act, the term ‘‘covered investment fund’’ would not include an investment company that is registered solely under the Investment Company Act, such as certain master funds in a master-feeder structure. See id. 52 See proposed rule 139b(c)(2). This approach reflects the approach taken in other Commission rules that define the term ‘‘fund’’ to include a separate series of an investment company. See, e.g., rule 22e–4(a)(4) under the Investment Company Act [17 CFR 270.22e–4(a)(4)]; rule 22c–1(a)(3)(v)(A) under the Investment Company Act [17 CFR 270.22c–1(a)(3)(v)(A)] (effective Nov. 19, 2018). PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 26793 We request comment on the proposed definition of ‘‘covered investment fund.’’ • Should we define ‘‘covered investment fund’’ substantially the same as this term is defined in the FAIR Act as proposed? Why or why not? Should we specify in the definition, as proposed, that the term ‘‘investment company’’ includes a ‘‘series or class thereof’’? What modifications, if any, to this definition do commenters recommend? • Are there any types of funds, trusts, or other pooled investment vehicles that would not be included within the proposed definition of ‘‘covered investment fund’’ that we should consider including in the definition? If so, why? 4. Non-Exclusivity of Safe Harbor Broker-dealers publishing or distributing research reports for some covered investment funds, such as commodity- or currency-based trusts or funds that have a class of securities registered under the Exchange Act, may be able to rely on existing rule 139.53 We do not intend for proposed rule 139b to preclude a broker-dealer from relying on existing rule 139 where appropriate. In order to clarify that a broker-dealer may rely on existing research safe harbors, proposed rule 139b provides that the rule does not affect the availability of any other exemption or exclusion from sections 2(a)(10) or 5(c) of the Securities Act that may be available to a broker-dealer.54 A broker-dealer therefore would be able to rely on proposed rule 139b to publish or distribute a covered investment fund research report or could choose to rely instead on any other available exemption or exclusion from sections 2(a)(10) or 5(c) of the Securities Act, 53 Section 803(b)(2)(F) of the Small Business Credit Availability Act, which was enacted on March 23, 2018 as sections 801–803 of the 2018 Consolidated Appropriations Act, directs the Commission to amend rules 138 and 139 to specifically include a business development company as an issuer to which those rules apply. Section 803(b) of the Small Business Credit Availability Act directs the Commission to make these revisions to rules 138 and 139, as well as the other rule revisions that section 803(b)(2) of the Act describes, within one year of enactment, and these revisions would be addressed in a Commission action that is separate from the proposal that this release describes. 54 See proposed rule 139b(a) (providing, in part, that the rule does not affect the availability of any other exemption or exclusion from sections 2(a)(10) or 5(c) of the Act available to the broker or dealer); see also proposed addition to rule 139(a) (for purposes of the Fair Access to Investment Research Act of 2017 [Pub. L. 115–66, 131 Stat. 1196 (2017)], a safe harbor has been established for covered investment fund research reports, and the specific terms of that safe harbor are set forth in Rule 139b (§ 230.139b)). E:\FR\FM\08JNP3.SGM 08JNP3 26794 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules including those provided by rules 137,55 138, and 139, as applicable. We request comment on the nonexclusivity provision in proposed rule 139b. • Should other exemptions, exclusions, or safe harbors from sections 2(a)(10) or 5(c) of the Securities Act for research reports, such as rules 137, 138, or 139, continue to be available to broker-dealers as proposed? Why or why not? Should we make any additional clarifications? If so, what clarifications should we make? B. Conditions for the Safe Harbor The Commission has previously acknowledged the value of research reports in providing the market and investors with information about reporting issuers.56 To mitigate the risk of research reports being used to circumvent the prospectus requirements of the Securities Act,57 the Commission has placed conditions on a brokerdealer’s publication or distribution of research reports.58 Under rule 139, these conditions include restrictions on who may rely on the rule and on the issuers to which the research may relate, as well as a requirement that such reports be published in the regular course of a broker-dealer’s business. These conditions vary depending on whether a research report covers a specific issuer (‘‘issuer-specific research reports’’) or a substantial number of issuers in an 55 17 CFR 230.137. Securities Offering Reform Adopting Release, supra note 39. For example, the Commission has recognized that, for companies that are well-followed, the research-report-related rules ‘‘enhance the efficiency of the markets by allowing a greater number of research reports to provide a continuous flow of essential corporate information into the marketplace.’’ See Research Reports, Securities Act Release No. 6550 (Sept. 19, 1984) [49 FR 37569 (Sept. 25, 1984)] (‘‘1984 Adopting Release’’). 57 See supra note 13 and accompanying text (noting that the rule 139 safe harbor permits a broker-dealer to publish or distribute a research report without this publication or distribution being deemed to constitute an offer that otherwise could be a non-conforming prospectus in violation of section 5 of the Securities Act). See, also, e.g., Securities Offering Reform Adopting Release, supra note 39 (discussing how the Sarbanes-Oxley Act, Regulation AC, and a global research analyst settlement required structural changes and increased disclosures in the early 2000s in connection with certain abuses identified with analyst research); discussion at supra note 37 (discussing certain rules and regulations under the federal securities laws, as well as certain SRO rules, that are designed to help address certain conflicts of interest and abuses identified with analyst research). 58 Many research reports that broker-dealers publish or distribute in reliance on the rule 139 safe harbor may also be subject to other federal securities rules and regulations under the Exchange Act and SRO rules governing their content and use. See supra note 57. amozie on DSK3GDR082PROD with PROPOSALS3 56 See VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 industry or sub–industry (‘‘industry research reports’’). Consistent with the FAIR Act’s directive to revise rule 139 to extend the rule’s safe harbor to covered investment fund research reports, proposed rule 139b seeks to address concerns that could accompany broker-dealers’ publication or distribution of these research reports. Rule 139b proposes conditions for both issuer-specific reports and industry research reports that must be satisfied in order for a broker-dealer to rely on the safe harbor.59 The conditions are intended to track the conditions already in place under rule 139 to the extent practicable. We believe that any deviations from the requirements of rule 139 are consistent with the FAIR Act’s directives.60 Tracking the requirements in rule 139 to the extent practicable also provides efficiencies for broker-dealers familiar with the requirements of rule 139. 1. Issuer-Specific Research Reports a. Reporting History and Timeliness Requirements In order for a broker-dealer to include a covered investment fund in a research report published or distributed in reliance on the proposed safe harbor, we propose that the fund must meet certain reporting history requirements. Specifically, we are proposing that any such covered investment fund must have been subject to relevant requirements under the Investment Company Act and/or the Exchange Act to file certain periodic reports for at least 12 calendar months prior to a broker-dealer’s reliance on proposed rule 139b.61 We also are proposing that any such covered investment fund must have filed certain periodic reports in a timely manner during the immediately preceding 12 calendar months. 59 Proposed 60 See rule 139b(a)(1)–(2). supra paragraph accompanying notes 32– 34. 61 Proposed rule 139b(a)(1)(i)(A). We believe that this proposed condition also gives effect to FAIR Act section 2(e), which makes the safe harbor contemplated by the FAIR Act unavailable with respect to broker-dealers’ publication or distribution of research reports about closed-end registered investment companies or business development companies during these covered investment fund issuers’ first year of operation. See section 2(e) of the FAIR Act (The safe harbor under subsection (a) of the FAIR Act shall not apply to the publication or distribution by a broker or a dealer of a covered investment fund research report, the subject of which is a business development company or a registered closed-end investment company, during the time period described in 17 CFR 230.139(a)(1)(i)(A)(1), except where expressly permitted by the rules and regulations of the Securities and Exchange Commission under the Federal securities laws.); see also infra note 74 and accompanying text (discussing rule 139(a)(1)(i)(A)(1)). PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 Specifically, covered investment funds that are registered investment companies would need to have been subject to the reporting requirements of the Investment Company Act for a period of at least 12 calendar months prior to reliance on the proposed rule and to have filed in a timely manner all required reports, as applicable, on Forms N–CSR,62 N–SAR,63 N–Q,64 N– PORT,65 N–MFP,66 and N–CEN 67 during the immediately preceding 12 months.68 If the covered investment fund is not a registered investment company, it would need to have been subject to the reporting requirements under section 13 or 15(d) of the Exchange Act for a period of at least 12 calendar months and to have filed all required reports in a timely manner on Forms 10–K 69 and 10–Q 70 and 20–F 71 during the immediately preceding 12 months.72 The proposed reporting history requirements are consistent with current rule 139.73 The timeliness 62 17 CFR 249.331 and 17 CFR 274.128. CFR 249.330 and 17 CFR 274.101. CFR 249.332 and 17 CFR 274.130. 65 17 CFR 274.150. Form N–PORT will be filed with the Commission on a monthly basis, but only information reported for the third month of each fund’s fiscal quarter on Form N–PORT will be publicly available (and not until 60 days after the end of the fiscal quarter). See Investment Company Reporting Modernization, Investment Company Act Release No. 32314 (Oct. 13, 2016) [81 FR 81870 (Nov. 18, 2016)] (‘‘Reporting Modernization Release’’). Therefore, we would consider Form N– PORT to have been timely filed for purposes of the proposed timeliness requirement if the public filing of Form N–PORT every third month is timely filed. 66 17 CFR 274.201. 67 17 CFR 249.330 and 17 CFR 274.101. 68 Proposed rule 139b(a)(1)(i)(A)(1). Form N–SAR will be rescinded on June 1, 2018, which is the compliance date for Form N–CEN. Form N–Q will be rescinded May 1, 2020. Larger fund groups will begin submitting reports on Form N–PORT by April 30, 2019, and smaller fund groups by April 30, 2020. See Reporting Modernization Release, supra note 65; Investment Company Reporting Modernization, Investment Company Act Release No. 32936 (Dec. 8, 2017) [82 FR 58731 (Dec. 14, 2017)]. At the time of these compliance dates, covered investment funds would no longer be required to file reports N–SAR and N–Q, and filing these reports would not be required as a condition to rely on the rule 139b safe harbor. Accordingly, we propose that rule 139b, if adopted, would be amended effective May 1, 2020 by removing the reference to Form N–Q. See infra section VII (instruction 4 under Text of Proposed Rules and Amendments). 69 17 CFR 249.310. 70 17 CFR 249.308a. 71 17 CFR 249.220f. 72 Proposed rule 139b(a)(1)(i)(A)(2). 73 Rule 139(a)(1)(i)(A)(2) [17 CFR 230.139(a)(1)(i)(A)(2)] (As of the date of reliance on the section, has filed all periodic reports required during the preceding 12 months on Forms 10–K (§ 249.310), 10–Q (§ 249.308a), and 20–F (§ 249.220f) pursuant to section 13 or section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)).). In addition, the reporting history requirement is also a consequence of rule 139(a)(1)(i)(A)(1), which requires that an issuer 63 17 64 17 E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 component of the proposed requirement also tracks rule 139.74 As the Commission has previously recognized in the context of Form S–3 and F–3 issuers, satisfaction of the applicable reporting history and public float requirements suggests the presence of a sufficiently broad market following for the issuer’s securities and, consequently, an adequate mix of information to inform investors as to material risks.75 Consistent with this view, we believe the proposed reporting history and timely reporting requirements would facilitate investors’ analysis of issuer-specific covered investment fund research reports and aid them in making informed investment decisions.76 The Commission believes that it is appropriate to require a 12-month reporting history for covered investment fund issuers that may be included in issuer-specific research reports, rather than a shorter duration.77 As under rule included in an issuer-specific research report (other than a foreign private issuer) either must have filed a registration statement on Form S–3 or Form F–3, or met the registrant requirements of Form S–3 or Form F–3, as eligibility to register on these forms incorporates a reporting history requirement. Rule 139(a)(1)(i)(A)(1) and (a)(1)(i)(B)(1) [17 CFR 230.139(a)(1)(i)(A)(1) and (a)(1)(i)(B)(1)]. In order to be eligible for registration on Form S–3 or Form F– 3, the registrant must have been subject to the requirements of section 12 or 15(d) of the Exchange Act and have filed all materials required to be filed pursuant to section 13, 14 or 15(d) for a period of at least 12 calendar months immediately preceding the filing of the Form S–3 or Form F–3. See General Instruction I.A.3(a) to Form S–3 and General Instruction I.A.2 to Form F–3. 74 The timely reporting component in rule 139 is a consequence of the rule 139 requirement that issuers be eligible to register on Form S–3 or Form F–3. See supra note 73 (discussing rule 139(a)(1)(i)(A)(1)); see also General Instruction I.A.3(b) to Form S–3 and General Instruction I.A.2 to Form F–3 (each providing that the registrant must have filed the reports specified in the instruction ‘‘in a timely manner’’). 75 See, e.g., Revisions To The Eligibility Requirements For Primary Securities Offerings On Forms S–3 and F–3, Securities Act Release No. 8878 (Dec. 19, 2007) [72 FR 73533 (Dec. 27, 2007)] (‘‘S– 3 Revisions Adopting Release’’); Securities Offering Reform Proposing Release, supra note 14. 76 See, e.g., Securities Offering Reform Proposing Release, supra note 14. 77 As noted above, the FAIR Act specifically contemplates that we set a reporting history requirement for covered investment fund issuers that may be included in covered investment fund research reports, but we may not require a reporting history period for longer than what is required under rule 139(a)(1)(i)(A)(1). See supra note 26. The reporting history period required under rule 139(a)(1)(i)(A)(1) is currently the preceding 12 months from the time of the broker-dealer’s reliance on the rule 139 safe harbor. Rule 139(a)(1)(i)(A)(1) requires that an issuer included in an issuerspecific research report (other than a foreign private issuer) either must have filed a registration statement on Form S–3 or Form F–3, or met the registrant requirements of Form S–3 or Form F–3, as eligibility to register on these forms incorporates a reporting history requirement. Under these VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 139, this approach would provide investors with publicly-available information about the issuers included in a research report for a full year. The proposed approach also has the benefit of maintaining consistency between rule 139b and the long-established reporting history conditions of rule 139.78 We recognize, however, that in the context of covered investment funds that are open-end registered investment companies, use of a reporting history of only 12 months could result in certain performance and other information that may be relevant to investors not yet being available in the fund’s prospectus at the time the broker-dealer publishes or distributes a research report on that fund. This is because the disclosure requirements for a registered investment company, or a series thereof, are based in part on how long the fund has been operational. For example, for a newlyregistered covered investment fund that is an open-end registered investment company, a bar chart pursuant to Item 4 of Form N–1A is not required to be included in the fund’s prospectus until the fund has been operational for one full calendar year.79 We note, however, that other information for such a fund, such as principal investment strategies and estimated expenses, would be available at the time the fund launches. We request comment below on whether—and if so, how—the proposed reporting history and timeliness requirements could be more tailored to covered investment funds. We request comment on the proposed reporting history and timeliness requirements. • Are the proposed reporting requirements an appropriate condition for issuer-specific covered investment fund research reports whose publication eligibility requirements, the registrant must have been subject to the requirements of section 12 or 15(d) of the Exchange Act and have filed all materials required to be filed pursuant to section 13, 14 or 15(d) for a period of at least 12 calendar months immediately preceding the filing of the Form S–3 or Form F–3. See discussion at supra note 73. In addition, rule 139(a)(1)(i)(A)(2) separately requires that, as of the date of reliance on the rule 139 safe harbor, the registrant must have filed all periodic reports required during the preceding 12 months on Forms 10–K, 10–Q, and 20–F. See id. 78 See supra paragraph accompanying notes 32– 34. 79 For example, under the requirements of Form N–1A, a fund that launched on January 4 and has an August 31 fiscal year-end would not be required to include a bar chart, which reflects calendar yearend information, until almost three years after launch (less a few days). However, other performance information about such a fund would be required to appear in reports filed on Form N– PORT (which will be made public quarterly, see supra notes 65, 68) and the fund’s annual reports, and also could appear in rule 482 advertisements. PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 26795 or distribution would be covered under the rule 139b safe harbor? • Should the proposed reporting requirements for issuer-specific covered investment fund research reports track the existing reporting requirements for issuer-specific reports under rule 139 (e.g., the length of reporting history, required reports, and timeliness component)? If not, how should they differ? Is the proposed requirement for a 12-month periodic reporting history the right amount of time in the context of covered investment funds? For example, should the reporting history requirement instead provide that an issuer that is a registered open-end investment company must have filed a prospectus reflecting at least a full calendar year of performance information prior to the time that a broker-dealer relies on the proposed safe harbor, and would this approach be consistent with section 2(b)(2)(A) of the FAIR Act? Under proposed rule 139b, issuers that are registered investment companies must have timely filed reports on Forms N–CSR, N–SAR, N–Q, N–PORT, N–MFP, and N–CEN, as applicable,80 for the immediately preceding 12 calendar months, and issuers that are not registered investment companies must have timely filed reports on Forms 10–K and 10–Q or 20–F for the immediately preceding 12 calendar months, in order to be included in a research report for whose publication or distribution the proposed safe harbor would be available. Should we require a different set of periodic reports to be timely filed, other than what we propose? For example, should the requirement be based on a limited subset of the reports? Why or why not? b. Minimum Public Market Value Requirement In order for broker-dealers to use the proposed rule 139b safe harbor to publish or distribute issuer-specific research reports, we also are proposing that the covered investment fund that is the subject of a report must satisfy a minimum public market value threshold at the date of reliance on the proposed rule (the ‘‘minimum public market value requirement’’). Specifically, we are proposing that the aggregate market value of a covered investment fund,81 or the net asset value in the case of a registered open-end investment company (other than an exchange80 See supra note 68 (noting that we are proposing to remove references to Form N–Q on the date that Form N–Q is rescinded). 81 The aggregate market value is the aggregate market value of voting and non-voting common equity held by non-affiliates of the covered investment fund. See proposed rule 139b(a)(1)(i)(B). E:\FR\FM\08JNP3.SGM 08JNP3 26796 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 traded fund (‘‘ETF’’)),82 must equal or exceed the aggregate market value required by General Instruction I.B.1 to Form S–3.83 This amount is currently $75 million.84 Proposed rule 139b also specifies that both aggregate market value and net asset value would be calculated net of the value of shares held by affiliates.85 The proposed minimum public market value requirement generally tracks the minimum public float and aggregate market value requirements under rule 139, modified as appropriate to apply to covered investment fund issuers.86 As 82 See proposed rule 139b(a)(1)(i)(B), proposed rule 139b(c)(4) (defining ‘‘exchange-traded fund’’ for purposes of the proposed rule to have the meaning given the term in General Instruction A to Form N–1A). 83 Because the proposed rule refers to General Instruction I.B.1 to Form S–3, we would generally consider that, pursuant to these instructions, aggregate market value would be ‘‘computed by use of the price at which the common equity was last sold, or the average of the bid and asked prices of such common equity, in the principal market for such common equity as of a date within 60 days prior to the date of filing.’’ General Instruction I.B.1 to Form S–3. The definition of ‘‘market price’’ in the General Instructions of Form N–1A contemplates valuing an ETF’s shares similarly. See General Instruction A to Form N–1A. For a registered open-end investment company other than an ETF, net asset value would be computed using the investment company’s current net asset value, as used in determining its share price. See rule 22c–1 under the Investment Company Act [17 CFR 270.22c–1] (requiring registered open-end investment companies, their principal underwriters, and dealers in the investment company’s shares (and certain others) to sell and redeem the investment company’s shares at a price determined at least daily based on the current net asset value next computed after receipt of an order to buy or redeem). For covered investment funds that are not actively traded (such as non-traded closed-end funds and non-traded business development companies), we anticipate that, for purposes of proposed rule 139b, net asset value and aggregate market value would be calculated based on the fund’s last publicly-disclosed share price (for nontraded business development companies, this would be the common equity share price). 84 General Instruction I.B.1 to Form S–3. 85 See proposed rule 139b(a)(1)(i)(B) (specifying for purposes of this provision that ‘‘aggregate market value’’ is the aggregate market value of voting and non-voting common equity held by nonaffiliates of the covered investment fund, and that ‘‘net asset value’’ is calculated subtracting the value of shares held by affiliates). This requirement tracks the minimum public float requirement under rule 139, as discussed below. See infra note 86 and accompanying text. As guidance, for purposes of this calculation, we believe that shares held by affiliates generally should be determined with reference to the security ownership information listed in the covered investment fund’s registration statement. See, e.g., Item 11(m) of Form S–1; Item 18 of Form N–1A. 86 See proposed rule 139b(a)(1)(i)(B); rule 139(a)(1)(i)(A)(1)(i) and (a)(1)(i)(B)(2)(i) [17 CFR 230.139(a)(1)(i)(A)(1)(i) and (a)(1)(i)(B)(2)(i)]. For registered open-end investment companies other than ETFs, the proposed threshold is expressed in terms of net asset value rather than aggregate market value, to reflect market structure differences between registered open-end investment companies VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 discussed above, the FAIR Act specifically permits us to set a minimum public float requirement for covered investment funds, as long as the minimum public float is not greater than what is required by rule 139.87 Historically, the Commission has used public float as an approximate measure of a security’s market following, through which the market absorbs information that is reflected in the price of the security.88 We continue to view as significant the relationship between public float, information dissemination to the market, and following by investment institutions.89 In the context of covered investment funds, we would expect market information to be most limited for new funds (which the reporting history and timeliness requirements could help to address) and for funds that are marketed to a niche segment of investors (which the minimum public market value requirement could help to address).90 The proposed public market value requirement is designed to protect investors by excluding research reports on covered investment funds with a relatively small amount of total assets, and hence a limited market following. We believe that it is appropriate to include a $75 million public market value requirement for issuers that may be included in issuer-specific research reports, rather than some lower threshold. The proposed minimum public market value threshold is the same as the parallel threshold in rule 139, which we believe would increase compliance efficiencies among brokerdealers relying on the rule 139 and proposed rule 139b safe harbors.91 Moreover, a significantly lower minimum public market value threshold may not adequately protect investors, as we expect the information environment to be more limited for smaller funds than for larger funds.92 We request comment on the proposed minimum public market value requirement. • Is the proposed minimum public market value requirement an appropriate restriction for issuerspecific covered investment fund research reports whose publication or (other than ETFs) and all other covered investment funds. 87 See supra note 25 and accompanying text. 88 See, e.g., S–3 Revisions Adopting Release, supra note 75; see also Securities Offering Reform Proposing Release, supra note 14 (discussing public float of a certain level as a factor indicating that an issuer has a demonstrated market following). 89 See, e.g., S–3 Revisions Adopting Release, supra note 75. 90 See infra section III.C.2.c. 91 See infra discussion following note 299. 92 See infra section III.C.6.a. PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 distribution would be covered under the proposed rule 139b safe harbor? • Should the proposed minimum public market value requirement track the minimum float requirements under rule 139? Why or why not? If so, is tying the proposed minimum public market value requirement to the Form S–3 General Instruction I.B.1 appropriate, as in rule 139? Why or why not? Should the aggregate market value threshold be lower? Are there other requirements we should consider? Why or why not? • Is it appropriate for the proposed requirement to refer to ‘‘aggregate market value’’ for covered investment funds, and ‘‘net asset value’’ in the case of a registered open-end investment company (other than an ETF)? Should the proposed requirement instead refer to ‘‘net asset value’’ for ETFs? Is there another measure of market value that is more appropriately tailored for covered investment fund research reports? • Should we include different or more specific instructions about how covered investment funds would compute aggregate market value and net asset value? For example, should we specify that an ETF’s aggregate market value be calculated with reference to the definition of ‘‘market price’’ in Form N– 1A rather than General Instruction I.B.1 of Form S–3? 93 Should we include more specific instructions about how a covered investment fund that is not actively traded should compute aggregate market value and net asset value? 94 • Would the proposed minimum public market value requirement promote the dissemination into the market of an appropriate amount of research about covered investment funds? Conversely, would it unduly impede analyst coverage of covered investment fund issuers, and could this in turn affect the market following for these issuers? Is the approach we are proposing consistent with section 2(b)(2)(B) of the FAIR Act? c. Regular-Course-of-Business Requirement The proposed rule also would condition eligibility for the safe harbor on a broker-dealer’s publication or distribution of research reports ‘‘in the regular course of its business’’ 95 (the ‘‘regular-course-of-business’’ requirement). Although the proposed regularcourse-of-business requirement is generally similar to the existing provisions of rule 139, it differs in one 93 See supra note 83. id. 95 Proposed rule 139b(a)(1)(ii). 94 See E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 respect as required by the FAIR Act. Rule 139 provides, in addition to the requirement that a broker-dealer ‘‘publish[] or distribute[] research reports in the regular course of its business,’’ that such publication or distribution may not represent either the initiation of publication of research reports about the issuer or its securities or the reinitiation of such publication following a discontinuation thereof (the ‘‘initiation or reinitiation’’ requirement).96 The FAIR Act, however, provides that the safe harbor shall not apply the ‘‘initiation or reinitiation’’ requirement to a report concerning a covered investment fund with a class of securities ‘‘in substantially continuous distribution.’’ 97 Proposed rule 139b reflects this requirement by incorporating the ‘‘initiation or reinitiation’’ requirement from current rule 139 but specifying that it applies only to research reports regarding a covered investment fund that does not have a class of securities in substantially continuous distribution.98 Determining whether a class of securities is in substantially continuous distribution would be based on an analysis of the relevant facts and circumstances. We request comment below on whether there are any types of covered investment funds or classes of securities that raise particular questions as to the presence or absence of a ‘‘substantially continuous distribution.’’ We also request comment as to whether market participants would benefit from further Commission guidance on this point. Since rule 139 was first adopted, the regular-course-of-business requirement has been a condition for a brokerdealer’s publication or distribution of research reports in reliance on the rule.99 We believe requiring that research reports be published or distributed in the regular course of a broker-dealer’s business, consistent with the requirements of rule 139, could reduce the potential that covered investment fund research reports will be used to circumvent the prospectus requirements of the Securities Act. Moreover, we are concerned about certain potential consequences of broker-dealers’ ability, under proposed rule 139b, to publish or distribute communications as research reports that 96 Rule 139(a)(1)(iii) [17 CFR 230.139(a)(1)(iii)]. 2(b)(1) of the FAIR Act. 98 See proposed rule 139b(a)(1)(ii). 99 See Adoption of Rules Relating to Publication of Information and Delivery of Prospectus by Broker-Dealers Prior to or After the Filing of a Registration Statement Under the Securities Act of 1933, Securities Act Release No. 5105 (Nov. 19, 1970) [35 FR 18456 (Dec. 4, 1970)] (‘‘1970 Adopting Release’’). 97 Section VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 have traditionally been viewed by the investing public as advertisements or sales material related to registered investment companies or business development companies. The safe harbor provided under rule 139 is currently not available for a brokerdealer’s publication or distribution of research reports pertaining to specific registered investment companies or business development companies.100 Therefore, a research report about a covered investment fund that is a registered investment company currently must comply with the requirements of Securities Act rule 482.101 Given the definition of ‘‘research report’’ under the FAIR Act,102 however, certain communications that are currently treated as covered investment fund advertisements under Securities Act rule 482 also could fall under the proposed rule 139b definition of ‘‘research report.’’ Investors, particularly retail investors, may be unaware of the differences in regulatory status and purpose among the various types of communications regarding registered investment companies and business development companies. This may result in investors not being able to readily discern what constitutes a research report and what constitutes an advertisement about these issuers. Context helps investors evaluate and weigh the information presented to them. For example, investors likely know that advertising directly promotes sales of a particular product. A brokerdealer publishing or distributing a research report, on the other hand, may do so with multiple purposes for multiple audiences. While a research report may have the effect of promoting sales of the securities of the issuer that the research report features, it may serve a number of market functions as well, such as promoting market trading, educating a particular audience, or providing a service to clients.103 We believe that broker-dealers that publish or distribute research reports in the regular course of business are more likely to publish analysis that investors recognize as research. For example, these broker-dealers are more likely to have compliance structures in place, 100 See supra notes 11–15 and accompanying text. CFR 230.482. An investment company advertisement that complies with rule 482 is deemed to be a section 10(b) prospectus (also known as an ‘‘advertising prospectus’’ or ‘‘omitting prospectus’’) for purposes of section 5(b)(1) of the Securities Act. As a section 10(b) prospectus, an investment company advertisement is subject to liability under section 12(a)(2) of the Securities Act, as well as the antifraud provisions of the federal securities laws. 102 Section 2(f)(6) of the FAIR Act. 103 See infra section III.C.1.b. 101 17 PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 26797 with relevant policies and procedures, governing their publication of research and (as applicable) their distribution of registered investment company advertisements. Similarly, if a brokerdealer were to publish or distribute research reports in the regular course of its business, the broker-dealer may be more likely to have a research department with research analysts who regularly cover particular issuers or industries. This commitment in resources and infrastructure makes it more likely that the market recognizes the broker-dealer as a provider of research-related communications. A research report published or distributed by a research analyst in the research department at a broker-dealer that regularly covers that issuer or industry would therefore be a factor indicating that the regular-course-of-business requirement has been satisfied for purposes of proposed rule 139b.104 Additional factors may include whether the broker-dealer maintains policies and procedures governing its research protocols and whether the broker-dealer regularly publishes or distributes research on any other type of company or business other than covered investment funds. We request comment on the proposed regular-course-of-business requirement. • Is the proposed regular-course-ofbusiness requirement appropriate in the context of covered investment fund research reports? • Would the proposed regular-courseof-business requirement allow an appropriate flow of analyst-generated information to the market? • Should we define ‘‘regular course of business’’ in proposed rule 139b more specifically in the context of research reports on registered investment companies or business development companies? Today, due to the unavailability of rule 139, we understand that broker-dealers are generally not in the business of publishing and distributing what we consider issuer-specific research reports on registered investment companies or business development companies (although some broker-dealers have 104 We believe it is appropriate to include the regular-course-of-business requirement because it is important that the broker-dealer have a history of publishing or distributing a particular type of research. If a broker or dealer begins publishing research about a different type of security around the time of a public offering of an issuer’s security and does not have a history of publishing research on those types of securities, such publication or distribution could be viewed as a way to provide information about the publicly-offered securities in circumvention of the provisions of section 5 of the Securities Act. See Securities Offering Reform Adopting Release, supra note 39. E:\FR\FM\08JNP3.SGM 08JNP3 amozie on DSK3GDR082PROD with PROPOSALS3 26798 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules published and distributed communications styled as ‘‘research reports’’ in compliance with rule 482, and some broker-dealers have published and distributed research reports on other issuers in reliance on the rule 139 safe harbor). Does this raise questions as to how to apply a regular-course-ofbusiness requirement to research reports regarding these issuers that we should address in the proposed rule or through additional Commission guidance? If so, what further definitions or guidance should we consider? Would the proposed regular-course-of-business requirement promote the publication or distribution of research reports on covered investment funds that investors recognize as research? • What facts and circumstances suggest that a covered investment fund has a class of securities in ‘‘substantially continuous distribution’’? Are there any types of covered investment funds that raise specific questions about whether or not they have a class of securities in substantially continuous distribution, either generally or in particular circumstances? For example, do all open-end management investment companies, and those closed-end interval funds that make periodic repurchase offers pursuant to rule 23c– 3, have a class of securities in substantially continuous distribution, while other closed-end investment companies do not? Why or why not? Are there other types of funds with a class of securities in substantially continuous distribution, or are there specific circumstances that should definitively constitute substantially continuous distribution? Would market participants benefit from Commission guidance as to how one would make a determination that a covered investment fund has a class of securities in substantially continuous distribution? • Alternatively, should we define the term ‘‘substantially continuous distribution’’ in rule 139b, and if so, how? Should this definition include certain types of funds (e.g., open-end management investment companies, closed-end interval funds that make periodic repurchase offers pursuant to rule 23c–3, and other types of funds that are engaged in continuous offerings pursuant to Securities Act rule 415(a)(1)(ix) or others that conduct continuous offerings as shelf takedowns pursuant to rule 415(a)(1)(x))? If so, what funds and under what circumstances? Are there any specific factors that we should incorporate in proposed rule 139b in order to determine whether a covered investment fund is in substantially continuous distribution? VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 • Because a safe harbor is generally not currently available for brokerdealers’ publication or distribution of covered investment fund research reports,105 should the proposed regularcourse-of-business requirement be modified to address how broker-dealers that have not previously published or distributed research reports could satisfy this requirement? If we were to modify the proposed regular-course-ofbusiness requirement to incorporate factors indicating that a broker-dealer has created a history of publishing or distributing research reports in the regular course of business, what should these factors be, and why? Alternatively, should rule 139b provide a ‘‘start-up’’ period to allow broker-dealers to establish a regular course of business of publishing research reports? For example, should the rule provide that a broker-dealer that could not satisfy the regular-course-of-business requirement could nonetheless rely on rule 139b for a specified period of time (e.g., one year) to establish a regular course of business of publishing research reports? Without such a provision, would the regularcourse-of-business requirement pose challenges for broker-dealers that had not previously published research reports because of the absence of an applicable safe harbor? If we do not modify the proposed requirement in this way, should we provide further guidance regarding broker-dealers that have not previously published or distributed research reports? • Should the proposed regularcourse-of-business requirement incorporate any more specific requirements regarding the person(s) preparing a covered investment fund research report (e.g., a requirement that the person who prepares the research report must be employed by the brokerdealer to prepare research in the normal course of his or her duties)? 2. Industry Research Reports Our proposed conditions for industry research reports parallel those set forth in rule 139 and are intended to provide appropriate parameters to address the risk of circumvention of the prospectus requirements of the Securities Act.106 a. Reporting Requirement Under the proposed safe harbor, each covered investment fund included in an industry research report must be subject to the reporting requirements of section 30 of the Investment Company Act (or, for covered investment funds that are 105 See supra notes 11–15 and accompanying text. supra notes 57–58 and accompanying text; see also paragraph accompanying notes 32–34. 106 See PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 not registered investment companies under the Investment Company Act, the reporting requirements of section 13 or section 15(d) of the Exchange Act). This proposed reporting requirement generally tracks an existing requirement for industry research reports under rule 139 107 but has been modified so that it would be applicable to industry research reports that include covered investment fund issuers. Like the parallel provision of rule 139, the proposed reporting requirement helps assure that there is publicly available information about the relevant issuers and that investors are able to use such information in making their investment decisions. We request comment on the reporting requirement in proposed rule 139b. • Is the proposed reporting requirement appropriate? Why or why not? • As discussed above, proposed rule 139b’s framework, including its scope and conditions, generally tracks rule 139.108 Therefore, as in rule 139, the conditions applicable to industry and issuer-specific research reports differ. For example, as proposed, rule 139b (like rule 139) would not require the issuers included in an industry research report to satisfy the minimum market value thresholds discussed in section II.B.1.b above. Is there any reason we should extend all of the conditions for issuer-specific research reports (or a subset of these conditions, to the extent they are not already reflected in proposed rule 139b) to industry reports, even if this approach would diverge from the approach taken in rule 139? Are the concerns underlying the proposed conditions for broker-dealers’ publication or distribution of covered investment fund research reports the same for issuer-specific research reports and industry research reports? Are there any other concerns specific to industry research reports that we should consider? b. Regular-Course-of-Business Requirement We are also proposing that a brokerdealer be required to publish or distribute research reports in the regular course of its business in order to rely on the proposed safe harbor.109 The 107 See rule 139(a)(2)(i) [17 CFR 230.139(a)(2)(i)] (‘‘The issuer is required to file reports pursuant to section 13 or section 15(d) of the Securities Exchange Act of 1934 or satisfies the conditions in paragraph (a)(1)(i)(B) of this section.’’). 108 See supra paragraph accompanying notes 32– 34. 109 Proposed rule 139b(a)(2)(iv) (the broker or dealer publishes or distributes research reports in the regular course of its business and, at the time E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 proposed regular-course-of-business requirement for industry research reports similarly applies to issuerspecific research reports,110 and it also tracks an existing requirement for industry research reports under rule 139.111 Like the parallel provision in rule 139, the proposed regular-course-ofbusiness requirement for industry research reports includes a ‘‘similar information’’ requirement. To satisfy this requirement, at the time a brokerdealer publishes or distributes an industry research report, the brokerdealer would have to include similar information, in similar reports, about the issuer covered in the industry report (or its securities).112 However, unlike rule 139, we are proposing that the ‘‘similar information’’ requirement apply only to circumstances in which a broker-dealer is publishing or distributing a research report regarding a covered investment fund that does not have a class of securities in substantially continuous distribution. As discussed above, the FAIR Act provides that the safe harbor shall not apply the ‘‘initiation or reinitiation’’ requirement to a research report concerning a covered investment fund with a class of securities ‘‘in substantially continuous distribution.’’ 113 We believe that the proposed ‘‘similar information’’ requirement is akin to the proposed ‘‘initiation or reinitiation’’ requirement, in that both would have the effect of limiting a broker-dealer’s ability to rely on the proposed safe harbor to publish or distribute a research report about a particular covered investment fund if the broker-dealer had not previously published research on that issuer. Therefore, as in the proposed ‘‘initiation or reinitiation’’ requirement, we are proposing to exclude covered investment funds from the ‘‘similar information’’ requirement if they have a class of securities in substantially continuous distribution.114 As discussed above, we believe that the proposed regular-course-of-business requirement could reduce the possibility that broker-dealers’ publication or distribution of covered investment fund research reports may be used to circumvent the prospectus of the publication or distribution of the research report (in the case of a research report regarding a covered investment fund that does not have a class of securities in substantially continuous distribution) is including similar information about the issuer or its securities in similar reports). 110 See supra section II.B.1.c. 111 See rule 139(a)(2)(v) [17 CFR 230.139(a)(2)(v)]. 112 Proposed rule 139b(a)(2)(iv). 113 See supra notes 97–98 and accompanying text. 114 See id. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 requirements of the Securities Act. We also believe that broker-dealers that publish or distribute research reports in the regular course of business are more likely to publish reports incorporating analysis that investors recognize as research and to have appropriate compliance structures in place governing their publication of research.115 We continue to believe, in the context of proposed rule 139b as well as in rule 139, that a regularcourse-of-business requirement is equally appropriate for issuer-specific research reports and industry research reports. We request comment on the proposed regular-course-of-business requirement. • Is the proposed regular-course-ofbusiness requirement appropriate? Why or why not? • In the context of covered investment fund research reports, would the proposed ‘‘similar information’’ requirement unduly restrict brokerdealers’ ability to rely on the proposed safe harbor? Why or why not? • Would any of the questions, concerns, or issues discussed above with respect to the proposed regularcourse-of-business requirement in the context of issuer-specific research reports be equally applicable in the context of industry research reports? Why or why not? c. Content Requirements for Industry Research Reports The proposed rule would also condition eligibility for the safe harbor for industry research reports on certain content requirements. Specifically, under the proposed rule, industry research reports either must include similar information about a substantial number of covered investment fund issuers of the same type or investment focus (the ‘‘industry representation requirement’’),116 or alternatively contain a comprehensive list of covered investment fund securities currently recommended by the broker or dealer (the ‘‘comprehensive list requirement’’).117 Industry Representation Requirement The proposed industry representation requirement imposes a requirement similar to one contained in rule 139 to covered investment fund research reports.118 The Commission has stated 115 See supra section II.B.1.c. rule 139b(a)(2)(ii)(A). 117 Proposed rule 139b(a)(2)(ii)(B). 118 Rule 139 requires an industry research report to include ‘‘similar information with respect to a substantial number of issuers in the issuer’s industry or sub-industry.’’ Rule 139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)]. See infra note 121 and accompanying text. 116 Proposed PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 26799 that ‘‘where a publication covers a broad range of companies in an industry and is issued not on a sporadic but on a regular schedule, the possibility that such a publication could condition the market is lessened.’’ 119 Furthermore, the possibility of market conditioning is lessened ‘‘where research reports discussing the registrant contain similar information, opinions or recommendations with respect to a substantial number of other companies in the registrant’s industry.’’ 120 We believe that these observations are applicable today in the context of covered investment fund industry research reports, and therefore we propose that rule 139b include an industry representation requirement. Accordingly, we are proposing to replicate the language from rule 139’s industry representation requirement in rule 139b, with modifications designed to apply the language to the covered investment fund context. Under rule 139’s corresponding requirement, an industry research report must include ‘‘similar information with respect to a substantial number of issuers in the issuer’s industry or sub-industry.’’ 121 When this section of rule 139 first was proposed, the Commission explained that the term ‘‘industry’’ in this context refers to a broad category of similar businesses, such as the airline or steel 119 Research Reports, Securities Act Release No. 6492 (Oct. 6, 1983) [48 FR 46801 (Oct. 14, 1983)] (‘‘1983 Proposing Release’’); see also supra notes 57–58 and accompanying text (discussing the role of rule 139 in helping to mitigate the risk that research reports might be used to circumvent the prospectus requirements of the Securities Act). See also The Regulation of Securities Offerings, Securities Act Release No. 7607A (Nov. 13, 1998) [63 FR 67174 (Dec. 4, 1998)] (proposal to modernize and clarify the regulatory structure for offerings under the Securities Act of 1933). We note that, in some cases, concerns about market conditioning in the context of research reports about covered investment funds may be substantially similar to these concerns in the context of operating company issuers. For example, for covered investment funds that are not in continuous distribution, ‘‘gun-jumping’’ concerns, i.e., the failure to comply with restrictions on communications when a securities offering is being contemplated or is in process (similar to those that are applicable to operating companies) could be applicable. For covered investment funds that are in continuous distribution, on the other hand, we understand the role of the conditions of rule 139b more generally as to help mitigate the risk that research reports could be used to circumvent the Securities Act’s prospectus requirements. 120 See 1983 Proposing Release, supra note 119. As a corollary, the Commission has noted that ‘‘The opportunity for the abuses Section 5 was enacted to correct may still be present, however, where a research report covers only a few companies constituting a sub-industry group or where an entire industry is composed of a small number of companies.’’ See id. 121 Rule 139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)]. E:\FR\FM\08JNP3.SGM 08JNP3 26800 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules industries.122 In adopting the rule, the Commission added ‘‘sub-industry’’ to the rule text in order to clarify that the safe harbor would apply to research reports covering a smaller number of companies in a particular industry.123 While operating companies are typically grouped based on their business category, entities that are included in the definition of ‘‘covered investment fund’’ are typically grouped based either on their type or investment focus.124 Therefore, the proposed industry representation requirement would require an industry research report to include similar information about a substantial number of issuers either of the same type (e.g., ETFs or mutual funds that are large cap funds, bond funds, balanced funds, money market funds, etc.) or investment focus (e.g., primarily invested in the same industry or sub-industry, or the same country or geographic region).125 We believe that this proposed requirement tracks rule 139 to the extent practicable and appropriate. Comprehensive List Requirement Under the proposed rule, a brokerdealer’s publication or distribution of an industry research report that conforms to the comprehensive list requirement, rather than the industry representation requirement, also would be eligible for the rule’s safe harbor.126 Rule 139 contains a similar provision,127 and we are proposing to replicate the language from rule 139’s comprehensive list requirement in rule 139b, with some modifications owing to the difference in context and the FAIR Act’s affiliate exclusion.128 Like the proposed industry representation requirement, the proposed comprehensive list requirement is designed to result in industry research reports that cover a broad range of investment companies or securities.129 We are proposing that a amozie on DSK3GDR082PROD with PROPOSALS3 122 1983 Proposing Release, supra note 119. 123 1984 Adopting Release, supra note 56. 124 See Investment Company Names, Investment Company Act Release No. 24828 (Jan. 17, 2001) [66 FR 8509 (Feb. 1, 2001)] (registered investment companies are typically categorized based on industry (e.g., sector funds or country or geographic region)). 125 Proposed rule 139b(a)(2)(ii)(A). 126 Proposed rule 139b(a)(2)(ii)(B). 127 Rule 139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)]. 128 Proposed rule 139b(a)(2)(ii)(B). 129 1983 Proposing Release, supra note 119. We note that when the Commission originally adopted rule 139 in 1970, this rule only provided a safe harbor for research reports that included ‘‘a comprehensive list of securities, opinions or recommendations concerning the issuer’’ and did not provide a parallel safe harbor for issuer-specific research reports. See 1970 Adopting Release, supra note 99. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 comprehensive list of recommended issuers appearing in an industry research report could not include any covered investment fund issuer that is an affiliate of the broker-dealer, or for which the broker-dealer serves as investment adviser (or is an affiliated person of the investment adviser), as this could implicate the proposed affiliate exclusion.130 As discussed in the context of the proposed industry representation requirement, we believe that including a broad range of issuers in a research report lessens concerns over market conditioning.131 At the same time, the proposed comprehensive list requirement would permit a different presentation of research about multiple covered investment funds than the industry representation requirement would permit.132 We understand that the two types of presentations could serve different research needs. We request comment on the proposed content requirements for industry research reports. • Are the proposed industry representation requirement and the proposed comprehensive list requirement appropriate? Why or why not? • How would the publication or distribution of industry research reports help investors, and do commenters anticipate that industry research reports would be published or distributed more or less frequently than issuer-specific research reports? Do commenters anticipate that broker-dealers would be more likely to publish or distribute industry research reports that comply with the industry representation requirement, or alternatively the comprehensive list requirement, or both, in relying on the proposed rule 139b safe harbor? • Are there other conditions that we should consider in addition to the proposed industry representation 130 See proposed rule 139b(a)(2)(ii)(B) (excluding from the comprehensive list securities of a covered investment fund that is an affiliate of the broker or dealer, or for which the broker or dealer serves as investment adviser (or for which the broker or dealer is an affiliated person of the investment adviser)); see also supra section II.A.1. 131 See supra notes 119–120 and accompanying text. 132 Under proposed rule 139b, a ‘‘comprehensive list’’ research report would have to include a list of all of the broker’s currently-recommended covered investment fund securities, whereas an ‘‘industry representation’’ report would not be required to list each currently-recommended security (but instead could cover a more limited number of issuers as long as a ‘‘substantial number’’ of covered investment fund issuers of the same type or investment focus were included). See also requests for comment infra at the end of this section II.B.2.c (requesting comment on how these types of research reports might be used and the content that would be included in each type of research report). PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 requirement and the proposed comprehensive list requirement? For example, should we require that there must be a minimum number of funds included in an industry research report for it to qualify under the industry representation requirement, particularly in light of the fact that there may be only a few funds that track a particular sub-industry or geographic region or country? If so, what should that minimum number be? Is there another approach to industry research report content requirements that would be more appropriately tailored to covered investment fund research reports? • The proposed industry representation requirement would be based on the ‘‘type’’ or ‘‘investment focus’’ of the issuers covered in the research report. Are these the appropriate terms to achieve comparisons of similar entities in industry research reports? Why or why not? Are there other more appropriate terms that could be used to specify subsets of covered investment funds that would be included in industry research reports (e.g., category, asset class, strategy, topic, or investment policy)? Should we include more specific definitions for the terms ‘‘type’’ and ‘‘investment focus’’ in rule 139b, and if so, what should these definitions be? Should we instead identify categories that can qualify for the industry report provisions, such as ‘‘legal structure’’ (e.g., ETF, mutual fund, business development company, interval fund), ‘‘asset class’’ (e.g., international equity, domestic equity, international fixed income, domestic fixed income), ‘‘investment focus’’ (e.g., sector, industry, sub-industry, geographic region), or ‘‘strategy’’ (e.g., passive, active, market-cap-weighted, smart beta, capital preservation, capital appreciation)? • The proposed comprehensive list requirement would require the research report to contain a list of covered investment funds that are ‘‘currently recommended’’ by the broker-dealer. Is it clear what is meant by the terms ‘‘comprehensive list’’ and ‘‘currently recommended’’ under proposed rule 139b? Would broker-dealers seeking to rely on the proposed safe harbor understand that we interpret these terms in the context of rule 139b to have the same meaning as they do in the context of rule 139? For example, would the term ‘‘currently recommended’’ be interpreted as meaning ‘‘available for sale by the broker-dealer,’’ ‘‘given a ‘buy’ recommendation by the brokerdealer,’’ or something else? Should we further define either of the terms ‘‘comprehensive list’’ or ‘‘currently E:\FR\FM\08JNP3.SGM 08JNP3 amozie on DSK3GDR082PROD with PROPOSALS3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules recommended’’ as they appear in rule 139b (or, within rule 139b, as these terms apply to certain types of covered investment funds such as registered investment companies), and if so, how? • Do commenters anticipate that, if a broker-dealer were to rely on the proposed rule 139b safe harbor to publish or distribute research reports that meet the proposed comprehensive list requirement, there would be a sufficient number of ‘‘currently recommended’’ covered investment funds to produce an appropriately broad array of funds included in the report given the affiliate exclusion? • We are proposing that a comprehensive list could not include any covered investment fund issuer that is an affiliate of the broker-dealer, or for which the broker-dealer serves as investment adviser (or is an affiliated person of the investment adviser), as this could implicate the proposed affiliate exclusion. Should rule 139b instead provide that a comprehensive list of recommended issuers could include issuers that are affiliates of the broker-dealer that is publishing or distributing the research report under certain circumstances? If so, what information, if any, should a brokerdealer be permitted to include about affiliated issuers such that the list can be described as ‘‘comprehensive’’ while continuing to address the goals of the affiliate exclusion? For example, should the rule provide that these issuers could be included in a comprehensive list if the research report were to identify which issuers in the list, if any, were affiliated with the broker-dealer? In addition, or in the alternative, should we permit these issuers to be included in a comprehensive list if disclosure about the affiliated issuers were limited, for example, to basic identifying information such as the name of the covered investment fund, its type and investment focus, and its ticker symbol (if applicable)? As another example, should the rule require that if a comprehensive list includes affiliated issuers and includes performance information, the performance information must be presented in accordance with rule 482 in order to address the concern that the brokerdealer may be incentivized to present more favorably the performance of its affiliated covered investment funds? 133 d. Presentation Requirement for Industry Research Reports Proposed rule 139b also would condition the safe harbor for industry research reports on a presentation 133 See infra section 0. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 requirement. Under the proposed rule, analysis of any covered investment fund issuer or its securities included in an industry research report could not be given materially greater space or prominence in the publication than that given to any other covered investment fund issuer or its securities.134 The proposed presentation requirement tracks a parallel ‘‘no greater space or prominence’’ requirement in rule 139.135 The Commission has stated that the ‘‘no greater space or prominence’’ language is necessary to mitigate the risk of conditioning the market 136 but also that the materiality standard within this presentation requirement provides flexibility.137 We believe that the concerns underlying the rule 139 presentation requirements apply equally in the context of covered investment fund research reports. We believe that, if the proposed rule were to permit a broker-dealer to rely on the safe harbor even if it were to publish or distribute an industry research report that gives materially greater space or prominence to one issuer than to others, this would create an avenue for circumventing the conditions associated with issuer-specific research reports. The industry should already be familiar with this long-established and wellunderstood condition, and therefore we believe implementing a similar presentation condition for industry research reports on covered investment funds would be straightforward. We request comment on the proposed presentation requirement for industry research reports. • Is the proposed presentation requirement appropriate for covered investment fund industry research reports? Why or why not? • Is the proposed presentation requirement sufficiently clear? Should we provide guidance as to what compliance with this requirement would entail? • Would this requirement unduly restrict design flexibility for research reports, or impede broker-dealers’ ability to provide material information in research reports? • Should we consider additional presentation requirements for covered investment fund research reports? Is there another approach that would be more appropriately tailored? 134 Proposed rule 139b(a)(2)(iii). 139(a)(2)(iv) [17 CFR 230.139(a)(2)(iv)]. 136 1983 Proposing Release, supra note 119. 137 Id. 135 Rule PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 26801 C. Presentation of Performance Information in Research Reports About Registered Investment Companies Specific statutory provisions and rules apply to advertising the performance of registered investment companies.138 An advertisement about a covered investment fund that is a registered investment company is deemed a section 10(b) prospectus (also known as an ‘‘advertising prospectus’’ or ‘‘omitting prospectus’’) for purposes of section 5(b)(1) of the Securities Act so long as it complies with rule 482.139 Therefore, under the current regulatory framework, a broker-dealer’s publication or distribution of a research report that complies with the requirements of rule 482 would not be deemed a nonconforming prospectus in violation of section 5 of the Securities Act.140 Given the breadth of the definition of ‘‘research report’’ under the FAIR Act (and the definition of ‘‘research report’’ that we propose under rule 139b), certain communications by brokerdealers that historically have been treated as advertisements for registered investment companies under rule 482 now could be considered covered investment fund research reports subject to the proposed rule 139b safe harbor.141 Among other things, rule 482 requires standardized presentation of performance data included in registered open-end investment company 138 See, e.g., section 24(g) of the Investment Company Act [15 U.S.C. 80a–24(g)] (directing the Commission to adopt rules or regulations that permit registered investment companies to use prospectuses that (i) include information the substance of which is not included in the statutory prospectus, and (ii) are deemed to be permitted by section 10(b) of the Securities Act); rule 34b–1 under the Investment Company Act [17 CFR 270.34b–1] (requiring that, in order not to be misleading, investment company sales literature must include certain information, including with respect to performance information by incorporating certain related provisions of rule 482 of the Securities Act); rule 156 of the Securities Act [17 CFR 230.156] (providing guidance on what statements or omissions of material fact may be misleading in investment company sales literature); rule 482 of the Securities Act [17 CFR 230.482] (setting forth that for an investment company advertisement to be deemed a prospectus under section 10(b) of the Securities Act, it must meet certain requirements thereunder, including with respect to standardized performance information presentation). 139 See supra note 101 and accompanying text. 140 See supra notes 13, 101 and accompanying text. FINRA content standards also would generally require a member’s publication or distribution of such a communication (to the extent it presents performance data as permitted by rule 482) to include certain of the standardized performance information specified under rule 482. See FINRA rule 2210(d)(5)(A). 141 See supra note 102 and accompanying text. E:\FR\FM\08JNP3.SGM 08JNP3 26802 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 advertisements.142 Alternatively, if other performance measures are presented, they must be accompanied by certain standardized performance data.143 Because a broker-dealer’s publication or distribution of a covered investment fund research report under proposed rule 139b would be deemed not to constitute an offer for purposes of sections 2(a)(10) and 5(c) of the Securities Act, a covered investment fund research report would no longer need to be deemed to be a section 10(b) prospectus (such as an advertising prospectus under rule 482) for purposes of section 5(b)(1) of the Securities Act. In addition, some communications that previously were considered supplemental sales literature that must be accompanied or preceded by a statutory prospectus under rule 34b–1 under the Investment Company Act now could be considered covered investment fund research reports (which need not be preceded or accompanied by a statutory prospectus).144 Rule 34b–1 incorporates many of the rule 482 requirements relating to performance disclosure and makes these requirements applicable to supplemental sales literature.145 We are concerned that this shift in regulatory treatment of research reports about registered investment companies could result in investor confusion if a communication were not easily recognizable as research as opposed to an advertising prospectus or supplemental sales literature. Although there are multiple provisions in proposed rule 139b that aim to limit the risk that broker-dealers could use the proposed safe harbor to circumvent the prospectus requirements of the Securities Act,146 there could be 142 See rule 482(d)(1)–(4) (for open-end investment companies other than money market funds) and rule 482(e) (for money market funds). 143 See rule 482(d)(5). These other performance measures are not subject to any prescribed method of computation, but must reflect all elements of return and be accompanied by quotations of standardized measures of total return as provided for in paragraphs (d)(3) and (d)(4) of the rule. Rule 482(d)(5) also includes other requirements for the inclusion of non-standardized performance data, such as presentation and prominence requirements. 144 See rule 34b–1 under the Investment Company Act. Rule 34b–1 provides that any advertisement, pamphlet, circular, form letter, or other sales literature addressed to or intended for distribution to prospective investors that is required to be filed with the Commission by section 24(b) of the Investment Company Act will have omitted to state a fact necessary in order to make the statements made therein not materially misleading unless it includes certain specified information. 145 See rule 34b–1(b)(1)–(2). 146 See, e.g., supra sections II.A.1 (affiliate exclusion) and II.B.1.c (regular course of business requirement). Certain covered investment fund research reports that meet the definition of ‘‘research report’’ in Regulation AC would be VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 circumstances where, under the proposed rule, broker-dealers could publish or distribute communications that historically have been viewed as registered investment company advertisements or selling materials. Research reports published under rule 139 are not required to present performance information in any particular fashion. To the extent the rules we are proposing today diverge from rule 139, these differences are designed to implement the FAIR Act or tailor existing provisions of rule 139 to the context of covered investment fund research reports. Therefore, unlike registered open-end investment company advertisements that must comply with the requirements of Securities Act rule 482, covered investment fund research reports would not be required to present investment performance data in a standardized manner.147 However, we have long recognized that investors tend to consider investment performance to be a particularly significant factor in evaluating or comparing investment companies.148 The Commission has previously identified a number of circumstances in which performance could be disclosed in a misleading manner.149 If a broker-dealer publishes or distributes a covered investment fund research report in reliance on the safe harbor—and presents performance information in a manner inconsistent with rule 482—retail investors could be confused about the comparability of the subject to the requirements of Regulation AC. Similarly, covered investment fund research reports that meet the definition of ‘‘research report’’ in FINRA rule 2241 or the definition of ‘‘debt research report’’ in FINRA rule 2242 would be subject to the content requirements in those rules as applicable. See supra note 58; infra section II.D.1. 147 See supra notes 142–143 and accompanying text. 148 As the Commission has previously noted ‘‘[a]lthough there are many factors other than performance that an investor should consider in deciding whether to invest in a particular fund, many investors consider performance to be one of the most significant factors when evaluating mutual funds.’’ See Amendments to Investment Company Advertising Rules, Securities Act Release No. 8101 (May 17, 2002) [67 FR 36712 (May 24, 2002)] (‘‘Rule 482 Amendments Proposing Release’’) (proposing release for amendments to investment company advertising rules). 149 See id. (such circumstances include: Advertising performance without providing adequate disclosure of unusual circumstances that have contributed to performance; advertising performance without providing adequate disclosure of the performance period, that more current performance information is available, or that more current performance may be lower than advertised performance; and advertising performance based on selective dates or time periods in order to showcase fund performance as of those specific dates or time periods without providing disclosure that would permit an investor to evaluate the significance of the performance). PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 performance to that presented in the prospectuses, sales literature, and advertisements of the fund and its competitors.150 In addition, the possibility exists that the requirements of rule 482 or rule 34b–1 could be circumvented by recasting registered investment company advertisements or selling materials as research reports. We request comment below as to whether, in light of these concerns, it would be appropriate to require that covered investment fund research reports that include performance information present that information in accordance with the requirements in rule 482 or rule 34b–1. In addition, all covered investment fund research reports under the proposed safe harbor would remain subject to the antifraud provisions of the federal securities laws.151 The Commission has previously articulated guidance on factors to be weighed in considering whether statements involving a material fact in registered investment company advertisements and sales literature, which are also subject to the antifraud provisions of the federal securities laws, could be misleading.152 This guidance provided factors to be weighed when determining whether fund performance in sales literature is adequately disclosed.153 The guidance factors in rule 156 154 are 150 Additional conditions that might lessen potential investor confusion are if a research report that presents performance information other than in accordance with the provisions of rule 482 were to: 1) adequately explain how the performance presentation differs from that which would be required under rule 482, and/or 2) include a statement noting that the document is a research report, and is not an investment company advertisement that is subject to the requirements of rule 482. We request comment on these and other conditions below. 151 See section 2(c)(1) of the FAIR Act (stating that nothing in the Act shall be construed as in any way limiting the applicability of the antifraud or antimanipulation provisions of the Federal securities laws and rules adopted thereunder to a covered investment fund research report, including section 17 of the Securities Act of 1933 (15 U.S.C. 77q), section 34(b) of the Investment Company Act of 1940 (15 U.S.C. 80a–33(b)), and sections 9 and 10 of the Securities Exchange Act of 1934 (15 U.S.C. 78i, 78j)). 152 See Amendments to Investment Company Advertising Rules, Securities Act Release No. 8294 (Sept. 29, 2003) [68 FR 57759 (Oct. 6, 2003)] (‘‘Amendments to Investment Company Advertising Rules Adopting Release’’); see also rule 156 under the Securities Act [17 CFR 230.156]. 153 See Amendments to Investment Company Advertising Rules Adopting Release, supra note 152. 154 Rule 156(b) under the Securities Act provides guidance factors concerning misleading statements in investment company sales literature including: (i) Statements and omissions generally (including in light of general economic or financial conditions or circumstances), (ii) representations about past or future investment performance, and (iii) statements involving a material fact about an investment company’s characteristics or attributes. E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 informative in evaluating whether any presentations of registered investment company performance in these research reports could be misleading because they reflect principles (such as providing information to investors that is informative and that does not create unrealistic investor expectations 155) that would help guide this analysis. Rule 139 includes an instruction on the use of projections of an issuer’s sales and earnings.156 This instruction provides that a projection ‘‘constitutes an analysis or information falling within the definition of research report’’ and includes certain conditions associated with the use of projections.157 We are not incorporating this or a similar instruction in proposed rule 139b for a number of reasons. FINRA content standards governing communications with the public generally prohibit a broker-dealer from using performance projections.158 In addition, rule 156 notes as guidance that statements and illustrations about a registered fund’s future performance in sales literature could be misleading depending on the context in which they are made, and lists considerations to weigh in making this evaluation. The projection instruction in rule 139—which refers to ‘‘sales’’ and ‘‘earnings’’—also appears inapplicable to covered investment For example, rule 156(b)(2) provides guidance on whether investment performance representations may be misleading by highlighting the following situations: (1) Portrayals of past income, gain, or growth of assets convey an impression of the net investment results achieved by an actual or hypothetical investment which would not be justified under the circumstances, including portrayals that omit explanations, qualifications, limitations, or other statements necessary or appropriate to make the portrayals not misleading; and (2) representations, whether express or implied, about future investment performance, including: (i) Representations, as to security of capital, possible future gains or income, or expenses associated with an investment; (ii) representations implying that future gain or income may be inferred from or predicted based on past investment performance; or (iii) portrayals of past performance, made in a manner which would imply that gains or income realized in the past would be repeated in the future. 155 See Rule 482 Amendments Proposing Release, supra note 148. 156 See ‘‘Instruction’’ to rule 139 [17 CFR 230.139]. 157 See id. The instruction provides that, when a broker or dealer publishes or distributes projections of an issuer’s sales or earnings in reliance on rule 139(a)(2), it must: (1) Have previously published or distributed projections on a regular basis in order to satisfy the ‘‘regular course of its business’’ condition; (2) at the time of publishing or disseminating a research report, be publishing or distributing projections with respect to that issuer; and (3) for purposes of rule 139(a)(2)(ii), include projections covering the same or similar periods with respect to either a substantial number of issuers in the issuer’s industry or sub-industry or substantially all issuers represented in the comprehensive list of securities contained in the research report. 158 See FINRA rule 2210(d)(1)(F). VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 funds. A covered investment fund’s returns will be based on the returns of the fund’s investments and fund expenses, among other factors, as opposed to ‘‘earnings’’ and ‘‘sales.’’ We request comment on whether we should adopt any additional conditions in rule 139b or issue guidance to help mitigate the potential for investor confusion regarding research reports about registered investment companies. • Do commenters anticipate that certain issuer-specific covered investment fund research reports could be confused with registered investment company advertisements and sales materials? If so, what additional conditions could prevent investor confusion, including, for example, legends? • If commenters anticipate that certain covered investment fund research reports could be confused with registered investment company advertisements and sales materials, what additional conditions or guidance factors would help mitigate investor confusion? For example, should we incorporate any of the rule 156 guidance factors, which are weighed in considering whether statements in investment company sales literature could be misleading? Why or why not? Alternatively, should we provide any additional guidance regarding considerations to be weighed in considering whether research reports about registered investment companies (including any performance information presented in these research reports) could be misleading? Should any additional guidance be limited either to issuer-specific research reports or to industry research reports? • Do commenters anticipate that broker-dealers would include performance information in covered investment fund research reports about registered open-investment investment companies in a manner inconsistent with the requirements for the presentation of total return or yield in rule 482 (‘‘non-482 performance information’’)? 159 We request that commenters provide specific examples of non-482 performance information that they would consider using in a research report about an open-end investment company, and why they would use this information. 159 As discussed above, rule 482 also permits the inclusion of performance measures in an open-end registered investment company advertisement that are not subject to any prescribed method of computation, provided (among other things) that these other performance measures are accompanied by certain standardized performance data. See supra note 143 and accompanying text. PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 26803 • What, if any, risks could result from including non-482 performance information in covered investment fund research reports about registered openend investment companies? For example, would the variability of non482 performance information result in investor confusion? Would the inclusion of non-482 performance information result in any of the concerns that the provisions of rule 482 are meant to address, such as disclosing performance without providing adequate disclosure of unusual circumstances that have contributed to performance; without providing adequate disclosure of the performance period (including information about current performance); or without disclosing important context that would permit an investor to evaluate performance (such as the fact that the performance is based on selective dates or time periods)? 160 Would the ability of a covered investment fund to include non-482 performance information incentivize broker-dealers to recast registered investment company advertisements or selling materials as research reports that they could publish or distribute under proposed rule 139b, instead of meeting the requirements of rule 482? To what extent would any such risks be mitigated by regulations that are currently in effect, for example, the rule 156 guidance factors discussed above, or other factors (such as the applicable content standards in SRO rules, such as FINRA rule 2210 161)? • If we were to permit non-482 performance information to appear in covered investment fund research reports about registered open-end investment companies, as proposed, what benefits could result? Would any benefits of the ability to include the non-482 performance information be diminished if the broker-dealer were also required to include the standardized information required by rule 482? 162 • If commenters anticipate that the potential risks of including non-482 performance information in covered investment fund research reports would outweigh the benefits, what action should we take to mitigate these risks? Would these risks be mitigated if we were to incorporate any of the requirements of rule 482 directly into rule 139b? 163 Why or why not? If so, 160 See Rule 482 Amendments Proposing Release, supra note 148. 161 See infra section II.D.1. 162 See supra note 159. 163 Rule 34b–1, which governs the use of registered investment company supplemental sales literature as discussed above, also incorporates E:\FR\FM\08JNP3.SGM Continued 08JNP3 amozie on DSK3GDR082PROD with PROPOSALS3 26804 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules which requirements? For example, should we incorporate a provision in rule 139b stating that, where a registered open-end investment company’s total return or yield is presented in a covered investment fund research report, the presentation must be consistent with the requirements for the presentation of total return or yield in rule 482? Should we include in rule 139b only certain of the requirements in rule 482, such as those listed in paragraphs (d)(5) and (e) of rule 482 for the presentation of other, non-482 conforming performance information measures? • Should we incorporate a requirement in rule 139b relating to the timeliness of performance data about registered investment companies, similar to timeliness of performance requirements for advertising prospectuses under rule 482 164 or supplemental sales literature under rule 34b–1? 165 If so, why? Would unaffiliated broker-dealers have any difficulty obtaining this information in order to comply with such a requirement? Would the inclusion of performance data in covered investment fund research reports entail the same concerns about timeliness that rules 482 and rule 34b–1 are designed to address? Why or why not? • Alternatively, should we incorporate a provision in rule 139b requiring that a research report must include certain disclosures or disclaimers when performance information about registered open-end investment companies is presented as non-482 performance information? For example, should we require that a research report about a registered investment company must incorporate disclosure stating that the document is a research report and is not subject to the Commission’s regulations applicable to sales and advertising? If a covered investment fund research report about a registered open-end investment company includes non-482 performance information, should we require that the research report must disclose the website address for that registered openend investment company (including a hyperlink for research reports in electronic format), to facilitate investor access to total return or yield disclosure that is presented in a manner consistent with the requirements in rule 482? Should we require that the methodology used to calculate the registered openmany of the rule 482 requirements relating to performance disclosure, and a related alternative approach could be to reference the performance presentation requirements of rule 34b–1 in rule 139b. See supra note 144. 164 Rule 482(g) [17 CFR 230.482(g)]. 165 Rule 34b–1(b)(2) [17 CFR 270.34b–1(b)(2)]. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 end investment company’s total return or yield be disclosed, if the research report includes non-482 performance information? • Should we include an instruction in rule 139b on the use of projections that is similar to the instruction on the use of projections in rule 139? Why or why not? If we were to include such an instruction, would the instruction in rule 139 be appropriate to include in rule 139b, or should it be modified in any way? As discussed above, we recognize that the guidance factors set forth under rule 156 of the Securities Act address future investment performance, and similarly, certain SRO rules that would apply to covered investment fund research reports prohibit the prediction or projection of performance.166 D. Role of Self-Regulatory Organizations 1. SRO Content Standards and Filing Requirements for Covered Investment Fund Research Reports SRO Content Standards The FAIR Act contemplates that SRO content standards applicable to research reports would apply to covered investment fund research reports.167 Specifically, the FAIR Act provides that, unless covered investment fund research reports are subject to the content standards in the rules of any SRO related to research reports, these research reports may still be subject to the filing requirements of section 24(b) of the Investment Company Act for the review of investment company sales literature.168 As discussed in more detail below, we are proposing rule 166 See supra paragraph accompanying notes 156– 158. 167 See section 2(b)(4) of the FAIR Act (A covered investment fund research report shall not be subject to section 24(b) of the Investment Company Act of 1940 (15 U.S.C. 80a–24(b)) or the rules and regulations thereunder, except that such report may still be subject to such section and the rules and regulations thereunder to the extent that it is otherwise not subject to the content standards in the rules of any self-regulatory organization related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards.). This provision is relevant only to covered investment funds that are investment companies subject to section 24(b) of the Investment Company Act. For example, registered closed-end investment companies, business development companies, and commodity- or currency-based trusts or funds are covered investment funds that are not subject to section 24(b) of the Investment Company Act. A covered investment fund that is not subject to section 24(b) of the Investment Company Act would have no obligations under that section even if research reports concerning the covered investment fund were not subject to the content standards in the rules of any self-regulatory organization related to research reports. 168 See id. PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 24b–4 to implement this provision of the FAIR Act. Proposed rule 24b–4 provides that a covered investment fund research report about a registered investment company will not be subject to section 24(b) of the Investment Company Act (or the rules and regulations thereunder), except to the extent the research report is otherwise not subject to the content standards in SRO rules related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards.169 Currently, the SRO content standards relevant to communications that would be considered covered investment fund research reports under proposed rule 139b include the applicable content standards of FINRA rules 2210, 2241(c)(1), and 2242(c)(1).170 FINRA’s rule governing communications with the public (FINRA rule 2210) contains general content standards that apply broadly to member communications,171 including broker-dealer research reports. These general content standards require, among other things, that all member communications ‘‘must be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry or service.’’ 172 The FAIR Act does not explicitly refer to specific content standards in SRO rules. It refers more generally to ‘‘the content standards in the rules of any self-regulatory organization related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards.’’ 173 In order to provide clarity and facilitate consistent and predictable application of proposed rule 24b–4, we interpret section 2(b)(4) of the FAIR Act as 169 See proposed rule 24b–4. infra note 174 (discussing the scope of these rules in more detail, including noting that the scope of certain provisions of FINRA rule 2210, and the scope of FINRA rules 2241(c)(1) and 2242(c)(2) generally, apply only to a certain subset of communications that would be considered covered investment fund research reports under proposed rule 139b). 171 See FINRA rule 2210(d)(1). 172 See FINRA rule 2210(d)(1)(A). FINRA rule 2210’s general content standards also provide, among other things, that FINRA members may not ‘‘make any false, exaggerated, unwarranted, promissory or misleading statement or claim in any communication’’ nor ‘‘publish, circulate or distribute any communication that the member knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading.’’ See FINRA rule 2210(d)(1)(B). 173 Section 2(b)(4) of the FAIR Act. 170 See E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 excluding covered investment fund research reports from section 24(b) of the Investment Company Act so long as they continue to be subject to the general content standards in FINRA rule 2210(d)(1) (or substantially similar SRO rules). Accordingly, by operation of proposed rule 24b–4, covered investment fund research reports under proposed rule 139b that otherwise would be subject to section 24(b) of the Investment Company Act would not be subject to that section so long as they remain subject to the general content standards of FINRA rule 2210(d)(1).174 This interpretation is consistent with our belief that it is important for SRO content standards to continue to apply to covered investment fund research reports, especially if, as discussed 174 A subset of communications that would fall within the definition of ‘‘covered investment fund research report’’ under proposed rule 139b also would be subject to additional content-related requirements under FINRA rules that are applicable to certain research reports, but that are more narrowly applicable than the general content standards of FINRA rule 2210(d)(1). However, under our interpretation, whether or not these additional content standards apply to any given covered investment fund research report would not determine the applicability of section 24(b) to that research report under proposed rule 24b–4. A different interpretation could lead to results that we believe could be inconsistent with section 2(b)(4) of the FAIR Act (i.e., if only communications that are subject to additional FINRA content standards discussed in this footnote (e.g., those applicable to retail communications) were excluded from section 24(b) filing requirements). Additional FINRA content-related requirements include the content standards of FINRA rule 2210 that apply only to retail communications (or retail communications and correspondence, as those terms are defined in FINRA rule 2210(a)). See, e.g., FINRA rules 2210(d)(2) (Comparisons), 2210(d)(3) (Disclosure of Member’s Name). Accordingly, covered investment fund research reports that would meet the definition of institutional communications would not be subject to some of the content standards of FINRA rule 2210. These additional requirements also include the content standards incorporated in FINRA rules 2241 and 2242, which apply to certain research reports defined in these FINRA rules. The scope of FINRA rules 2241 and 2242 only includes research reports or debt research reports as defined in these rules, and the definitions of ‘‘research report’’ and ‘‘debt research report’’ in these rules are different than the definitions of ‘‘research report’’ set forth in rule 139 and proposed rule 139b. Under FINRA rule 2241, ‘‘research report’’ is defined as any written (including electronic) communication that includes an analysis of equity securities of individual companies or industries (other than an open-end registered investment company that is not listed or traded on an exchange) and that provides information reasonably sufficient upon which to base an investment decision; similarly, under FINRA rule 2242, ‘‘debt research report’’ is defined as any written (including electronic) communication that includes an analysis of a debt security or an issuer of a debt security and that provides information reasonably sufficient upon which to base an investment decision, excluding communications that solely constitute an equity research report as defined in [FINRA] rule 2241(a)(11).’’ See FINRA rules 2241(a)(11), 2242(a)(3). VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 below, research reports about registered investment companies would no longer be required to be filed pursuant to section 24(b) of the Act or rule 497 under the Securities Act,175 and therefore would no longer be subject to routine review.176 Filing Requirements for Covered Investment Fund Research Reports The FAIR Act, as implemented by proposed rule 24b–4, would modify the filing requirements that currently apply to certain broker-dealer communications regarding registered investment companies. As discussed above, research reports about registered investment companies have historically not been included within the scope of rule 139.177 Therefore, a research report or other communication about a covered investment fund that is a registered investment company, particularly one that contains performance information, would ordinarily have to comply with rule 482.178 Today, registered investment company sales literature, including rule 482 omitting prospectus advertisements, are required to be filed with the Commission under section 24(b) of the Investment Company Act 179 and rule 497 under the Securities Act.180 Rule 24b–3 under the Investment Company Act and rule 497(i) deem these materials to have been 175 See infra discussion at notes 177–181 and accompanying text. 176 Broker-dealer communications that are excluded from, or otherwise not subject to FINRA’s filing requirements may still be reviewed by FINRA, for example, through examinations, targeted sweeps or spot-checks. FAIR Act section 2(c)(2) provides that nothing in the Act shall be construed as in any way limiting ‘‘the authority of any self-regulatory organization to examine or supervise a member’s practices in connection with such member’s publication or distribution of a covered investment fund research report for compliance with applicable provisions of the Federal securities laws or selfregulatory organization rules related to research reports, including those contained in rules governing communications with the public.’’ See also, e.g., FINRA rule 2210(c)(6) (‘‘In addition to the foregoing requirements, each member’s written (including electronic) communications may be subject to a spot-check procedure. Upon written request from [FINRA’s Advertising Regulation] Department, each member must submit the material requested in a spot-check procedure within the time frame specified by the Department.’’). 177 See supra notes 11–15 and accompanying text. 178 See FINRA rule 2210(d)(5) (providing that non-money market fund open-end management company performance data as permitted by rule 482 in retail communications and correspondence must disclose standardized performance information and, to the extent applicable, certain sales charge and expense ratio information); see also supra note 140. 179 See supra note 29. 180 17 CFR 230.497. Rule 497 generally requires investment company prospectuses, including investment company advertisements deemed to be a section 10(b) prospectus pursuant to rule 482, to be filed with the Commission. PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 26805 filed with the Commission if filed with FINRA.181 As discussed in the Economic Analysis below, we anticipate that certain communications that historically have been treated as investment company sales literature, including rule 482 ‘‘omitting prospectus’’ advertisements, would be published or distributed by a broker-dealer as covered investment fund research reports pursuant to the rule 139b safe harbor.182 Such communications that previously had been subject to the filing requirements of section 24(b) no longer would be subject to these requirements by operation of proposed rule 24b–4 because they would be subject to the general content standards of FINRA rule 2210(d)(1).183 FINRA rule 2210 requires the filing of certain communications, including retail communications that promote or recommend a specific registered investment company or family of registered investment companies.184 However, FINRA provides a number of exclusions from the filing requirements.185 For example, with respect to research reports (as that term is defined in FINRA rule 2241),186 FINRA currently excludes from filing those that concern only securities that are listed on a national securities exchange, other than research reports required to be filed with the Commission pursuant to section 24(b) of the Investment Company Act.187 Because covered investment fund research reports would no longer be required to be filed with the Commission pursuant to section 24(b), 181 See supra notes 29, 180. infra section III.C.3. 183 See supra notes 11–15 and accompanying text. A communication that previously had been subject to the filing requirements of rule 497 also would no longer be subject to the rule 497 filing requirements if it were published or distributed by a broker-dealer as a covered investment fund research report, because it would no longer be considered to be a section 10(b) prospectus. See supra paragraph accompanying notes 141–146. 184 See FINRA rule 2210(c)(3) (broker-dealers must file, within 10 business days of first use or publication, retail communications that promote or recommend a specific registered investment company or family of registered investment companies). See generally, FINRA rule 2210(c)(1)– (3). In addition to these FINRA filing requirements, as discussed above, such communications would be required to be filed with the Commission (and are deemed to have been filed with the Commission if filed with FINRA). See supra notes 179–181 and accompanying text. 185 See generally FINRA rule 2210(c)(7). 186 See supra note 11. 187 See FINRA rule 2210(c)(7)(O) (excluding ‘‘[r]esearch reports as defined in Rule 2241 that concern only securities that are listed on a national securities exchange, other than research reports required to be filed with the Commission pursuant to Section 24(b) of the Investment Company Act’’). 182 See E:\FR\FM\08JNP3.SGM 08JNP3 26806 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 proposed rule 24b–4 could have the effect of narrowing the types of communications that would be filed with FINRA (under current FINRA rule 2210) regarding registered investment companies. We note, however, that the FAIR Act’s rules of construction provide that the Act shall not be construed as limiting the authority of an SRO to require the filing of communications with the public if the purpose of such communications ‘‘is not to provide research and analysis of covered investment funds.’’ 188 Therefore, even if the exclusion of covered investment fund research reports from the provisions of section 24(b) affects the applicability of the filing requirements or exclusions under FINRA rule 2210 with respect to covered investment fund research reports, it would not affect FINRA’s authority to require the filing of a communication that is included in the FAIR Act’s definition of ‘‘covered investment fund research report’’ but whose purpose is not to provide research and analysis. In addition, a covered investment fund research report would continue to be subject to FINRA recordkeeping requirements applicable to communications with the public, even if the broker-dealer would not be required to file the research report with FINRA or the Commission.189 We request comment on issues relating to SRO content standards for covered investment fund research reports. • Should we implement FAIR Act section 2(b)(4) through proposed rule 24b–4? Are there any modifications to the proposed rule that we should consider? • Do commenters believe that we should incorporate any of the SRO content standards currently applicable to research reports into rule 139b? If so, which ones and why? 2. SRO Limitations The FAIR Act directs us to provide that SROs may not maintain or enforce any rule that would (i) prohibit the ability of a member to publish or distribute a covered investment fund research report solely because the member is also participating in a registered offering or other distribution of any securities of such covered investment fund; or (ii) prohibit the ability of a member to participate in a 188 See section 2(c)(2) of the FAIR Act. FINRA rule 2210(b)(4)(A) (requiring members to maintain all retail communications and institutional communications for the retention period required by Exchange Act rule 17a–4(b) and in a format and media that comply with Exchange Act rule 17a–4). 189 See VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 registered offering or other distribution of securities of a covered investment fund solely because the member has published or distributed a covered investment fund research report about such covered investment fund or its securities.190 These limitations on an SRO and any rules relating to research reports that an SRO might adopt would not affect the safe harbor provided by proposed rule 139b. To provide additional context for the proposed safe harbor, however, and in light of Congress’s direction that we provide these limitations in implementing the rulemaking required by the FAIR Act, we have set forth these SRO limitations in proposed rule 139b.191 E. Conforming Amendment Rule 101 of Regulation M under the Exchange Act 192 prohibits any person who participates in a distribution from attempting to induce others to purchase securities covered by the rule during a specified period. It provides an exception for certain research activities—namely, the publication or dissemination of any information, opinion, or recommendation—if the conditions of Securities Act rule 138 or rule 139 are satisfied. In light of our proposal of Securities Act rule 139b, we are proposing a corresponding change to the exception contained within rule 101(b)(1) of Regulation M to permit the publication or dissemination of any information, opinion, or recommendation so long as the conditions of proposed rule 139b are satisfied. The proposed conforming amendment is intended to align the treatment of research under proposed rule 139b with the treatment of research under rules 138 and 139 for purposes of Regulation M. In the absence of the conforming amendment, rule 101 could prevent the publication or dissemination of a covered investment fund research report under the proposed rule 139b safe harbor by a broker-dealer that is participating in a distribution that is covered by Regulation M. We believe that such a result would be contrary to the mandate of the FAIR Act. As such, the proposed conforming amendment is intended to harmonize treatment of research under the Securities Act and Exchange Act rules. We request comment on the proposed conforming amendment to Regulation M. • Is the proposed conforming amendment appropriate? 190 Section 2(b)(3) of the FAIR Act. proposed rule 139b(b). 192 17 CFR 242.101(a). 191 See PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 • Are there other conforming amendments to Regulation M or any of our other rules appropriate for consideration based on the FAIR Act? If so, what rules should be amended and why? III. Economic Analysis A. Introduction We are mindful of the costs and benefits of our rules. Section 2(b) of the Securities Act, section 3(f) of the Exchange Act, and section 2(c) of the Investment Company Act state that when the Commission is engaging in rulemaking under such titles and is required to consider or determine whether an action is necessary or appropriate in (or, with respect to the Investment Company Act, consistent with) the public interest, the Commission shall consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.193 Additionally, Exchange Act section 23(a)(2) requires us, when making rules or regulations under the Exchange Act, to consider, among other matters, the impact that any such rule or regulation would have on competition and states that the Commission shall not adopt any such rule or regulation which would impose a burden on competition that is not necessary or appropriate in furtherance of the Exchange Act.194 The economic analysis proceeds as follows. We begin with a discussion of the baseline used in the analysis. We then discuss the proposed rules’ costs and benefits, as well as their effects on efficiency, competition, and capital formation compared to the baseline. Where possible, we attempt to quantify the economic effects we discuss. However, we cannot produce reasonable estimates for most of the effects. In such cases we instead provide qualitative economic assessments. B. Baseline The Commission’s economic analysis evaluates the costs and benefits of the proposed rule relative to a baseline that represents the best assessment of relevant markets and market participants in the absence of the proposed rule. In this section, we begin by characterizing the relevant market structure and participants.195 We then 193 15 U.S.C. 77b(b), 15 U.S.C. 78c(f), 15 U.S.C. 80a–2(c), and 15 U.S.C. 80b–2(c). 194 15 U.S.C. 78w(a)(2). 195 To characterize the baseline, we rely on data from year-end 2017 where possible; however, in some cases, timing issues related to data availability require us to rely on data from prior periods. E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules The proposed rules would directly affect broker-dealers, but their indirect effects would extend to covered investment funds, other producers of research on covered investment funds, and consumers of information about covered investment funds.196 The ‘‘covered investment fund’’ definition in the FAIR Act and proposed rule 139b has the effect of capturing five common types of investment vehicles: Mutual funds, ETFs, certain currency and commodity exchanged traded products (‘‘ETPs’’),197 closed-end funds, and BDCs.198 As shown in Figure 1, the universe of covered investment funds is large. At the end of 2017, there were 196 The proposed rules, through their effects on capital formation, may also affect securities issuers more broadly. See infra section III.C.5. 197 Exchange-traded trusts with assets consisting primarily of commodities, currencies, or derivative instruments that reference commodities or currencies, commonly referred to as currency ETPs and commodity ETPs, and which are not registered under the Investment Company Act; see proposed rule 139b(c)(2)(ii). 198 See supra section II.A.3. 199 Mutual fund, ETF, and ETP statistics based on data from CRSP mutual fund database (2017Q3). Closed-end fund statistics based on data from CRSP monthly stock file (Dec. 2017). BDC statistics based on Commission’s listing of registered BDCs. amozie on DSK3GDR082PROD with PROPOSALS3 1. Market Structure and Market Participants VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 PO 00000 Frm 00021 Fmt 4701 Sfmt 4725 11,924 such entities, including 9,564 mutual funds, 1,629 ETFs and ETPs, 596 closed-end funds, and 135 BDCs.199 The total public market value of covered investment funds exceeds $20 trillion. Of this total, $17 trillion is held through shares issued by open-end mutual funds, $3 trillion through shares of ETFs and ETPs, $317 billion through shares of closed-end funds, and $27 billion through shares of BDCs.200 BILLING CODE 8011–01–P Securities and Exchange Commission, Business Development Company Report: January 2012– September 2017 (Sept. 19, 2017), available at https://www.sec.gov/open/datasets-bdc.html. 200 See supra note 199. Market value of BDC shares based on information obtained from Compustat and Audit Analytics. E:\FR\FM\08JNP3.SGM 08JNP3 EP08JN18.000</GPH> a. Covered Investment Funds proceed to describe the relevant regulatory structure. 26807 26808 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules Covered investment fund shares represent a significant fraction of investment assets held by U.S. residents. Approximately one-third of U.S. corporate equity issues, one-quarter of U.S. municipal securities, one-fifth of corporate debt, one-fifth of U.S. commercial paper, and one-tenth of U.S. treasury and agency securities are held through covered investment funds.201 Mutual funds comprise the bulk (84%) of covered investment funds.202 Nearly half of U.S. households hold mutual fund shares 203 and the vast majority (89%) of mutual fund shares are held 201 See Investment Company Institute, 2017 Investment Company Fact Book (2017), available at https://www.icifactbook.org/ (‘‘ICI Fact Book’’). 202 See supra note 200. 203 See Investment Company Institute, Ownership of Mutual Funds, Shareholder Sentiment, and Use of the internet (2017), available at https:// www.ici.org/pdf/per23-07.pdf. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 through retail accounts (i.e. accounts of retail investors, or households).204 Consequently, at least 75% of the public market value of all covered investment funds are held through retail accounts. By analyzing institutional holdings from year-end 2016 Form 13F filings we estimate that across ETF and ETPs, the mean institutional holding 205 was 50%.206 For BDCs, we estimate the mean institutional holding was 33%, while for closed-end funds, we estimate the mean institutional holding was 23%. Based on these figures, we further estimate that shares representing 87% of the public market value of all covered investment funds are held through retail accounts.207 As depicted in Figure 3, the covered investment fund market is dynamic. In 204 Percentage by value. See ICI Fact Book, supra note 201, at 30. Excluding money market funds (‘‘MMF’’), mutual fund shares held in retail accounts make up an even larger fraction (95%) of mutual fund shares. 205 We calculated ‘‘institutional holding’’ as the sum of shares held by institutions (as reported on Form 13F filings) divided by shares outstanding (as reported in CRSP). 206 Year-end 2016 Form 13F filings were used to estimate institutional ownership. Closed-end funds were matched to reported holdings based on CUSIP. We note that there are long-standing questions around the reliability of data obtained from 13F filings. See Anne M. Anderson, & Paul Brockman, Form 13F (Mis)Filings, SSRN Scholarly Paper. Rochester, NY: Social Science Research Network (Oct. 15, 2016), available at https:// papers.ssrn.com/abstract=2809128. See also Securities and Exchange Commission, Office of Inspector General, Office of Audits, Review of the SEC’s Section 13(f) Reporting Requirements (2010). 207 Staff calculated the percentage of net asset value held by institutions reported on Form 13F for ETFs, ETPs and BDCs as public market value of shares held by institutions divided by public market value of all shares. Mutual funds shares are generally not required to be reported on Form 13F. We estimate institutional ownership of non-MMF mutual funds using ICI Fact Book estimate (95%). See supra note 204 and accompanying text. PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 E:\FR\FM\08JNP3.SGM 08JNP3 EP08JN18.001</GPH> amozie on DSK3GDR082PROD with PROPOSALS3 BILLING CODE 8011–01–C Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules merged into other covered investment funds.208 We are requesting comments on our characterization of the covered investment fund market and data to help us further describe this market and current market practices. • Do commenters agree with our characterization of the covered investment fund market? Do commenters agree with our characterization of ownership patterns? Are there ways to improve our estimates? • Do commenters believe that our estimates of institutional ownership of covered investment funds are accurate? If not, are there ways to improve our estimates? Do commenters believe that our estimates of institutional ownership of different types of covered investment fund shares (e.g., mutual funds, ETFs, ETPs, BDCs) include shares held in street name where the beneficial owners are retail investors? • Do commenters believe that our estimates of institutional holdings of covered investment funds represent securities held for investment or securities held for other purposes (e.g. market-making inventory, proprietary trading)? 208 See supra note 199. VerDate Sep<11>2014 17:21 Jun 07, 2018 b. Broker-Dealers The broker-dealers directly affected by the proposed rules are those who participate in registered offerings of covered investment funds while at the same time publishing or distributing information about those funds. The Commission does not have comprehensive data on the number or characteristics of broker-dealers currently publishing and distributing communications about covered investment funds, the extent of their communications, and their distribution arrangements with covered investment funds. Therefore we rely on inferences based on the data that are available 209 and make certain assumptions when characterizing the baseline. We believe that broker-dealers that do not derive revenues from the distribution of covered investment funds are less likely to be directly 209 We rely here primarily on broker-dealers’ quarterly FOCUS reports. Jkt 244001 PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 E:\FR\FM\08JNP3.SGM 08JNP3 EP08JN18.002</GPH> amozie on DSK3GDR082PROD with PROPOSALS3 2017, 638 covered investment funds were created, while 853 were closed or 26809 26810 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules investment funds varies widely.214 However, in aggregate, these revenues accounted for 13% of affected brokerdealers’ total revenues.215 For comparison, among the affected brokerdealers, revenues from brokerage trading commissions and account management accounted for 9%, and 20% of total revenues, respectively, while revenues from propriatery trading and underwriting accounted for 4% and 8% of total revenues, respectively. c. Research on Covered Investment Funds The Commission does not have comprehensive data on broker-dealers that publish or distribute research reports on entities that would be included within the definition of ‘‘covered investment fund’’ under proposed rule 139b.216 The Commission estimates that in 2017, there were 1,417 broker-dealers that reported revenues from the distribution of covered investment funds.217 We assume that these broker-dealers would have incentives to publish or distribute research reports about covered investment funds. However, due to the large number of covered investment funds, we do not expect that many broker-dealers’ in-house research departments (if they have such 212 The sum of FOCUS Supplemental Statement of Income items: 13970 (‘‘revenues from sales of investment company shares’’), 11094 (‘‘12b–1 fees’’), and 11095 (‘‘mutual fund revenue other than concessions or 12b–1 fees’’). 213 We describe these dealers as ‘‘affected,’’ but note that the degree to which they are affected will vary based on individual characteristics. Other things being equal, we expect broker-dealers that are currently more active in the marketing of covered investment funds would be more affected. 214 This suggests that the degree to which the ‘‘affected’’ broker-dealers are affected by the proposed rule will also vary widely. 215 Estimates are based on staff analysis of FOCUS filings. 216 See supra section III.B.1.b. 217 See id. 210 We believe that broker-dealers that do not participate in the distribution of covered investment funds are less likely to publish or distribute research reports about such funds and— to the extent that they do—may not derive significant benefits from the safe harbor of proposed rule 139b. 211 See supra section III.B.1.a. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 E:\FR\FM\08JNP3.SGM 08JNP3 EP08JN18.003</GPH> covered investment funds exceeded $28 billion, or 9% of total broker-dealers’ revenues. Of these 3,882 broker-dealers, 1,417 reported revenues from the distribution of investment company shares. These 1,417 ‘‘affected’’ brokerdealers accounted for 74% of total broker-dealer revenues and 59% of total broker-dealer assets.213 As shown in Figure 4, among the affected brokerdealers, the importance of revenues from the distribution of covered We are seeking comment on our assumptions used in characterizing this market. • Do commenters agree with our estimates of the immediately-affected broker-dealers based on revenue from sales of investment company shares? If not, what other proxy would be more appropriate? amozie on DSK3GDR082PROD with PROPOSALS3 affected by the proposed rules.210 As discussed above, registered investment companies represent the vast majority of covered investment funds.211 Brokerdealers report revenues from the distribution of investment company shares in regulatory filings,212 and we use this to estimate broker-dealers’ revenues from distribution of covered investment funds. We estimate that for the 3,882 broker-dealers active in 2017, revenues related to distribution of Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules departments) are currently capable of providing research on a large percentage of covered investment funds. As discussed above, ‘‘research reports’’ pertaining to most covered investment funds are not specifically addressed in existing Commission or SRO rules.218 Consequently, it is not possible to identify which broker-dealer communications under the baseline would be considered ‘‘research reports’’ as defined in proposed rule 139b. However, we understand that some broker-dealers have published and distributed communications styled as ‘‘research reports’’ in compliance with rule 482 under the Securities Act.219 FINRA member firms—the vast majority 220 of broker-dealers—file these communications with FINRA.221 The number of communications filed with FINRA help to provide a baseline estimate of the number of communications currently published or distributed by broker-dealers that could potentially be considered ‘‘research reports’’ under proposed rule 139b. FINRA staff have reported reviewing 47,707 filings subject to rule 482 in 2017. FINRA staff reviewed an additional 8,528 communications that are subject to Investment Company Act rule 34b–1, for a total of 56,235 communications.222 There are several factors that limit our ability to extrapolate from these estimates the number of communications that brokerdealers currently publish or distribute that would satisfy the definition of ‘‘covered investment fund research report’’ under proposed rule 139b. First, these data do not reflect the affiliate exclusion incorporated in the proposed rule 139b definition of ‘‘covered investment fund research report,’’ which would have the effect of excluding from the proposed safe harbor research reports that are published or distributed by persons covered by the affiliate exclusion.223 Second, the data do not include communications about 218 See supra note 174 and accompanying text. supra note 101. 220 Based on staff analysis of FOCUS filings, we estimate that as of year-end 2016, there were 3,882 registered broker-dealers, 3,755 of which were members of FINRA. 221 See supra note 181 and accompanying text. 222 Under rule 34b–1, ‘‘sales literature’’ required to be filed by section 24(b) shall have omitted to state a fact necessary in order to make the statements made therein not materially misleading unless the sales literature includes certain specified information. See rule 34b–1 [17 CFR 270.34b–1]; see also supra notes 144–145 and accompanying text. Of the 47,707 filings subject to rule 482, 229 were also subject to rule 34b–1. These 229 are not included in the 8,528 figure. Statistics provided by FINRA. 223 See supra note 36 and accompanying text. amozie on DSK3GDR082PROD with PROPOSALS3 219 See VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 entities that would be considered ‘‘covered investment funds,’’ but that do not need to comply with the requirements of rule 482 (e.g., commodity- or currency-based trusts or funds). Third, for those communications that are currently filed as rule 482 advertising prospectuses or rule 34b–1 supplemental sales literature, we are uncertain what percentage of these communications brokers dealers would continue to structure as rule 482 advertising prospectuses or rule 34b–1 supplemental sales literature, as opposed to publishing or distributing them as covered investment fund research reports under the proposed rule 139b safe harbor. We have also analyzed the number of ‘‘research reports’’ as defined under FINRA rules 2241 and 2242 that FINRA staff reviewed in 2017. However, for reasons discussed below, we also believe that these data have limited value in assessing the number of covered investment fund research reports whose publication or distribution could be eligible for the safe harbor under proposed rule 139b. FINRA reviewed 354 filings in 2017 that were identified as ‘‘research reports’’ as defined in FINRA rules 2241 and 2242. However, the definitions of ‘‘research report’’ and ‘‘debt research report’’ under FINRA rules 2241 and 2242, respectively, do not correspond in every respect to the term ‘‘research report’’ as defined in the FAIR Act and proposed rule 139b. Under FINRA rule 2241, the term ‘‘research report’’ includes any written communication that includes an analysis of equity securities (other than mutual fund securities) and that provides information reasonably sufficient upon which to base an investment decision.224 Under FINRA rule 2242, the term ‘‘debt research report’’ includes any written communication that includes an analysis of a debt security or an issuer of a debt security and that provides information reasonably sufficient upon which to base an investment decision.225 As discussed above, the FAIR Act and proposed rule 139b definition of ‘‘research report’’ would not require a communication to provide information reasonably sufficient upon which to base an investment decision.226 Also, unlike the definition of ‘‘research report’’ in FINRA rule 2241, the FAIR Act and proposed rule 139b definitions of ‘‘research report’’ would include communications about 224 See FINRA rule 2241(a)(11). FINRA rule 2242(a)(3). 226 See supra note 44 and accompanying text. 225 See PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 26811 mutual funds. Thus, while the number of ‘‘research reports’’ as defined in FINRA rules 2241 and 2242 that FINRA staff has historically reviewed provides an estimate of a subset of communications currently being styled as research reports whose publication or distribution could be eligible for the proposed rule 139b safe harbor, this number would represent only a small portion of the complete universe of research reports whose publication or distribution could be eligible for this safe harbor. We also understand that the reported number of ‘‘research reports’’ as defined in FINRA rules 2241 and 2242 that FINRA staff has historically reviewed also could relate to research reports for securities products other than entities that would be considered ‘‘covered investment funds’’ (e.g., certain stocks, bonds, or master limited partnership interests). In addition to broker-dealers, various firms that are independent of the offering process currently provide data and analysis on different subsets of the covered investment fund universe (e.g., through subscription services or through licensing agreements with brokerdealers). Because data and analysis provided by these firms play an important role in investors’ information environment under the baseline, these firms would be affected by changes to the competitive environment resulting from the proposed rules.227 We understand that communications styled as research reports on covered investment funds distributed by brokerdealers may rely on information obtained from these independent sources. In particular, we understand that information that is commonly provided by these independent firms may include: (1) Information obtained from regulatory filings, such as narrative descriptions of fund objectives, information about key personnel, performance history, fees, and top holdings; (2) statistics and other information derived from public, proprietary, and licensed data sources, such as risk exposures (e.g., geographic, sectoral), quantitative characteristics (e.g., beta, correlations, tracking error), and peer group; and (3) fund ratings. The fund ratings that independent firms may provide are generally based on methodologies proprietary to each firm.228 227 See infra section III.C.5. e.g., Zacks Investment Research, ETF Rank Guide (Mar. 12, 2013), available at https:// www.zacks.com/stock/news/94561/zacks-etf-rankguide; Morningstar, Morningstar’s Two Rating for Assessing a Fund (2014), available at https:// corporate1.morningstar.com/Documents/UK/ 228 See, E:\FR\FM\08JNP3.SGM Continued 08JNP3 26812 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules We are seeking comment on our characterization of the market for research reports on covered investment funds. • What other data are available on broker-dealers’ current publication or distribution of research reports on entities that would be included within the definition of ‘‘covered investment fund’’ under proposed rule 139b? On the scope of their coverage? On their consumers? • Do commenters agree with our characterization of the data and analysis on covered investment funds that is provided by independent (non-brokerdealer) research firms? Are there significant gaps or limitations to the information and analysis on covered investment funds provided by such firms? 2. Regulatory Structure a. Current Legal and Regulatory Framework Applicable to Statements Included in Covered Investment Fund Research Reports amozie on DSK3GDR082PROD with PROPOSALS3 As discussed above, the rule 139 safe harbor is currently not available for broker-dealers that publish or distribute research reports about most covered investment funds.229 A broker-dealer’s publication or distribution of a covered investment fund research report could therefore be deemed to constitute an offer that otherwise could be a nonconforming prospectus whose use in the offering may violate section 5 of the Securities Act.230 We understand that some broker-dealers currently publish and distribute communications styled as ‘‘research reports’’ regarding covered investment funds in compliance with rule 482 under the Securities Act.231 Unlike research reports covered under the rule 139 safe harbor, broker-dealers’ publication or distribution of rule 482 advertisements could subject the brokerdealer to liability under section 12(a)(2) Landing/Morningstars-Two-Ratings-For-AssessingA-Fund/; and McGraw Hill Financial, S&P Capital IQ’s Mutual Fund Ranking Methodology, available at https://marketintelligence.spglobal.com/ documents/products/Mutual_Fund_Methodology_ v2.pdf. 229 Among covered investment funds, only issuers that register their offerings under the Securities Act (certain commodity and currency ETPs eligible to use Form S–3) qualify for inclusion in research reports under the rule 139 safe harbor. See supra note 11–15 and accompanying text. 230 See supra note 13 and accompanying text. 231 Research reports regarding covered investment funds could also be distributed today as ‘‘supplemental sales literature’’ under rule 34b–1 under the Investment Company Act. However, research reports distributed under rule 34b–1 would need to be preceded or accompanied by a statutory prospectus. See supra note 144 and accompanying text. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 of the Securities Act 232 In addition, rule 482 advertisements are subject to requirements on the standardized presentation of performance information.233 Additionally, certain SRO rules governing content standards may apply to communications that would be considered covered investment fund research reports under proposed rule 139b or advertisements styled as ‘‘research reports’’ under rule 482. These include FINRA rule 2210 which contains general content standards that apply broadly to member communications.234 In addition, covered investment fund research reports pertaining to funds other than open-end registered investment companies that are not listed or traded on an exchange (i.e., ETFs, ETPs, closedend funds, and BDCs) may be subject to FINRA rules 2241 and 2242 governing content standards of ‘‘research reports’’ as defined by FINRA.235 Exposure to liability under section 12(a)(2) of the Securities Act, rule 482 requirements on the standardized presentation of performance information, and the various aforementioned FINRA rules impose costs on broker-dealers. These include conduct costs resulting from additional liability (e.g. foregoing publication of certain reports), and compliance costs associated with the relevant content standards. We are not able to quantify these costs and are seeking comments on our characterization of these costs: • What do commenters view as the most significant costs associated with distributing and publishing research reports on covered investment funds under existing regulation? Can commenters quantify these costs? 232 Section 12(a)(2) provides express remedies to the person purchasing the security (i.e., a private right of action) for material misstatements and omissions made by any seller of the security. It also provides a different standard for claims for damages than under Exchange Act rule 10b–5, which requires proof of scienter in the representations made. See 15 U.S.C. 77l(a)(2); see also rule 10b–5 [17 CFR 240.10b–5]. 233 Research reports that are published or distributed as rule 34b–1 supplemental sales literature also would be subject to requirements relating to the standardized presentation of performance information, because rule 34b–1 incorporates many of the rule 482 requirements relating to performance disclosure. See supra notes 231, 145. 234 See FINRA rule 2210(d)(1). 235 See supra note 174 (discussing the scope of these rules in more detail, including noting that the scope of FINRA rules 2241(c)(1) and 2242(c)(2) generally apply only to a subset of communications that would be considered covered investment fund research reports under proposed rule 139b). PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 b. Current Filing Requirements As discussed above, the rule 139 safe harbor currently is not available for broker-dealers’ publication and distribution of research reports about specific registered investment companies and BDCs.236 Therefore, a research report or other communication about a covered investment fund that is a registered investment company would have to comply with the requirements of Securities Act rule 482.237 Today, registered investment company sales material, including rule 482 ‘‘omitting prospectus’’ advertisements as well as supplemental sales literature,238 are required to be filed with the Commission under section 24(b) of the Investment Company Act.239 Brokerdealers that are FINRA members are also subject to certain additional filing requirements under current FINRA rule 2210.240 C. Costs and Benefits In this section, we first consider the overarching costs and benefits associated with the FAIR Act’s statutory mandates. Second, we evaluate the costs and benefits of the specific proposed provisions and their relation to the overarching considerations resulting from the statutory mandate. Next, we discuss the effects on efficiency, competition, and capital formation of the proposed rules. We conclude with a discussion of alternatives considered. 1. FAIR Act Statutory Mandate a. Benefits We believe that the proposed expansion of the rule 139 safe harbor (as mandated by the FAIR Act) will generally reduce broker-dealers’ costs of publishing and distributing research reports about covered investment funds. These cost reductions are expected because under the proposed rules a broker-dealer could publish or distribute covered investment fund 236 See supra note 15. FINRA rule 2210(d)(5) (providing that non-money market fund open-end management company performance data as permitted by rule 482 in retail communications and correspondence must disclose standardized performance information and, to the extent applicable, certain sales charge and expense ratio information); see also supra note 178. 238 See supra note 231. 239 Rule 24b–3 under the Investment Company Act deems these materials to have been filed with the Commission if filed with FINRA. See supra note 29. 240 FINRA rule 2210’s filing requirements include a number of exclusions, including an exclusion for certain research reports, except that broker-dealers are required to file research reports with FINRA if they are also required to be filed with the Commission pursuant to section 24(b) of the Investment Company Act. See supra notes 167–169, and accompanying text. 237 See E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules research reports without reliance on rule 482 or rule 34b–1 and without being required to file these reports under section 24(b) of the Investment Company Act and the rules and regulations thereunder.241 Brokerdealers publishing or distributing covered investment fund research reports in reliance on the expanded safe harbor would not be subject to the liability provisions of section 12(a)(2) of the Securities Act,242 the content requirements of rule 482 or rule 34b–1, or the filing requirements of section 24(b) of the Investment Company Act.243 Thus, they would be expected to incur lower costs associated with liability under section 12(a)(2), lower conduct costs, and lower compliance costs (including fewer content and filing requirements).244 Because of these cost reductions, we expect publication and distribution of such reports to increase. First, we expect that certain brokerdealers that had previously published and distributed communications under rule 482 that could be styled as ‘‘research reports’’ would aim to meet the conditions of the expanded safe harbor and increase their supply of covered investment fund research as a result. Second, we expect some brokerdealers that have previously not published or distributed such reports (due to the activity being deemed too costly or subject to too many restrictions), to begin doing so. We believe that the aforementioned effects will generally benefit broker-dealers and advisers to covered investment funds if, as we expect, they increase brokerdealers’ sales of covered investment funds. Because there is limited historical experience dealing specifically with broker-dealers’ research reports on covered investment funds, there is little in the way of direct empirical evidence on the value of such reports to investors. Prior research on the informativeness of broker-dealers’ research on operating companies suggests that broker-dealers can produce research that positively contributes to the information content of market prices,245 and—perhaps more 241 See supra section II.D.1. supra note 232. 243 See supra section II.D.1. 244 We note, however, that we would not expect any lower costs of compliance for any research reports that currently are structured as rule 34b–1 supplemental sales literature (and are not rule 482 advertising prospectuses), because supplemental sales literature is not an ‘‘offer’’ to which prospectus liability under section 12(a)(2) of the Securities Act would attach. 245 See, e.g., Brad M. Barber, Reuven Lehavy, & Brett Trueman, Ratings changes, ratings levels, and the predictive value of analysts’ recommendations, 39 Financial Management 2, 533–553 (2010) amozie on DSK3GDR082PROD with PROPOSALS3 242 See VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 importantly—that broker-dealers may enjoy a comparative advantage in its production.246 However, other studies have questioned the investment value of such research to investors247 or its continued relevance.248 We are cautious in drawing implications from these findings to broker-dealers’ research on covered investment funds. While analysts researching operating companies generally endeavor to identify mispricing—to forecast the idiosyncratic component of firms’ future returns— covered investment funds represent portfolios of securities, and many covered investment funds are priced at net asset value (‘‘NAV’’).249 Although individual securities within a covered investment fund’s portfolio may be (broker-dealers’ research analysts’ upgrades (downgrades) elicit positive (negative) price reactions, respectively). See also Scott E. Stickel, The Anatomy of the Performance of Buy and Sell Recommendations, 51 Financial Analysts Journal 5, 25–39 (Sept. 1, 1995) (broker-dealers’ research provides new information, particularly for smaller firms, where information is less generally available). See also Kent L. Womack, Do Brokerage Analysts’ Recommendations Have Investment Value?, 51 The Journal of Finance 1, 137–167 (1996) (price reactions are permanent and exhibit post-announcement drift). 246 See, Boris Groysberg, Paul Healy & Craig Chapman, Buy-Side vs. Sell-Side Analysts’ Earnings Forecasts, 64 Financial Analysts Journal 4, 25–39 (July 1, 2008) (informativeness of broker-dealers’ sell-side research is superior to that of buy-side firms). 247 See Brad Barber, Reuven Lehavy, Maureen McNichols & Brett Trueman, Can Investors Profit from the Prophets? Security Analyst Recommendations and Stock Returns, 56 The Journal of Finance 2, 531–563 (Apr. 1, 2001) (investors hoping to exploit research analysts’ recommendations must trade frequently and these transaction costs often exceed the gains from trading); see also Xi Li, The persistence of relative performance in stock recommendations of sell-side financial analysts, Journal of Accounting and Economics 40.1–3, 129–152 (2005). See also Narasimhan Jegadeesh, Joonghyuk Kim, Susan D. Krische & Charles M.C. Lee, Analyzing the Analysts: When Do Recommendations Add Value?, 59 The Journal of Finance 3, 1083–1124 (2004) (significant portion of investment value may be attributable to previously documented trading signals, with little incremental value attributable to the broker-dealer research). See also Yongtae Kim & Minsup Song, Management Earnings Forecasts and Value of Analyst Forecast Revisions, 61 Management Science 7, 1663–1683 (2015) (past estimates of the informativeness of analyst recommendations may be confounded by the impact of forecasts issued by management). 248 See Oya Alt(nk(l(c, Robert S. Hansen & Liyu ¸ Ye, Can analysts pick stocks for the long-run?, 119 Journal of Financial Economics 2, 371–398 (Feb. 2016) (reductions in transactions costs and increases in computational speed reduced the amount of new information available for analysts to discover). 249 Closed-end funds, for example, are not priced on a NAV basis and their (mis-) pricing has long served as a puzzle in the finance literature. See, e.g., Charles M.C. Lee, Andrei Schleifer, & Richard H. Thaler, Investor Sentiment and the Closed-End Fund Puzzle, 46 The Journal of Finance 1 (Mar. 1991). Similar pricing issues may arise in BDCs. PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 26813 individually viewed as ‘‘mispriced’’ by a research analyst, diversification effects will tend to drown out such effects at the fund level and minimize idiosyncratic variation in investors’ return on their investment in the fund. Therefore, any ‘‘investment value’’ 250 of research on covered investment funds would likely be rooted in analysts’ ability to predict broader market movements. Such ability is generally believed to be rather rare.251 We therefore believe that the value to investors of information in brokerdealers’ research reports will largely be limited to the synthesis or discovery of factual information about fund characteristics, fees, or other transactions costs. For example, investors may find analysts’ views of a fund’s management, objectives, risk exposures, tracking error, volatility, tax efficiency, fees, or other fund characteristics to be valuable. Such analysis could be valuable a source of information for investors evaluating relative fund performance.252 We believe that the quantity of information available to potential investors of covered investment funds would increase as a result of brokerdealers’ increased publication and distribution of covered investment fund research reports. The proposed rules will also allow for greater flexibility in the type of information that brokerdealers may communicate to customers.253 To the extent that this new information is valuable, it will benefit investors by providing them with additional information to help shape investment decisions. Finally, we believe that important negative information about a covered investment fund, such as high fees, high risk exposure, or an inefficient portfolio strategy will be more likely to be publicized as a result of increased competition among information providers, with attendant benefits to investors.254 We request comment generally on the benefits that we anticipate may arise 250 We mean this in the sense of providing a signal about future investment performance. 251 See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman, & Russ Wermers, Measuring Mutual Fund Performance with CharacteristicBased Benchmarks, 52 The Journal of Finance 3, 1035–1058 (July 1997). 252 See, e.g., W.J. Armstrong, Egemen Genc & Marno Verbeek, Going for Gold: An Analysis of Morningstar Analyst Ratings, Management Science (Aug. 2017). 253 Currently such communications would be subject to rule 482 requirements, including standards on the presentation of performance information. See supra section II.C. 254 See Matthew Gentzkow & Jesse M. Shapiro, Media Bias and Reputation, 114 Journal of Political Economy 2, 280–316 (Apr. 1, 2006). E:\FR\FM\08JNP3.SGM 08JNP3 26814 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules Broker-dealers’ financial incentives to sell covered investment funds could undermine the objectivity of the information they produce about such funds, and the existence of the proposed safe harbor could increase opportunities for broker-dealers to promote funds from which they derive the most financial benefits. If such conflicts are unrecognized by or unknown to investors, they could reduce investor welfare. Although market mechanisms 257 as well as existing regulation 258 may limit the extent of such actions, there is the potential that they could nonetheless impose costs on investors—particularly retail investors.259 The potential for conflicts of interest to lead to actions that impose costs on investors depends in large part on the strength of the underlying incentives. In the context of broker-dealers’ research on covered investment funds, the greatest conflicts of interest are faced by broker-dealers serving as investment advisers to covered investment funds, who—due to asset-based management fees—have strong incentives to increase demand for the funds that they advise. Because the FAIR Act by its terms,260 and also proposed rule 139b,261 would not extend the safe harbor to a brokerdealer that is publishing or distributing a research report about a covered investment fund for which the brokerdealer serves as an investment adviser (or where the broker-dealer is an affiliated person of the investment adviser), we believe that there would be limited potential for the greatest b. Costs Prior experience and academic research suggests that, unchecked, broker-dealers’ conflicts of interest can lead to bias in research reports,255 and that such bias has the potential to adversely affect investor welfare.256 amozie on DSK3GDR082PROD with PROPOSALS3 from proposed rule 139b and proposed rule 24b–4 as a result of the FAIR Act’s statutory mandate. • Do commenters generally agree with our assessment of the cost reductions that we expect to result from the proposed rules? • To what extent would brokerdealers rely on the proposed rule 139b safe harbor to publish or distribute communications that are currently structured as rule 482 advertising prospectuses or rule 34b–1 supplemental sales literature? What would motivate broker-dealers to instead use the proposed rule 139b safe harbor? For example, would brokerdealers expect to incur significantly lower legal and compliance costs and lower costs related to potential litigation due to covered investment fund research reports’ lack of prospectus liability under section 12(a)(2) of the Securities Act under the safe harbor? Alternatively, would the primary cost savings arise in other ways (for example, because covered investment fund research reports would not be subject to section 24(b) filing requirements, including filing and review by FINRA, and would not be subject to the content requirements of rule 482 or rule 34b–1)? What other factors could determine whether a broker-dealer that is currently publishing or distributing communications under rule 482 or rule 34b–1 might continue to do so, even if these communications could fall within the definition of a ‘‘covered investment fund research report’’? • Have we appropriately captured the potential benefits that the proposed rule could generate for investors? 1999) (‘‘Michaely and Womack Article’’) (stock recommendations of affiliated analysts perform worse prior to, at the time of, and subsequent to the recommendation); see also Patricia M. Dechow, Amy P. Hutton & Richard G. Sloan, The Relation between Analysts’ Forecasts of Long-Term Earnings Growth and Stock Price Performance Following Equity Offerings*, 17 Contemporary Accounting Research 1, 1–32 (Mar. 1, 2000). See also Lit. Rel. No. 18438, supra note 37 (The court issued an Order approving a $1.4 billion global settlement of the SEC enforcement actions against several investment firms and certain individuals alleging undue influence of investment banking interests on securities research); see also Deutsche Bank Securities Inc. and Thomas Weisel Partners LLC Settle Enforcement Actions Involving Conflicts of Interest Between Research and Investment Banking, SEC Press Release 2004–120 (Aug. 26, 2004). The settlement was an action in response to conflicts of interest that certain broker-dealers were found to have failed to manage in an adequate or appropriate manner and was modified in 2010 to remove certain requirements where FINRA and NYSE rules addressed the same concerns. See Lit. Rel. No. 21457, supra note 37. 257 See infra section III.C.1.b(2). 258 See infra section III.C.1.b(1). 259 See infra section III.C.1.b(2). 260 See section 2(f)(3) of the FAIR Act. 261 See proposed rule 139b(a). 255 See Amitabh Dugar & Siva Nathan, The Effect of Investment Banking Relationships on Financial Analysts’ Earnings Forecasts and Investment Recommendations*, 12 Contemporary Accounting Research 1, 131–160 (Sept. 1, 1995) (‘‘Dugar and Nathan Article’’) (affiliated analysts issue more optimistic earnings forecasts and investment recommendations about companies with which their firms had an investment banking relationship). See also Hsiou-wei Lin & Maureen F. McNichols, Underwriting Relationships, Analysts’ Earnings Forecasts and Investment Recommendations, 25 Journal of Accounting and Economics 1, 101–127 (Feb. 26, 1998) (‘‘Lin and McNichols Article’’) (affiliated analysts are more optimistic in their longterm growth forecasts and investment recommendations). 256 See Roni Michaely & Kent L. Womack, Conflict of Interest and the Credibility of Underwriter Analyst Recommendations, 12 The Review of Financial Studies 4, 653–686 (July 2, VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 conflicts of interest to impose costs on investors. Other conflicts of interest may nevertheless arise from incentives in fund distribution arrangements.262 Distributing broker-dealers may receive compensation from sales loads, 12b–1 fees,263 shelf space fees, or other revenue sharing agreements, all of which create financial incentives for broker-dealers to promote and sell funds and potentially to promote and sell particular funds or share classes.264 Associated persons of broker-dealers (i.e. analysts) may face similar conflicts of interests arising from incentives in their compensation agreements.265 Finally, broker-dealers may have fewer direct or non-pecuniary incentives.266 However, in all of these cases, the risk 262 See Susan E. K. Christoffersen, Richard Evans & David K. Musto, What Do Consumers’ Fund Flows Maximize? Evidence from Their Brokers’ Incentives, 68 The Journal of Finance 1, 201–235 (Feb. 1, 2013) (where brokers’ compensation arrangements with funds are found to drive their customers’ fund flows). 263 See rule 12b–1 under the Investment Company Act [17 CFR 270.12b–1]. 264 See infra note 278 (noting that the Commission has historically charged broker-dealers with violating sections 17(a)(2) and (3) of the Securities Act for making recommendations of more expensive mutual fund share classes while omitting material facts). 265 Such conflicts of interest arising from incentives in compensation agreements involving research analyst issuing research reports covered by FINRA Rule 2241 are mitigated by FINRA rules 2241(b)(2)(C), (E), (F), and (K). Additionally, section 501(a)(2) of Regulation AC (17 CFR 242.501(a)(2)) requires specific disclosure regarding research analyst compensation in order to mitigate the conflicts of interest that can arise based on analyst compensation arrangements. 266 For example, although it is prohibited conduct, a broker-dealer may have a financial incentive to provide coverage for, or to promote, a fund based on an understanding that the fund will participate in offerings underwritten by the brokerdealer. See, e.g., FINRA rule 2241(b)(2) (requiring that a member’s written policies and procedures must be reasonably designed to, among other things, ‘‘prevent the use of research reports or research analysts to manipulate or condition the market or favor the interests of the member’’); see also NASD Fines U.S. Bancorp Piper Jaffray and Managing Director $300,000, FINRA News Release (June 25, 2002) available at https://www.finra.org/ newsroom/2002/nasd-fines-us-bancorp-piperjaffray-and-managing-director-300000 (announcing settlement with U.S. Bancorp Piper Jaffray and one of its managing directors in which the NASD found that the firm violated a NASD (now FINRA) rule requiring all firms and associated persons to adhere to high standards of commercial honor and just and equitable principles of trade when it threatened to discontinue research coverage of a company if the company did not select it as lead underwriter for an upcoming offering). But see also note 43. Rule 12b–1(h)(1) prohibits funds from compensating a broker-dealer for promoting or selling funds shares by directing brokerage transactions to that broker. See rule 12b–1(h)(1) under the Investment Company Act [17 CFR 270.12b–1(h)(1)]; see also Prohibition on the Use of Brokerage Commissions to Finance Distribution, Investment Company Act Release No. 26591 (Sept. 2, 2004) [69 FR 54727 (Sept. 9, 2004)]. E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules that such conflicts of interest could result in actions that negatively impact information communicated to investors are mitigated by the fact that a brokerdealer will bear the costs of such actions, but generally may be unable to fully appropriate the benefits.267 It is difficult for us to quantify the aforementioned costs in the context of this proposal. We are not aware of any studies directly examining the role that conflicts of interest play in brokerdealers’ research reports on covered investment funds in U.S. markets, or of any data that would support a quantitative analysis of an expanded safe harbor in this context.268 As with the potential benefits discussed above, we are limited to characterizing the potential costs qualitatively. While we believe that expanding the rule 139 safe harbor to broker-dealers’ publication or distribution of covered investment fund research reports has the potential to impose costs on retail investors, existing regulations, specific provisions of the rules that we are proposing,269 and certain market mechanisms would reduce these costs. amozie on DSK3GDR082PROD with PROPOSALS3 (1) Existing Regulation Rules and regulations have been implemented to address potential conflicts of interest that may arise with broker-dealers specifically in the context of research reports.270 As discussed in detail above,271 the definition of ‘‘research report’’ for purposes of Regulation AC and FINRA rule 2241 is narrower than the definition of ‘‘research report’’ for purposes of the FAIR Act and proposed rule 139b. However, to the extent a research report meets both the definition of a research report under proposed rule 139b and the definition of research report as defined in Regulation AC, Regulation AC would be applicable to that research report (and, if it meets 267 For example, if a broker-dealer firm publishes biased research about a fund, some of the gains (i.e. compensation from sales of that fund) may accrue to other broker-dealer firms (i.e. other broker-dealer firms that distribute the same fund) while the costs of the action (i.e., reputation costs, litigation risk, and risk of regulatory action) will be borne entirely by the broker-dealer firm that published the biased research. 268 Authors have examined the impact of conflicts of interest on mutual fund research in China, providing evidence consistent with bias arising from conflicts of interest in that market, though differences between Chinese and U.S. markets and corresponding regulatory frameworks make it difficult to apply inferences drawn from experience in Chinese markets to U.S. markets. See Y. Zeng, Q. Yuan & J. Zhang, Blurred stars: Mutual fund ratings in the shadow of conflicts of interest, Journal of Banking & Finance 60, 284–295 (2015). 269 See infra section III.C.2. 270 See supra note 37. 271 See supra notes 11, 21, 43, and 174. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 the definition of ‘‘research report’’ in FINRA rule 2241, FINRA rule 2241 also would apply if the research report otherwise were within the scope of rule 2241 272). These rules may help promote objective and reliable research.273 Additionally, as described above, FINRA rule 2210 contains general content standards that apply broadly to member communications, including broker-dealer research reports. These general content standards require, among other things, that all member communications ‘‘must be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry or service.’’ 274 If a broker-dealer recommends 275 a covered investment fund to its customers, additional obligations under the federal securities laws and FINRA rules would apply. As a general matter, broker-dealers must deal with their customers fairly 276—and, as part of that obligation, have a reasonable basis for any recommendation.277 Furthermore, 272 See supra note 174. Regulation AC Adopting Release, supra note 37. Several studies have analyzed bias in broker-dealers’ research following the Global Settlement and subsequent regulatory changes, in particular at sanctioned banks. See O. Kadan, L. Madureira, R. Wang, & T. Zach, Conflicts of interest and stock recommendations: The effects of the global settlement and related regulations 22 The Review of Financial Studies 10, 4189–4217 (2009). See also, S.A. Corwin, S.A. Larocque & M.A. Stegemoller, Investment banking relationships and analyst affiliation bias: The impact of the global settlement on sanctioned and non-sanctioned banks, 124 Journal of Financial Economics 3, 614– 631(2017). 274 See supra section II.D.1. 275 See, e.g., Additional Guidance on FINRA’s New Suitability Rule, FINRA Regulatory Notice 12– 25 (May 2012), at Q.2 and Q.3 (regarding the scope of ‘‘recommendation’’) and n.25. 276 See, e.g., Duker & Duker, Exchange Act Release No. 2350 (Dec. 19, 1939), at 2 (Commission opinion) (‘‘Inherent in the relationship between a dealer and his customer is the vital representation that the customer be dealt with fairly, and in accordance with the standards of the profession.’’). 277 See Mac Robbins & Co., Exchange Act Release No. 6846 (July 11, 1962), at 3 (‘‘[T]he making of representations to prospective purchasers without a reasonable basis, couched in terms of either opinion or fact and designed to induce purchases, is contrary to the basic obligation of fair dealing borne by those who engage in the sale of securities to the public.’’), aff’d sub nom., Berko v. SEC, 316 F.2d 137 (2d Cir. 1963). A broker-dealer’s recommendation must also be suitable for the customer. See, e.g., J. Stephen Stout, Exchange Act Release No. 43410 (Oct. 4, 2000), at 11 (Commission opinion) (‘‘As part of a broker’s basic obligation to deal fairly with customers, a broker’s recommendation must be suitable for the client in light of the client’s investment objectives, as determined by the client’s financial situation and needs.’’); see also FINRA Rule 2111.05(b) (‘‘The customer-specific obligation requires that a member or associated person have a reasonable basis to 273 See PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 26815 when making recommendations, brokerdealers may be generally liable under the antifraud provisions if they do not give ‘‘honest and complete information’’ or disclose any material adverse facts or conflicts of interest, including any economic self-interest.278 (2) Market Mechanisms We believe that by facilitating production of information on covered investment funds, the FAIR Act’s mandates will contribute to competition among information providers,279 which we believe can mitigate the effects of conflicts of interest on research reports.280 With respect to brokerdealers’ research on operating companies, analysts’ career concerns 281 believe that the recommendation is suitable for a particular customer based on that customer’s investment profile, as delineated in Rule 2111(a).’’). 278 See, e.g., De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d 1293, 1302 (2d Cir. 2002); Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2d Cir. 1970). Generally, under the antifraud provisions, whether a broker-dealer has a duty to disclose material information to its customer is based upon the scope of the relationship with the customer, which is fact intensive. See, e.g., Conway v. Icahn & Co., Inc., 16 F.3d 504, 510 (2d Cir. 1994) (‘‘A broker, as agent, has a duty to use reasonable efforts to give its principal information relevant to the affairs that have been entrusted to it.’’). For example, where a broker-dealer processes its customers’ orders, but does not recommend securities or solicit customers, then the material information that the broker-dealer is required to disclose is generally narrow, encompassing only the information related to the consummation of the transaction. See, e.g., Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 536 (2d Cir. 1999). The Commission has historically charged broker-dealers with violating sections 17(a)(2) and (3) of the Securities Act for making recommendations of more expensive mutual fund share classes while omitting material facts. See, e.g., In re IFG Network Sec., Inc., Exchange Act Release No. 54127 (July 11, 2006), at 15 (Commission opinion) (registered representative violated 17(a)(2) and (3) by omitting to disclose to his customers material information concerning his compensation and its effect upon returns that made his recommendation that they purchase Class B shares misleading; ‘‘The rate of return of an investment is important to a reasonable investor. In the context of multiple-share-class mutual funds, in which the only bases for the differences in rate of return between classes are the cost structures of investments in the two classes, information about this cost structure would accordingly be important to a reasonable investor.’’). 279 See infra section III.C.5. 280 See Harrison Hong & Marcin Kacperczyk, Competition and Bias, 125 The Quarterly Journal of Economics 4, 1683–1725 (Nov. 1, 2010) (reduction in (analyst) competition resulting from mergers reduces analyst coverage and increases bias in the remaining coverage). 281 See Harrison Hong & Jeffrey D. Kubik, Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts, 58 The Journal of Finance 1, 313–351 (2003) (analysts’ reputation plays a role in the analyst’s career outcome); see also Andrew R. Jackson, Trade Generation, Reputation, and Sell-Side Analysts, 60The Journal of Finance 2, 673–717 (Apr. 1, 2005) see also Lily Fang & Ayako Yasuda, The Effectiveness of Reputation as a Disciplinary Mechanism in Sell- E:\FR\FM\08JNP3.SGM Continued 08JNP3 26816 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 have also been found to have similar effects, and, in principle, broker-dealers’ reputations could as well.282 However, we do not believe that analyst career concerns or broker-dealer reputation will play as significant a role in the context of covered investment fund research reports. Research reports about operating companies have traditionally been provided to institutional investors as part of a bundle of services provided by full-service brokerages.283 In this setting, broker-dealers benefit from institutional customers that are willing to pay for broker-dealers’ additional services (e.g., research).284 They are also generally capable of producing similar reports, and so can evaluate the quality of broker-dealers’ research.285 Thus, institutional investors can provide market discipline: broker-dealers’ provision of low-quality or misleading information could plausibly be discovered and lead to the loss of valuable customer relationships. We do not believe that similar mechanisms would be as effective in the covered investment fund context. We expect broker-dealers to publish and distribute covered investment fund research reports on funds that they distribute to their customers.286 With retail investors, information asymmetries are greater: retail investors do not generally possess the capabilities to replicate an analyst report or evaluate its quality.287 Moreover, the problem of evaluating the performance of analysts is harder in the Side Research, 22 The Review of Financial Studies 9, 3735–3777 (Sept. 1, 2009) (‘‘Fang and Yasuda Article’’) 282 For a discussion of the role of reputation in financial intermediation, see Thomas J. Chemmanur & Paolo Fulghieri, Investment Bank Reputation, Information Production, and Financial Intermediation, 49 The Journal of Finance 1, 57–79 (1994) (‘‘Chemmanur and Fulghieri Article’’). See also Fang and Yasuda Article, supra note 281 (analyst reputation mitigates bias, but institutional reputation does not). 283 See Mehran, Hamid, and Rene M. Stulz, The ´ Economics of Conflicts of Interest in Financial Institutions, 85 Journal of Financial Economics 2, 267–296 (Aug. 1, 2007) (‘‘Mehran and Stulz Article’’). 284 Institutional customers are valuable in that they are willing to pay for brokers-dealers’ additional services (e.g. research). Payments for such services need not be direct and be reflected in (relatively) higher brokerage commissions. See Michael A. Goldstein, Paul Irvine, Eugene Kandel & Zvi Wiener, Brokerage Commissions and Institutional Trading Patterns, 22 The Review of Financial Studies 12, 5175–5212 (Dec. 1, 2009). 285 See id. See also Ulrike Malmendier & Devin Shanthikumar, Are Small Investors Naive about Incentives?, 85 Journal of Financial Economics 2, 457–489 (Aug. 1, 2007) (‘‘Malmendier and Shanthikumar Article’’) (institutions account for bias in analyst’s recommendations while retail investors do not). 286 See supra section III.B.1.c. 287 See Mehran and Stulz Article, supra note 283. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 context of covered investment funds.288 Because institutional investors are not major investors in covered investment funds,289 we believe they are unlikely to provide market discipline in this context,290 and we do not believe that individual retail investors could be similarly effective in this role. Thus, we believe that in the context of covered investment fund research reports, providing market discipline would largely fall on retail investors’ investment advisers. We also acknowledge that bias resulting from conflicts of interest need not adversely impact investors if investors disregard,291 discount,292 or de-bias 293 the recommendations of conflicted analysts.294 We believe however, that retail investors who are primary clientele for covered investment funds are less likely to be aware of potential bias in analysts’ recommendations,295 may fail to de-bias or otherwise condition their trades based on the credibility of the recommendation,296 and could thus be 288 Traditional analyst research reports on operating companies largely focus on firm-specific factors, and thus are more akin to ‘‘stock picking’’ than ‘‘market timing’’: they attempt to forecast the idiosyncratic component of firms’ future returns. Covered investment funds represent portfolios of securities and diversification effects reduce the amount of idiosyncratic variation in their returns. Thus, abstracting from fees, ‘‘fund picking’’ is more akin to ‘‘market timing’’ than ‘‘stock picking.’’ Market timing is a skill that is relatively rare and econometrically difficult to detect. See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman & Russ Wermers. Measuring Mutual Fund Performance with Characteristic-Based Benchmarks, 52 The Journal of Finance 3, 1035–1058 (July 1997). 289 See supra section III.B.1.a 290 See Alexander Ljungqvist, Felicia Marston, et al., Conflicts of Interest in Sell-Side Research and the Moderating Role of Institutional Investors, 85 Journal of Financial Economics 2, 420–456 (Aug. 1, 2007) (securities of interest to institutional investor receive coverage that is less biased). 291 See Dugar and Nathan Article, supra note 255. 292 See Michaely and Womack Article, supra note 256. 293 See Lin and McNichols Article, supra note 255. 294 Institutional market participants generally attribute bias in sell-side analysts’ research reports to conflicts of interest. See Michaely and Womack Article, supra note 256. 295 See Michael B. Mikhail, Beverly R. Walther & Richard H. Willis, When Security Analysts Talk, Who Listens?, 82 The Accounting Review 5, 1227– 1253 (2007) (‘‘Mikhail Walther and Willis Article’’). See also Diane Del Guercio & Paula A. Tkac, Star Power: The Effect of Morningstar Ratings on Mutual Fund Flow, 43 Journal of Financial and Quantitative Analysis 4, 907–936 (Dec. 2008) (retail investors in mutual funds are very sensitive to fund rankings). See Christopher R. Blake & Matthew R. Morey, Morningstar Ratings and Mutual Fund Performance, 35 The Journal of Financial and Quantitative Analysis 3, 451–483 (2000) (mutual fund ranking have little predictive power for future performance). 296 See id. and Malmendier and Shanthikumar Article, supra note 285. PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 led to invest in underperforming securities.297 We request comment generally on the costs that we anticipate may arise from proposed rule 139b and proposed rule 24b–4 as a result of the FAIR Act’s statutory mandate. • Do commenters generally agree with our assessment of the costs that we expect to result from the proposed rules? • Do commenters expect conflicts of interest to materially affect research reports on covered investment funds? If so, in what way? If not, why not? 2. Proposed Rule 139b As discussed above, proposed rule 139b conditions eligibility for the safe harbor on satisfaction of several conditions.298 These conditions are generally modeled on and resemble similar provisions in rule 139 (with differences from rule 139 that the FAIR Act specifically directs, or that tailor the provisions of rule 139 more directly or specifically to the context of covered investment fund research reports).299 We believe that modeling proposed rule 139b on rule 139 will benefit market participants through regulatory consistency and reduced opportunities for investor confusion. We address these conditions in turn in the sections that follow. a. Affiliate Exclusion Under the affiliate exclusion proposed in rule 139b,300 a broker-dealer who is 297 See Mikhail Walther and Willis Article, supra note 295. See also Malmendier and Shanthikumar Article, supra note 285. See also Amanda Cowen, Boris Groysberg & Paul Healy, Which Types of Analyst Firms Are More Optimistic?, 41 Journal of Accounting and Economics 1, 119–146 (Apr. 1, 2006) (finding that analysts at retail brokerage firms are more optimistic than those serving only institutional investors). See Xuanjuan Chen, Tong Yao & Tong Yu, Prudent Man or Agency Problem? On the Performance of Insurance Mutual Funds, 16 Journal of Financial Intermediation 2, 175–203 (Apr. 1, 2007) (underperformance of mutual funds sponsored by insurance companies is attributed to inadequate monitoring by less sophisticated retail customers who are subject to cross-selling efforts by their insurer). See also Daniel Bergstresser, John M.R. Chalmers, and Peter Tufano, Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry, 22 Review of Financial Studies 10, 4129– 4156 (Oct. 2009) (broker-sold mutual funds deliver lower risk-adjusted returns (even before subtracting distribution fees) than direct-sold funds). See also Diane Del Guercio & Jonathan Reuter, Mutual Fund Performance and the Incentive to Generate Alpha, 69 The Journal of Finance 4, 1673–1704 (Aug. 1, 2014) (underperformance of actively managed mutual funds is attributed to the underperformance of funds sold by brokers; the authors find little evidence for underperformance in the subset of funds that are sold directly to investors). 298 See supra section II.B. 299 See supra paragraph accompanying notes 32– 34. 300 See section 2(f)(3) of the FAIR Act. See supra section II.A.1. E:\FR\FM\08JNP3.SGM 08JNP3 amozie on DSK3GDR082PROD with PROPOSALS3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules an affiliate of a covered investment fund (or is an investment adviser or an affiliated person of the investment adviser to a covered investment fund), would not be eligible for the safe harbor of proposed rule 139b when publishing or distributing a research report about that covered investment fund. The economic benefit of the affiliate exclusion is that it reduces the potential for retail investors to receive research reports containing information that was published, distributed, authorized, or approved by persons whose financial incentives create the greatest conflicts of interest.301 The primary cost of the affiliate exclusion will be borne by broker-dealers that both distribute covered investment funds and act as investment advisers to such funds (or do so through affiliated persons). These broker-dealers will be unable to provide research reports to their customers on funds that they (or their affiliated persons) advise.302 In addition, we believe that smaller broker-dealers, and broker-dealers without significant research departments and who would want to rely on pre-publication materials distributed by a covered investment fund, its adviser, or affiliated persons, would also be significantly affected by the proposed rules. We expect covered investment funds and their investment advisers to engage in a broad range of marketing activities to support the distribution of fund shares (particularly in the case of redeemable securities such as those issued by mutual funds), and that funds and their advisers prepare and distribute materials to distributing broker-dealers intended to increase sales. As discussed in section II.A.1, we note that, if a broker-dealer were to publish or distribute a research report that were to include pre-publication materials that were specifically authorized or approved by a person covered by the affiliate exclusion for purposes of inclusion in a research report, this could inappropriately circumvent the affiliate exclusion. This guidance reduces the potential for retail investors to receive research reports containing materials from persons whose financial incentives create the greatest conflicts of interest.303 The proposed affiliate exclusion is also likely to limit the benefits of the proposed rule for certain broker-dealers. Many broker-dealers distributing 301 See supra section III.C.1.b. supra note 21. 303 Persons covered by the affiliate exclusion may have strong financial interests to increase sales of associated covered investment funds. See supra paragraph accompanying note 260. 302 See VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 covered investment fund securities do not have sizeable research departments, and we understand that very few brokerdealers operate at a scale that would allow for comprehensive coverage of the covered investment funds that they distribute. The proposed affiliate exclusion could have the effect of limiting broker-dealers’ ability and willingness to publish and distribute research reports about the funds they distribute: in order to rely on the rule to publish or distribute a covered investment fund research report, these broker-dealers would need to conduct their own research in-house or to rely on independent third-party service providers for their information. We are also seeking commenters’ views on our analysis: • Will the proposed affiliate exclusion reduce the potential for investors to receive research reports that were affected by significant conflicts of interest? • Will smaller broker-dealers, or broker-dealers without significant research departments, be most impacted by the proposed affiliate exclusion (and our guidance on the proposed affiliate exclusion)? If not, which broker-dealers would be most affected, and why? • Are there additional benefits associated with the content and presentation standards that we have not considered? • Are there additional costs associated with content and presentation requirements that we have not considered? b. Regular-Course-of-Business Requirement Under proposed rule 139b, research reports (both issuer-specific research reports and industry research reports) would need to be published or distributed by the broker-dealer in the ‘‘regular course of its business’’ in order to rely on the safe harbor.304 For issuers that do not have a class of securities in ‘‘substantially continuous distribution,’’ issuer-specific research reports that represent the initiation of publication of research reports about the issuer or its securities or reinitiation following discontinuation of publication of such research reports would be deemed to not satisfy the regular-course-ofbusiness requirement.305 The regularcourse-of-business requirement being proposed under rule 139b is similar to that of rule 139, except that, as directed by the FAIR Act, rule 139b specifies that the ‘‘initiation or reinitiation requirement’’ only applies to research 304 See 305 See PO 00000 supra sections II.B.1.c and II.B.2.b. supra note 96 and accompanying text. Frm 00031 Fmt 4701 Sfmt 4702 26817 reports regarding a covered investment fund that does not have a class of securities in substantially continuous distribution.306 Given the breadth of the definition of ‘‘research report’’ under the FAIR Act (and the definition of ‘‘research report’’ that we propose under rule 139b), certain communications that are currently treated as covered investment fund advertisements under Securities Act rule 482 could fall under the proposed rule 139b definition of ‘‘research report.’’ 307 Investors, particularly retail investors, may be unaware of the differences in regulatory status and purpose among the various types of communications regarding registered investment companies and business development companies. This may result in investors not being able to readily discern what constitutes a research report and what constitutes an advertisement about these issuers.308 We believe that broker-dealers that publish or distribute research reports in the regular course of business are more likely to publish analysis that investors recognize as research.309 Therefore, in principle we expect this requirement to benefit investors by reducing opportunities for communications published or distributed under the safe harbor to cause confusion about their intended purpose. However we also believe that establishing whether a research report is published in the ‘‘regular course of business’’ could, in practice, prove uniquely challenging in the covered investment funds context.310 First, in the context of covered investment funds, the distinction between communications intended as sales materials and those intended as research could be difficult to discern. Research reports about debt and equity securities have traditionally been provided to institutional customers as part of the broker-dealer’s collection of services.311 Institutional customers are generally capable of producing similar reports, and so can more readily evaluate the quality of broker-dealers’ 306 See section 2(b)(1) of the FAIR Act; see also supra discussion at note 98. 307 See supra note 102 and accompanying text. 308 See supra paragraph accompanying note 103. 309 See supra paragraph accompanying note 104. 310 See supra requests for comment in section II.B.1.c (requesting comment on the application of the regular-course-of-business requirement in the context of broker-dealers’ publication or distribution of covered investment fund research reports and unique concerns relevant to this context (e.g., whether the proposed requirement should be modified to address broker-dealers that have not previously published or distributed covered investment fund research reports)). 311 See Mehran and Stulz Article, supra note 283. E:\FR\FM\08JNP3.SGM 08JNP3 26818 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 research.312 In these circumstances, broker-dealers have a compelling business rationale for producing highquality research as distinct from sales materials. In contrast, we expect covered investment fund research reports to be produced by broker-dealers that distribute covered investment funds to retail customers.313 With retail investors, information asymmetries are greater: retail investors do not generally possess the capabilities to produce an analyst report or evaluate its quality, and some may have difficulty differentiating between research and sales literature.314 Moreover, the problem of evaluating the performance of research analysts is harder in the context of covered investment funds.315 Thus, we believe that cultivating a reputation for high-quality research is less likely to serve as the primary business rationale for broker-dealers’ publication and distribution of research reports on covered investment funds. Rather, we expect that facilitating the marketing of covered investment funds to customers (so as to increase revenues derived from distribution arrangements) will motivate these activities. In this setting, the distinction between different types of communications is not as clear. Second, we note that the information environment surrounding covered investment funds further complicates establishing whether publishing research reports about covered investment funds is undertaken in the regular course of business. In the context of research reports about operating companies, a research analyst ‘‘following’’ an operating company continually monitors that company so as to provide timely forecasts and recommendations. Because of differences in the nature of covered investment funds and operating companies, we believe that the same is less likely to hold for a research analyst ‘‘following’’ a covered investment 312 See id; see also Malmendier and Shanthikumar Article, supra note 285. 313 See supra section III.B.1.c. 314 See Mehran and Stulz Article, supra note 283. 315 Traditional analyst research reports on operating companies largely focus on firm-specific factors, and thus are more akin to ‘‘stock picking’’ than ‘‘market timing’’: they attempt to forecast the idiosyncratic component of firms’ future returns. Covered investment funds represent portfolios of securities and diversification effects reduce the amount of idiosyncratic variation in their returns. Thus, abstracting from fees, ‘‘fund picking’’ is more akin to ‘‘market timing’’ than ‘‘stock picking.’’ Market timing is a skill that is relatively rare and econometrically difficult to detect. See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman & Russ Wermers. Measuring Mutual Fund Performance with Characteristic-Based Benchmarks, 52 The Journal of Finance 3, 1035–1058 (July 1997). VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 fund.316 We believe that the opportunities for acquiring idiosyncratic information relevant to future returns of covered investment funds are generally more limited: Covered investment funds represent portfolios of securities and diversification effects reduce the value of idiosyncratic (i.e., firm-specific) information.317 Consequently, we expect research analysts ‘‘following’’ covered investment funds to focus instead on information related to fund characteristics (e.g., fees, portfolio composition, or index tracking strategy) and on developments at the sector- or macro-level. Because we do not expect the arrival of such information to be as frequent, we expect that the inclusion of new analysis in research reports about covered investment funds could be more rare than in the context of operating company research reports. Consequently, the publication or distribution of covered investment fund research reports could occur relatively infrequently, or could be driven largely by market-wide factors. This could make it more difficult to establish whether a covered investment fund research report is published in the regular course of business. Due to the aforementioned distinctions in the information environment and business rationale, we believe that the regular-course-ofbusiness requirement in the context of proposed rule 139b may be more challenging to apply in practice than the regular-course-of-business requirement in the context of rule 139. Accordingly, the potential benefits of this requirement in proposed rule 139b may be limited. The effects of the regularcourse-of-business requirement would be clearer in cases where, in the case of issuer-specific research reports, the proposed bright-line ‘‘initiation or reinitiation’’ requirement applies (i.e., where the covered investment fund does not have a class of securities in substantially continuous distribution). For such cases, the regular-course-ofbusiness requirement as proposed would condition the availability of the safe harbor on the research report not representing the initiation or reinitiate of coverage by the broker-dealer publishing or distributing said research report. As the universe of covered 316 The regular course of business requirement generically would require ‘‘research reports’’ to be published or distributed in the regular course of a broker-dealer’s business and would not be limited to covered investment fund research reports. We request comment about what the regular course of business requirement means in the context of covered investment fund research reports. See supra section II.B.1.c (requests for comments). 317 See supra notes 250¥251 and accompanying text. PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 investment funds is dominated by funds with a class of securities that could be considered to be in substantially continuous distribution,318 the brightline test of the regular course of business requirement would impact only a small subset of funds. We are also seeking commenters’ views on our analysis: • Is our assessment of the difficulties associated with establishing whether research reports about covered investment funds are published in the regular course of business accurate? If not, what factors will be indicative of the regular-course-of-business requirement having been satisfied? • Are there additional benefits associated with this requirement that we have not considered? • Are there additional costs associated with this requirement that we have not considered? c. Reporting History and Minimum Market Value Requirements for Issuers Appearing in Issuer-Specific Research Reports Under proposed rule 139b, a brokerdealer’s publication or distribution of issuer-specific research reports would not qualify for the safe harbor unless the covered investment fund included in the report satisfies a minimum public market value threshold of $75 million.319 Issuers would also be required to have been subject to the reporting requirements of the Investment Company Act (for covered investment funds that are registered investment companies) or the reporting requirements under section 13 or 15(d) of the Exchange Act (for covered investment funds that are not registered investment companies) for a period of at least 12 calendar months prior to reliance on the proposed rule as well as to have timely filed all required reports during the preceding 12 months.320 The covered investment funds market is dynamic.321 In 2016, more than six hundred covered investment funds entered the market, while more than seven hundred exited. The entry and exit of covered investment funds creates a situation in which a younger covered investment fund may not be widely followed by market participants.322 318 See supra note 98 and accompanying text. proposed rule 139b(a)(1)(i)(B). 320 Including Forms N–CSR, N–SAR, N–Q, N– PORT, N–MFP, and N–CEN as applicable for registered investment companies, and Forms 10–K, 10–Q, and 20–F as applicable for covered investment funds that are not registered investment companies. See proposed rule 139b(a)(1)(i)(A). 321 See supra section III.B.1.a. 322 In contrast, there were fewer than one hundred U.S. IPOs for operating companies in 2016. 319 See E:\FR\FM\08JNP3.SGM 08JNP3 amozie on DSK3GDR082PROD with PROPOSALS3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules Thus, for covered investment funds, the universe of young—and potentially lessfollowed—issuers is large. Moreover, securities issued by covered investment funds may not be subject to significant levels of market scrutiny. Unlike securities issued by operating companies (that generally have diverse groups of investors, including institutional investors, money managers, arbitrageurs, activist investors, and short sellers), covered investment funds are primarily held by retail investors.323 As covered investment fund shares are not a major component of institutional investors’ portfolios, we believe that they are less likely to garner widespread attention from the types of sophisticated institutional investors most capable of subjecting them to scrutiny.324 We believe that in the context of covered investment funds, where we expect limited market discipline from institutional investors and where large numbers of new funds are created each year, the information available to investors could be sparse. In such an environment, a single ‘‘research report’’ about a covered investment fund could have a disproportionate effect on retail investors’ beliefs about the fund and— in the case of a biased research reports— have a negative effect on investor welfare. We believe that conditioning the availability of the safe harbor on the aforementioned reporting history and market valuation requirements would help restrict the availability of the safe harbor in situations where we expect the information environment to be most limited: for new funds and for funds with niche markets. Moreover, we believe modeling the reporting history and minimum public market valuation requirements on those in rule 139 reduces regulatory complexity and opportunities for investor confusion. Because young and small covered investment funds are relatively common, the costs associated with these conditions on the availability of a safe harbor may be significant. In particular, as shown in Table 1, the $75 million minimum public market valuation condition would limit the availability of the safe harbor with respect to brokerdealers’ publication or distribution of research reports for approximately onethird of all covered investment funds.325 Research reports about nearly half of See Jay Ritter, Initial Public Offerings: Updated Statistics (Aug. 8, 2017), available at https:// site.warrington.ufl.edu/ritter/files/2017/08/ IPOs2016Statistics.pdf. 323 See supra section III.B.1.a. 324 See supra note 290. 325 31% of all covered investment funds have public market valuations less than $75 million. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 extant ETFs, ETPs and BDCs would not qualify for the safe harbor.326 Availability of the safe harbor would be least impacted for research reports on open end-mutual funds and closed-end funds.327 Although young and small funds represent a very small fraction of covered investment fund assets, they are relatively large in number.328 Because nearly one-third of covered investment funds would not satisfy the eligibility criteria for the proposed safe harbor, we believe that those funds would be less likely to receive coverage by brokerdealers insofar as the inability to rely on the proposed safe harbor reduces broker-dealers’ willingness to publish and distribute research reports. TABLE 1—COVERED INVESTMENT FUNDS WITH PUBLIC MARKET VALUE LESS THAN $75 MILLION, AND THE FRACTION OF COVERED INVESTMENT FUND ASSETS HELD BY THESE FUNDS. FOR EACH COVERED INVESTMENT FUND TYPE, WE REPORT THE PERCENTAGE OF FUNDS OF THAT TYPE WITH A PUBLIC MARKET VALUE BELOW $75 MILLION AND THE PERCENTAGE OF COVERED INVESTMENT FUND ASSETS HELD IN FUNDS WITH PUBLIC MARKET VALUES BELOW $75 MILLION. MUTUAL FUND, ETF, AND ETP STATISTICS BASED ON DATA FROM CRSP MUTUAL DATABASE (2017Q3). FUND CLOSED–END FUND STATISTICS BASED ON DATA FROM CRSP MONTHLY STOCK FILE (DEC. 2017). BDC STATISTICS BASED ON COMMISSION’S LISTING OF REGISTERED BDCS, AND REGULATORY FILINGS (2016) COMPILED BY COMPUSTAT AND AUDIT ANALYTICS Covered investment fund type Open-end .......... Closed–end ....... ETFs and ETPs BDC .................. 12 41 42 <1 <1 1 31 <1 326 41% of ETF and ETPs and 42% of BDCs have public market valuations less than $75 million. See Table 1. 327 30% of open-end mutual funds and 12% of closed-end funds have public market valuations less than $75 million. See Table 1. 328 See Table 1. Frm 00033 We are also seeking commenters’ views on our analysis: • Are there additional benefits associated with these requirements that we have not considered? • Are there additional costs associated with these requirements that we have not considered? d. Reporting Requirement for Issuers Appearing in Industry Reports Under proposed rule 139b an industry research report could only include covered investment funds that are required to file reports pursuant to section 30 of the Investment Company Act (or, for covered investment funds that are not registered investment companies under the Investment Company Act, required to file reports pursuant to section 13 or section 15(d) of the Exchange Act).329 As discussed above, these proposed conditions generally track parallel conditions under rule 139, but have been modified so that they would be applicable with respect to covered investment fund issuers. We do not expect these conditions to have economic effects beyond marginally improving economic efficiency by more closely aligning regulations with their intended context. We are also seeking commenters’ views on our analysis: • Are there additional benefits associated with these requirements that we have not considered? • Are there additional costs associated with these requirements that we have not considered? e. Content and Presentation Requirements for Industry Research Reports Under proposed rule 139b, the content and presentation standards for industry research reports of rule 139 would be tailored to the context of covered investment funds. Under proposed rule 139b (and rule 139), Funds with public market value <$75 million issuers appearing in industry research reports are subject to fewer conditions Number of Fund assets than issuers that are subjects of issuerfunds (%) specific research reports.330 We believe (%) that in the absence of content and 30 <1 presentation requirements such as those Total ........... PO 00000 26819 Fmt 4701 Sfmt 4702 329 Proposed rule 139b(a)(2)(i). As discussed previously, each issuer included in an issuerspecific research report also would be required to be subject to these reporting requirements, as well as the requirement to have filed in a timely manner all of the periodic reports required to be filed during the preceding 12 months. See supra section II.B.1.a. We note that this condition limits industry reports published or distributed in reliance on rule 139b to covered investment funds that file their reports pursuant to section 30 of the Investment Company Act or section 13 or section 15(d) of the Exchange Act. 330 See supra section II.B.2. E:\FR\FM\08JNP3.SGM 08JNP3 26820 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 we propose today, an industry research report could be used to circumvent the conditions associated with the safe harbor available for issuer-specific research reports. We therefore believe that the proposed content and presentation standards have benefits similar to those of the parallel content and presentation requirements in rule 139, and provide meaningful limits for issuer-specific research reports.331 We believe the compliance costs imposed by these requirements on the production of industry research reports would be low, particularly as brokerdealers are already familiar with similar conditions in rule 139, making implementation of presentation conditions for industry research reports on covered investment funds less burdensome. We are also seeking commenters’ views on our analysis: • Do commenters believe that there are there additional benefits associated with the content and presentation standards that we have not considered? • Do commenters believe that there additional costs associated with content and presentation requirements that we have not considered? • Do commenters agree with our assessment of the compliance costs? Are there certain types of broker-dealers for which these compliance costs will be higher (or lower)? 3. Proposed Rule 24b–4 Proposed rule 24b–4 would exclude a covered investment fund research report from the coverage of section 24(b) of the Investment Company Act and the rules and regulations thereunder, except to the extent that such report is not subject to the content provisions of SRO rules related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards. As discussed above, this proposed rule is meant to implement section 2(b)(4) of the FAIR Act, which we interpret to exclude covered investment fund research reports from section 24(b) of the Investment Company Act so long as they continue to be subject to the general content standards in FINRA rule 2210(d)(1).332 For covered investment fund research reports that are published or distributed by FINRA member firms, all such research reports would be subject to the content standards of FINRA rule 2210(d)(1), and thus we would interpret these research reports to 331 See supra notes 118–119, and paragraph accompanying note 136. 332 See supra note 174 and accompanying text. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 be excluded from the Commission’s filing requirements under the proposed rule.333 As discussed above, where covered investment fund research reports would no longer be required to be filed with the Commission pursuant to section 24(b), proposed rule 24b–4 could have the effect of narrowing the types of communications regarding registered investment companies that would be filed with FINRA (under current FINRA rule 2210).334 However, we believe that administrative processes related to handling regulatory reviews of communications subject to filing requirements impose costs on brokerdealers, which in turn can reduce their willingness to publish and distribute such communications. Consequently, although we do not believe that limiting these filing requirements as required by the FAIR Act represents a first-order economic effect of the proposed rules, we believe that doing so will reduce administrative costs for broker-dealers publishing or distributing covered investment fund research reports. At the same time, as discussed above, we believe that eliminating these filing requirements may have the result that some communications that are currently subject to FINRA’s filing requirements would no longer be subject to routine review.335 While these communications may still be reviewed by FINRA—for example, through examinations, targeted sweeps, or spot-checks—we believe that an effect of the FAIR Act, as implemented through proposed rule 24b–4, may be to reduce the monitoring by FINRA and the Commission of broker-dealers’ communications with customers for compliance with the applicable rules and regulations.336 We are seeking comments on the costs and benefits of proposed rule 24b–4: • Do commenters agree with our characterization of the costs and benefits? Are there additional costs and benefits that we should consider? • Do commenters expect non-FINRA member firms to publish or distribute covered investment fund research reports that would not be subject to the content standards of FINRA rule 2210(d)(1)? 333 See id. id. 335 See supra section II.D.1. 336 But see supra note 188 and accompanying text (noting that the FAIR Act’s rules of construction provide that the Act shall not be construed as limiting the authority of an SRO to require the filing of communications with the public if the purpose of such communications ‘‘is not to provide research and analysis of covered investment funds’’); see also section 2(c)(2) of the FAIR Act. 334 See PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 4. Proposed Amendment to Rule 101 of Regulation M As discussed above, rule 101 of Regulation M prohibits a person who participates in a distribution from attempting to induce others to purchase securities covered by the rule during a specified period.337 However, rule 101 provides an exception for research activities that satisfy the conditions of Securities Act rule 138 or rule 139. The proposed conforming amendment would expand this exception to include research activities that satisfy the conditions of proposed rule 139b. We believe that broker-dealers would generally be unable to make use of the proposed rule 139b safe harbor absent the proposed conforming amendment. Consequently, we do not consider its effects separately. 5. Effects on Efficiency, Competition, and Capital Formation The primary effects on economic efficiency and capital formation resulting from proposed rules 139b and 24b–4 obtain from the statutory mandates of the FAIR Act. Because financial intermediaries such as brokerdealers are generally assumed to possess some comparative advantage in the production of information about securities, efficiency considerations would—in the absence of significant market imperfections—dictate that broker-dealers should be active in the production of such information. To the extent that the increase in brokerdealers’ production of research reports about covered investment funds—that we expect to occur as a result of the FAIR Act’s statutory mandates 338—is valuable to investors, we expect it to increase allocative efficiency, with attendant positive consequences on capital formation. As noted earlier, the existence of the safe harbor could provide increased opportunities for broker-dealers to publish and distribute research on funds from which they derive financial benefits.339 To the extent that this could limit the value investors derive from research reports that broker-dealers publish and distribute, any potential gains to efficiency and improvements to capital formation could be reduced (or eliminated). Beyond the aforementioned broader effects on efficiency and capital formation resulting from the FAIR Act’s statutory mandates, we believe that the specific conditions on the availability of the safe harbor in proposed rule 139b 337 See supra section II.E. supra section III.C.1.a. 339 See supra section III.C.1.b. 338 See E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules will generally further economic efficiency and facilitate capital formation by reducing the potential for retail investors to receive research reports whose publication or distribution may be motivated by these financial incentives that could cause a conflict of interest. We believe that the affiliate exclusion and related guidance will have the largest impact because it addresses the greatest conflicts of interests in this context: Those arising from broker-dealers in investment advisory relationships.340 In addition, we believe that the Commission’s various tailoring of the proposed rules to the covered investment fund context will yield marginal efficiency improvements from reductions in regulatory ambiguity. With respect to competition, we believe that expansion of the rule 139 safe harbor will increase competition in the market for research reports on covered investment funds. Under the baseline, the market for research reports on covered investment funds is dominated by a small number of independent research firms, with few broker-dealers producing original research about such funds.341 We believe that the availability of the safe harbor will encourage some brokerdealers to publish proprietary research on covered investment funds. However, due to the high costs associated with maintaining research departments capable of covering the large covered investment fund universe,342 we believe that most broker-dealers will continue to rely on content licensed from amozie on DSK3GDR082PROD with PROPOSALS3 supra section III.C.2.a. 341 See supra section III.B.1.c. 342 See supra section III.B.1.a. 17:21 Jun 07, 2018 We are seeking comments on our analysis of the proposed rules’ effects on efficiency, competition, and capital formation: • Are there other significant effects on efficiency, competition, or capital formation that we have not considered? • What competitive effects, if any, would the proposed reporting history and minimum market value requirements have on smaller covered investment funds? Do commenters believe these requirements would adversely affect the type and amount of analysis available to investors on these funds? 6. Alternatives Considered We considered several alternative approaches to implementing the FAIR Act mandates that could satisfy the requirements of the FAIR Act. We summarize these here. 343 We expect that broker-dealers that choose to publish research on covered investment funds will generally not license it to their competitors. 344 See supra section III.C.2.a. 340 See VerDate Sep<11>2014 independent firms.343 We also believe that there are competitive implications stemming from the guidance we have given to address possible circumvention of the proposed affiliate exclusion.344 This guidance may have the effect of placing smaller broker-dealers— who may not operate at a scale large enough to sustain a research department—at a competitive disadvantage. These smaller broker-dealers may find that they are unable to compete with larger brokerdealers in the provision of ‘‘original’’ research about covered investment funds. Jkt 244001 PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 26821 a. Conditions on Issuers Appearing in Issuer-Specific Research Reports As discussed above, we believe that conditioning the availability of the safe harbor on the proposed $75 million minimum public market value requirement would promote investor protection by limiting research reports to issuers that have a demonstrated market following.345 However, we acknowledge that it would mean that research reports about significant numbers of smaller covered investment funds would not qualify for inclusion in research reports under the safe harbor. We believe that this will reduce the effect of the proposed rules on the availability of research reports about smaller covered investment funds.346 Depending on the distribution of covered investment funds’ public market values, a somewhat lower threshold could significantly increase the number of covered investment funds that qualify for inclusion in research reports without materially increasing the number of qualifying funds without a demonstrated market following and thus undermining investor protection. Conversely, a significantly higher threshold could further promote investor protection without significantly decreasing the number of qualifying funds (however, as discussed below, we did not consider this alternative because the FAIR Act prevents us from conditioning the availability of the safe harbor on a minimum public market value requirement that is greater than what is required under rule 139). BILLING CODE 8011–01–P 345 See 346 See E:\FR\FM\08JNP3.SGM supra section II.B.1.b. supra section III.C.2.c. 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 We have considered a range of alternative minimum public market values thresholds. Figure 5 plots the percentage of covered investment funds whose public market valuations would fall under each alternative threshold. As shown in the figure, material increases in the availability of the safe harbor are VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 only achievable through large reductions to the threshold. This is due to large numbers of funds being very small: as shown in Figure 6, over 600 covered investment funds have a public market valuation of $5 million or less. However, we do not believe that a significantly lower threshold would be PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 effective at promoting investor protection because, as discussed above in section III.C.2.c, we expect the information environment to be more limited for smaller funds than for larger funds. E:\FR\FM\08JNP3.SGM 08JNP3 EP08JN18.004</GPH> 26822 amozie on DSK3GDR082PROD with PROPOSALS3 BILLING CODE 8011–01–C The FAIR Act prevents us from conditioning the availability of the safe harbor on a minimum public market value requirement that is greater than what is required under rule 139.347 This effectively prevents us from conditioning the availability of the safe harbor for research reports on the subject covered investment fund having a public float of more than $75 million. Consequently, we do not consider higher minimum public market value thresholds. We seek information from commenters to assist us in assessing the economic impacts of a lower minimum threshold. • Would a public float threshold of less than $75 million for covered investment funds appropriately exclude those funds with a market following that is too small to permit investors to 347 See supra note 25 and accompanying text. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 evaluate covered investment fund research reports? What factors should govern such an alternative threshold and where should it be set? b. Conditions on Issuers Appearing in Industry Research Reports (1) Applying Uniform Conditions on Issuers Appearing in Issuer-Specific and Industry Research Reports With respect to conditions affecting the availability of the safe harbor for industry research reports, we considered applying to industry research reports the same requirements as would apply to issuer-specific research reports. As with the restrictions on issuer-specific research reports, similarly restricting industry research reports could help ensure that funds included in research reports are wellfollowed, and could restrict the availability of the safe harbor in PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 26823 situations where we expect the information environment to be most limited: for new funds and for funds with niche markets. In the context of research reports about covered investment funds, costbenefit considerations for including additional conditions on industry reports differ slightly from those that apply in the context of traditional research reports about equity and debt securities. In the context of research reports about equity and debt securities, analysis of an industry, in the case of operating companies, may require the discussion of specific firms within that industry. For example, a discussion about a mature industry (e.g., automobiles) may require discussion of a disruptive new entrant (e.g., autonomous vehicle start-up). In the context of the rule 139 safe harbor, the new entrant may not satisfy the E:\FR\FM\08JNP3.SGM 08JNP3 EP08JN18.005</GPH> Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules 26824 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 reporting history and minimum float requirements. This would reasonably prevent an issuer-specific research report about the new entrant from qualifying for the safe harbor. However, it would not further the goal of facilitating coverage of the industry to limit the safe harbor for industry reports to reports that do not discuss the new entrant: analysis of the industry may require discussion of specific issuers that would not qualify for inclusion in issuer-specific research reports. In the context of covered investment funds, a similar rationale would not apply as broadly. The proposed rule 139b content requirements for industry research reports would reference covered investment fund issuers of the same ‘‘type or investment focus,’’ rather than the issuers’ ‘‘industry or subindustry’’ (i.e., a broad category of similar businesses).348 Although it is clear that an industry research report about some covered investment fund types (e.g., emerging growth bonds) may have reasons to include a discussion of issuers that may not be eligible for inclusion in issuer-specific reports (e.g., best-performing new fund), it is not clear that such reasons would rise to the level of requiring the discussion of such issuers. Unlike the effects of an operating company issuer’s on its ‘‘industry,’’ the effects of a covered investment fund issuer on its fund ‘‘type’’ is very limited. (2) Allowing Affiliates To Appear in Comprehensive List of Recommended Issuers We considered providing that a comprehensive list of recommended issuers may include issuers that are affiliates of the broker-dealer that is publishing or distributing the research report under certain circumstances, including: If affiliates were identified; if disclosure about the affiliated issuers were limited; or if any performance information included in a list that includes affiliated issuers were presented in accordance with rule 482.349 Generally, we believe that including such provisions would benefit broker-dealers that play a significant role both as investment advisers to, and as distributors of, covered investment funds. However, as discussed above, we believe that broker-dealers publishing or distributing research reports about affiliated funds would have the potential for the most significant conflicts of interest.350 Moreover, permitting affiliated funds to be 348 See supra section II.B.2.c. id. 350 See supra section III.C.1.b. included in such comprehensive lists could result in confusion: broker-dealers would be able to offer recommendations for affiliated funds in industry research reports, but there would be no safe harbor enabling them to publish or distribute issuer-specific research reports (which could provide the basis for such recommendations) as a result of the affiliate exclusion. In proposed rule 139b, we have chosen not to incorporate these alternative conditions on issuers appearing in industry research reports. As discussed above, we are proposing that a comprehensive list of recommended issuers appearing in an industry research report could not include any covered investment fund that is an affiliate of the broker-dealer, or for which the broker-dealer serves as investment adviser (or is an affiliated person of the investment adviser), as this could implicate the proposed affiliate exclusion.351 However we are seeking comment on the economic effects of such alternative conditions. • Do commenters believe that the value of industry research reports about covered investment funds would be adversely affected if discussion of funds not satisfying the conditions applicable to issuer-specific research reports was precluded? If so, under what circumstances? • Do commenters believe that the value of industry research reports about covered investment funds would be improved if different conditions were applied to issuers appearing in such reports? If so, which conditions? • Do commenters believe that allowing affiliated funds to appear in comprehensive lists of recommended issuers would have additional costs or benefits? • Do commenters believe that conflicts of interests resulting from an advisory relationship would be likely to affect industry research reports featuring a comprehensive list? • Do commenters believe that allowing the inclusion of affiliated funds in industry research reports featuring a comprehensive list, when proposed rule 139b would not permit a broker-dealer relying on the safe harbor to publish or distribute an issuerspecific research report about an affiliated fund, would result in investor confusion? c. Approach to Regular-Course-ofBusiness Requirement As discussed in section III.B.3.b, in principle we expect a regular-course-ofbusiness requirement to reduce 349 See VerDate Sep<11>2014 17:21 Jun 07, 2018 351 See Jkt 244001 PO 00000 supra note 130 and accompanying text. Frm 00038 Fmt 4701 Sfmt 4702 opportunities for the safe harbor to be used in ways that lead to investor confusion. However, we also believe that in the context of covered investment funds, establishing whether a report is published in the ‘‘regular course of business’’ could present more challenges than in the rule 139 context of research reports about the securities of operating companies.352 Thus, we considered various alternative approaches to the proposed regularcourse-of-business requirements.353 Specifically, we have considered that this requirement be defined more specifically to address, for example, circumstances in which a broker-dealer has not previously published or distributed research reports.354 For example, we considered whether rule 139b should provide a ‘‘start-up’’ period to allow broker-dealers to establish a regular course of business of publishing research reports.355 We have also considered requiring that the regularcourse-of-business requirement incorporate more specific requirements regarding the persons preparing such reports (e.g., that they must be employed by a broker-dealer to prepare such research in the regular course of his or her duties).356 Conditioning availability of the safe harbor on a broker-dealer’s having published research reports for a given period of time, or on the broker-dealer having operated for some amount of time, could lead to the publication of reports that are more likely to be recognized as research.357 Moreover, we believe that broker-dealers with a longer operating history and those who have published research reports—relying on the existing rule 139 safe harbor or otherwise without relying on the safe harbor—will have made greater investments in their reputations. Such investments increase the reputational costs associated with the publication of research reflecting conflicts of interest, which as discussed above could mitigate the effects of conflicts of interest on research reports.358 352 See supra section II.B.2.b. supra section II.B.1.c (requests for comments). 354 See id. 355 See id. 356 See id. 357 See id. 358 See Chemmanur and Fulghieri Article, supra note 282; see also supra section III.C.1.b. However, we note that the efficacy of an institutional reputation mechanism has not found empirical support in related settings. See Fang and Yasuda Article, supra note 281 (where sell-side research analysts’ reputation mitigates manifestation of conflicts of interest from underwriting relationships, while institutional reputation does not). 353 See E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules In proposed rule 139b, we have chosen not to incorporate these alternative approaches to the regularcourse-of-business requirement. While we note the potential benefits of the approaches outlined above in enhancing the value that covered investment fund research reports may provide investors, we also understand that these alternatives may restrict the flow of relevant information to investors, and we are not proposing more prescriptive approaches to the regular-course-ofbusiness requirement at this time. However, we are seeking comment on the economic effects of such alternative conditions. • Do commenters believe that these alternative approaches to the regularcourse-of-business requirement would result in additional costs and benefits that we have not considered? What is the magnitude of these costs and benefits? d. Presentation of Performance Information amozie on DSK3GDR082PROD with PROPOSALS3 Given the definition of ‘‘research report’’ under the FAIR Act (and the definition of ‘‘research report’’ that we propose under rule 139b), certain communications by broker-dealers that historically have been treated as advertisements for registered investment companies under rule 482 now could be distributed as covered investment fund research reports under the proposed rule 139b safe harbor.359 Rule 482 imposes restrictions on the presentation of performance data included in registered open-end investment company advertisements.360 A covered investment fund research report that is published or distributed by a brokerdealer in reliance on the proposed rule 139b safe harbor would not need to adhere to rule 482’s requirements. 359 See supra note 141 and accompanying text. Similarly, ‘‘research reports’’ regarding covered investment funds that broker-dealers today might publish or distribute as ‘‘supplemental sales literature’’ under Investment Company Act rule 34b–1 (which must be preceded or accompanied by a statutory prospectus) could be distributed as covered investment fund research reports under proposed rule 139b. See supra note 144 and accompanying text. 360 As discussed above, rule 482 requires standardized presentation of performance data that is included in registered open-end fund advertisements. Alternatively, if other performance measures are presented, they must be accompanied by certain standardized performance data. See supra notes 142–143 and accompanying text. Research reports that are published or distributed as rule 34b–1 supplemental sales literature also would be subject to requirements relating to the standardized presentation of performance information, because rule 34b–1 incorporates many of the rule 482 requirements relating to performance disclosure. See supra note 145 and accompanying text. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 The above shift in the regulatory treatment of communications about registered investment companies could result in investors receiving communications about covered investment funds where the character of the communication (i.e., bona fide research versus advertising) is unclear and presentation of performance data is not subject to the restrictions of rule 482. Conflicts of interest resulting from broker-dealers’ financial incentives could affect the manner in which performance data is presented in research reports, potentially leading to misleading presentation of performance data. In addition, investors could be confused if performance is presented differently in an advertisement and in a research report, particularly if the research report doesn’t adequately disclose the methodologies used to produce the performance that could explain the differences. Retail investors, in particular, may be unable to assess the non-standardized performance figures when considering their investment decisions. While proposed rule 139b does not require that the performance of issuers included in covered investment fund research reports be presented in any particular fashion, we believe that certain guidance factors would assist a broker-dealer in evaluating whether any presentation of registered investment company performance in research reports could be misleading.361 These include consideration of the factors discussed in rule 156.362 We also note above that, if a covered investment fund research report were to substantially resemble a rule 482 advertisement, but present performance information in a manner inconsistent with the provisions of rule 482, retail investors may not be able to readily discern what constitutes a research report and what constitutes an advertisement.363 We have also considered the alternative approach of incorporating certain performance presentation standards of rule 482 and/or the guidance factors of rule 156 (concerning misleading statements in investment company sales literature) in the text of rule 139b.364 We also considered incorporating certain performance presentation requirements for when other performance measures that are not subject to any prescribed method of communication appear in covered investment fund research reports.365 We 361 See supra section II.C. id. 363 See id. 364 See rule 482(d)(1)–(4). 365 See rule 482(d)(5). 362 See PO 00000 Frm 00039 Fmt 4701 Sfmt 4702 26825 also considered requiring that the methodology used to calculate the registered investment company’s total return or yield be disclosed if these performance measures are not presented in a research report in a manner that is consistent with the requirements in rule 482. We also considered requirements relating to nonrecurring fees,366 and requirements on the timeliness of performance data,367 similar to the requirements for these items in rule 482.368 In addition, we considered incorporating the factors set forth in rule 156 (or a subset thereof) into the rule.369 We also considered a requirement in proposed rule 139b to incorporate general narrative disclosure into a research report about a registered investment company, aimed at reducing potential investor confusion. For example, we could have required such research reports to incorporate a legend stating that the document is a research report and is not subject to the Commission’s regulations applicable to sales and advertising. We also could have required such a research report to incorporate similar disclosure without requiring that it be structured as a legend (which would require the disclosure of similar concepts but would not require any particular wording). A main benefit associated with an alternative incorporating some or all of the aforementioned provisions into proposed rule 139b is reduced potential for confusion between (i) registered investment company advertisements and selling materials covered by rule 482 and (ii) advertisements or selling materials being recast as research reports.370 Additionally, incorporating some or all of the aforementioned provisions into proposed rule 139b would reduce potential for investor confusion resulting from divergent standards in the presentation of performance data. Because fees can represent a significant drag on investment returns,371 because different performance measures may be more or less favorable at different times, and because retail investors are known to be sensitive to past performance data,372 366 See rule 482(b)(3)(ii). rule 482(g). 368 See, e.g., rules 482(b)(3)(ii) and (g). 369 See supra section II.C (request for comments). 370 See supra note 150 and accompanying text. 371 See, e.g., Mark M. Carhart, On Persistence in Mutual Fund Performance, 52 The Journal of Finance 1, 57–82 (Mar. 1997). 372 See Erik R. Sirri & Peter Tufano, Costly Search and Mutual Fund Flows, 53 The Journal of Finance 5, 1589–1622 (Oct. 1, 1998). 367 See E:\FR\FM\08JNP3.SGM 08JNP3 amozie on DSK3GDR082PROD with PROPOSALS3 26826 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules we believe that the manner in which past performance data is presented can be an important factor driving investors’ investment decisions. As discussed above, even unaffiliated broker-dealers may have incentives, stemming from funds’ distribution arrangements, to promote a covered investment fund, or to promote certain funds over others.373 When broker-dealers publish or distribute research reports on covered investment funds, their choices with respect to how fees are disclosed, which performance measures are quoted, and for what time periods could be affected by these considerations. This in turn can adversely affect investors, particularly non-sophisticated investors. To the extent that any of the alternative approaches discussed above would limit opportunities for selective performance disclosure, this would curtail opportunities to circumvent the requirements of rule 482. If opportunities for selective performance disclosure were limited, this also could reduce investor confusion, because there would be fewer opportunities for the performance disclosure in registered investment company advertisements and research reports to diverge. There also could be less potential for investor confusion when comparing research reports about different covered investment funds, or obtained from different broker-dealers. These results would benefit investors. The extent of the benefit would depend on these measures’ effectiveness in ensuring consistent disclosure and/or alerting investors to factors that could influence their understanding of the disclosure in a research report. The extent of the benefit also would depend on the audience who will be reading research reports about registered investment companies. As discussed above, we assume that retail investors would generally be less likely to be able to identify sources of bias (and disregard or discount bias) in communications about covered investment funds than institutional investors and therefore could benefit from limitations on selective performance disclosure.374 The most significant costs associated with this alternative would likely result from its effect on the content of brokerdealers’ research reports. An alternative that limits the prominence afforded to performance measures that are calculated using a methodology that differs from that required under rule 482 supra section III.C.1.b. see discussion infra in this section III.C.6.d, discussing the potential benefits of allowing non-standardized information in the total mix of information available to investors, particularly for sophisticated investors. could adversely affect broker-dealers’ ability to provide valuable analysis. For example, a broker-dealer who wishes to center its analysis on a fund’s riskadjusted returns would be limited in how such information could be presented in the report even though certain audiences for research reports could consider this information to be particularly relevant. Investors’ access to potentially relevant and useful analysis could be limited by alternatives such as those discussed in this section. We believe that broker-dealers’ direct compliance costs under these alternative provisions would generally be minimal. For example, if we were to incorporate rule 482’s requirements on the presentation of performance data into proposed rule 139b, we expect that broker-dealers that publish research reports would have processes and systems that could produce charts and tables of the rule-specified performance measures using timely data.375 In proposed rule 139b, we have chosen not to incorporate additional provisions relating to the presentation of performance data, as this approach promotes flexibility for broker-dealers to make different types of information and analysis available to investors. We are seeking commenters’ views on these alternative provisions. • Do commenters believe that the safe harbor under proposed rule 139b would be used to publish or distribute communications that have traditionally been considered registered investment company advertisements or sales materials subject to rule 482? To what extent? If not, why not? Would this practice to be more prevalent for certain types of broker-dealers or research reports about certain types of registered investment companies? Do commenters believe that imposing additional requirements on the presentation of performance information in research reports that are published or distributed in reliance on the proposed rule 139b safe harbor would result in additional costs and benefits that we have not considered? What is the magnitude of these costs and benefits? If we were to issue guidance relating to the presentation of performance in research reports about registered investment companies that are published or distributed in reliance on the proposed rule 139b safe harbor, would this result in additional costs and benefits that we have not considered? What is the magnitude of these costs and benefits? 373 See 374 But VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 375 We believe that most broker-dealers that would publish such reports are currently distributing advertisement under rule 482, which are subject to similar requirements. See supra section II.D.1. PO 00000 Frm 00040 Fmt 4701 Sfmt 4702 IV. Paperwork Reduction Act We do not believe that the proposed rules would impose any new ‘‘collections of information’’ as defined by the Paperwork Reduction Act of 1995 (‘‘PRA’’), 44 U.S.C. 3501 et seq.; nor would they create any new filing, reporting, recordkeeping, or disclosure reporting requirements.376 Accordingly, we are not submitting the proposed rules to the Office of Management and Budget for review under the PRA.377 We request comment on whether our conclusion that there are no collections of information is correct. V. Regulatory Flexibility Act Analysis This Initial Regulatory Flexibility Act Analysis has been prepared in accordance with section 3 of the Regulatory Flexibility Act (‘‘RFA’’).378 It relates to proposed rule 139b, proposed rule 24b–4, and proposed revisions to the rules under the Securities Act and the Exchange Act to implement the FAIR Act. A. Reasons for, and Objectives of, the Proposed Action Proposed rule 139b provides that, if certain conditions are satisfied, a broker-dealer’s publication or distribution of a covered investment fund research report would be deemed for purposes of sections 2(a)(10) and 5(c) of the Securities Act not to constitute an offer for sale or offer to sell a security that is the subject of an offering of the covered investment fund, even if the broker-dealer is participating or may participate in a registered offering of the covered investment fund’s securities. Proposed rule 24b–4 provides that a covered investment fund research report about a registered investment company will not be subject to section 24(b) of the Investment Company Act (or the rules and regulations thereunder), except to the extent the research report is otherwise not subject to the content standards in SRO rules related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards. The 376 As discussed above, certain communications that previously would have been treated as rule 482 advertising prospectuses or rule 34b–1 supplemental sales literature could be considered covered investment fund research reports subject to the proposed rule 139b safe harbor, which could result in a reduction in the information collection burdens for rules 482 and 34b–1. In connection with an extension of a currently approved collection for rules 482 and 34b–1, the Commission will adjust the burdens associated with these collections of information, as appropriate. 377 44 U.S.C. 3507(d) and 5 CFR 1320.11. 378 See 5 U.S.C. 603. E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules proposed revision to paragraph (a) of rule 139 would clarify that rule 139 does not affect the availability of any other exemption or exclusion from sections 2(a)(10) or 5(c) of the Securities Act that may be available to a brokerdealer (as provided, for example, by the provisions of rule 139a or proposed 139b). The proposed revision to rule 101 under Regulation M would be a conforming amendment intended to harmonize treatment of research under the Securities Act and Exchange Act rules by permitting distribution participants under Regulation M, such as brokers-dealers, to publish or disseminate any information, opinion, or recommendation relating to a covered security if the conditions of rule 138, rule 139, or proposed rule 139b under the Securities Act are met. The proposed rules and proposed rule revisions would implement the directives under the FAIR Act to extend the current safe harbor available under rule 139 to broker-dealers’ publication or distribution of covered investment fund research reports. The reasons for, and objectives of, the proposed rules and proposed rule revisions are discussed in more detail in section II above. B. Legal Basis We are proposing the rules contained in this document under the authority set forth in the Securities Act, particularly sections 6, 7, 8, 10, 17(a), 19(a), and 28 thereof [15 U.S.C. 77a et seq.]; the Exchange Act, particularly, sections 2, 3, 9(a), 10, 11A(c), 12, 13, 14, 15, 17(a), 23(a), 30, and 36 thereof [15 U.S.C. 78a et seq.]; the Investment Company Act, particularly, sections 6, 23, 24, 30, and 38 thereof [15 U.S.C. 80a et seq.]; and the FAIR Act, particularly, section 2 thereof. amozie on DSK3GDR082PROD with PROPOSALS3 C. Small Entities Subject to the Proposed Rules The proposed rules would affect broker-dealers that publish or distribute covered investment fund research reports. As such, broker-dealers that are small entities would be affected by the proposed rules. A broker-dealer is a small entity if it has total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to § 240.17a-5(d),379 and it is 379 See rule 0–10(c)(1) under the Exchange Act [17 CFR 240.0–10(c)(1)]. Alternatively, if a brokerdealer is ‘‘not required to file such statements, a broker or dealer that had total capital (net worth plus subordinated liabilities) of less than $500,000 on the last business day of the preceding fiscal year VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 not affiliated with any person (other than a natural person) that is not a small business or small organization.380 As of December 31, 2017, the Commission estimates that there were approximately 1,042 broker-dealers that would be considered small entities as defined above.381 To the extent a small brokerdealer would participate in the activity of publishing or distributing covered investment fund research reports and would seek to rely on the proposed rule 139b safe harbor, it may be affected by our proposal. Generally, we believe larger broker-dealers engage in these activities, but we request comment on whether and how the rules we are proposing today would affect small broker-dealers. We also request comment on the number of small entities that would be impacted by our proposal, including any available empirical data. D. Reporting, Recordkeeping and Other Compliance Requirements We believe that there are no reporting, recordkeeping and other compliance requirements with respect to proposed rule 139b and the proposed revision to Regulation M. As such, we believe that there are no attendant costs and administrative burdens for small entities associated with these activities, as they relate to proposed rule 139b and the proposed revision to Regulation M. Proposed rule 139b would extend the safe harbor under current rule 139 to broker-dealers’ publication or distribution of covered investment fund research reports. As discussed above, rule 139 currently is not available for a broker-dealer’s publication or distribution of research reports about registered investment companies and business development companies.382 Instead, we understand that a research report or other communication about a covered investment fund that is a registered investment company would ordinarily have to comply with the requirements of Securities Act rule 482.383 As a result of the FAIR Act, however, communications that historically have been treated as covered investment fund advertisements under rule 482 now could fall under the (or in the time that it has been in business, if shorter).’’ See id. 380 See rule 0–10(c)(2) under the Exchange Act [17 CFR 240.0–10(c)(2)]. 381 This estimate is derived from an analysis of data for the period ending Dec. 31, 2017 obtained from FOCUS Reports (‘‘Financial and Operational Combined Uniform Single’’ Reports) that brokerdealers generally are required to file with the Commission and/or SROs pursuant to rule 17a–5 under the Exchange Act [17 CFR 240.17a–5]. 382 See supra note 100 and accompanying text. 383 See supra note 101 and accompanying text. PO 00000 Frm 00041 Fmt 4701 Sfmt 4702 26827 proposed rule 139b definition of ‘‘research report.’’ As discussed above, section 24(b) of the Investment Company Act requires registered open-end investment companies to file sales literature addressed to or intended for distribution to prospective investors with the Commission.384 Section 2(b)(4) of the FAIR Act directs the Commission to provide that a covered investment fund research report shall not be subject to section 24(b) of the Investment Company Act or the rules and regulations thereunder, except that such report may still be subject to 24(b) and the rules and regulations thereunder if it is otherwise not subject to the content standards in the rules of any SRO related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards.385 Today, registered investment company sales literature, including rule 482 advertisements, are required to be filed with the Commission under section 24(b) of the Investment Company Act.386 These filings are typically done by broker-dealers’ compliance staff. The Commission proposes to implement section 2(b)(4) of the FAIR Act via proposed rule 24b–4, which provides that a covered investment fund research report about a registered investment company shall not be subject to section 24(b) of the Investment Company Act (or the rules and regulations thereunder), unless the research report is not otherwise subject to the content standards in SRO rules related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards.387 We interpret section 2(b)(4) of the FAIR Act as excluding covered investment fund research reports from section 24(b) of the Investment Company Act so long as they continue to be subject to the general content standards in FINRA rule 2210(d)(1), described above (or substantially similar SRO rules).388 Thus, covered investment fund research reports, by operation of proposed rule 24b–4, would no longer be subject to 384 See 15 U.S.C. 80a–24(b); 17 CFR 270.24b–3; supra section II.D.1. 385 See supra note 167 and accompanying text. 386 See supra note 29. Rule 24b–3 under the Investment Company Act deems these materials to have been filed with the Commission if filed with FINRA. See id. 387 See proposed rule 24b–4; see also discussion accompanying supra notes 170–174. 388 See supra paragraph accompanying notes 174– 176. E:\FR\FM\08JNP3.SGM 08JNP3 26828 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 filing requirements under section 24(b) because they would be subject to the general content standards of FINRA rule 2210(d)(1).389 Proposed rule 24b–4 would affect broker-dealers that, in lieu of a safe harbor such as that proposed to be provided by rule 139b, would have published or distributed communications styled as ‘‘research reports’’ in compliance with rule 482, which communications would be required to be filed with the Commission subject to section 24(b) of the Investment Company Act. As such, we believe that the administrative costs of broker-dealers that previously filed these communications pursuant to section 24(b) of the Investment Company Act would be reduced. However, large and small broker-dealers would not be affected differently by proposed rule 24b–4. We encourage written comments regarding this analysis. We solicit comments as to whether the proposed regulation could have an effect that we have not considered. We request that commenters describe the nature of any impact on small entities and provide empirical data to support the extent of the impact. E. Duplicative, Overlapping, or Conflicting Federal Rules Although broker-dealers would be unable to rely on the rule 139 safe harbor in publishing or distributing certain communications that could be considered covered investment fund research reports,390 the existing rule 139 safe harbor may be available for their publication or distribution of research reports for certain covered investment funds, such as commodity- or currencybased trusts or funds that have a class of securities registered under the Exchange Act.391 As discussed above, the FAIR Act directs us to propose and adopt rule amendments that would extend the current safe harbor available under rule 139 to ‘‘covered investment fund research reports.’’ 392 Proposed rule 139b, which is intended to implement the FAIR Act’s directives, includes all of the entities in the definition of ‘‘covered investment fund’’ that are specified in the FAIR Act’s parallel definition (including some types of entities where, if a brokerdealer were to publish or distribute a research report about that entity, the rule 139 safe harbor could already be available).393 As a result, in certain 389 See supra section II.D.1. supra notes 11–15 and accompanying text. 391 See supra section II.A.4. 392 See supra section I.B. 393 See supra section II.A.3. 390 See VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 circumstances, a broker-dealer publishing or distributing a covered investment fund research report could rely either on rule 139 or proposed rule 139b. In light of this, we have clarified in proposed rule 139b that it provides a non-exclusive safe harbor, and we propose to amend rule 139 to include similar language regarding the nonexclusivity of the safe harbor available under rule 139.394 Thus, a broker-dealer would be able to rely on proposed rule 139b to publish or distribute a covered investment fund research report, or could choose to rely instead on any other available exemption or exclusion from sections 2(a)(10) or 5(c) of the Securities Act, including those provided by rules 137, 138, and 139, so long as the applicable conditions are satisfied. F. Significant Alternatives The RFA directs us to consider significant alternatives that would accomplish the Commission’s stated objectives, while minimizing any significant adverse impact on small entities. In connection with the proposals, we considered the following alternatives: (i) Establishing different compliance or reporting requirements that take into account the resources available to small entities; (ii) exempting broker-dealers that are small entities from certain proposed conditions that must be satisfied in order for the proposed rule 139b safe harbor to be available (e.g., the extent to which the proposed regular-course-ofbusiness requirements would apply to small broker-dealers); (iii) clarifying, consolidating, or simplifying the conditions that must be satisfied for the proposed rule 139b safe harbor to be available for broker-dealers that are small entities; and (iv) using performance rather than design standards. We do not believe that establishing different compliance and reporting requirements or timetables for brokerdealers that are small entities, or exempting broker-dealers that are small entities from certain proposed conditions, would permit us to achieve our stated objectives. We have considered a variety of approaches to achieve our regulatory objectives and the directives of the FAIR Act. We do not believe that the proposed rules would impose any significant new compliance obligations, because the proposed rules generally reduce the restrictions regarding communications that would be considered covered investment fund research reports. As discussed above, the FAIR Act directs us to extend the current safe harbor available under rule 139 to broker-dealers’ publication or distribution of covered investment fund research reports, and thus proposed rule 139b’s framework, including its scope and conditions, is modeled after and generally tracks rule 139.395 Rule 139 does not incorporate conditions that would affect the availability of the rule’s safe harbor differently for broker-dealers that are small (versus large) entities. We likewise do not believe it is necessary or appropriate that proposed rule 139b incorporate conditions that would affect the availability of the proposed rule’s safe harbor differently based on whether a broker-dealer is a small entity. We have considered whether a different regular-course-of-business requirement would help mitigate investor confusion in the case of covered investment fund research reports about registered investment companies, as discussed in more detail above.396 This could have had the effect of limiting the availability of the proposed rule 139b safe harbor to certain broker-dealers, which in turn could have direct or indirect effects on the availability of the safe harbor to smaller broker-dealers. However, for the reasons discussed above,397 we are not proposing a regular-course-of-business requirement, in either the proposed rule 139b provisions on issuer-specific research reports or the proposed provisions on industry reports, other than a requirement that tracks the provisions of rule 139 (modified as directed by the FAIR Act). Nor do we believe that clarifying, consolidating, or simplifying the proposed amendments for small entities would satisfy those objectives. Because proposed rule 139b’s framework (including its scope and conditions) is modeled after and generally tracks rule 139, proposed rule 139b like rule 139 does not treat small broker-dealers differently than large broker-dealers, including by clarifying, consolidating, or simplifying any conditions. Our proposal includes specific requests for comment on whether clarifications to certain proposed rule provisions are necessary or appropriate, and the comments we receive in response could, in certain circumstances, indirectly affect our approach to small entities.398 For example, we request comment about whether the proposed regular-course-ofbusiness requirement should be 395 See supra paragraph accompanying notes 32– 34. 396 See supra section III.C.6.c. id. 398 See generally supra section II. 397 See 394 See PO 00000 supra section II.A.4. Frm 00042 Fmt 4701 Sfmt 4702 E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS3 modified to address newly-established broker-dealers (which are likely to be small entities).399 We also recognize that the guidance that we provide in this release—which is meant to clarify certain of the provisions of the proposed rule—could indirectly affect small entities, and we request comment on the effects of this guidance on small entities. For example, we request comment about whether smaller brokerdealers, or broker-dealers without significant research departments, be most impacted by our guidance on the proposed affiliate exclusion.400 Further, with respect to using performance rather than design standards, the proposed rule generally uses performance standards for all broker-dealers relying on the proposed rule, regardless of size. We believe that providing broker-dealers with the flexibility with respect to the design of covered investment fund research reports that they may publish or distribute in reliance on the proposed safe harbor is appropriate in light of the diversity of entities included in the universe of covered investment funds. We also believe that this approach is appropriate in light of the diverse methodologies that might be taken with respect to research about these entities (particularly because the term ‘‘research report’’ in the FAIR Act and the proposed rule is defined broadly, as discussed above 401). However, we note that the proposed rule also uses design standards with respect to certain of its conditions (e.g., the conditions relating to reporting history and minimum public market value that apply to issuers that could appear in an issuerspecific research report). These are substantially similar to design standards used in rule 139, and they would apply with respect to the research reports published or distributed by all brokerdealers relying on the proposed rule, regardless of their size.402 For the reasons discussed above, we believe that this use of design standards is appropriate for the furtherance of investor protection, and to help ensure that the proposed rule is not used to circumvent the prospectus requirements of the Securities Act.403 As we consider the comments we receive on our proposal, we will consider the available information to 399 See supra section II.B.1.c; see also supra section II.B.2.b. 400 See requests for comment at supra section III.C.2.a. 401 See supra note 11. 402 See, e.g., supra sections II.B.1.a (Reporting History and Timeliness Requirements) and II.B.1.b (Minimum Public Market Value Requirement). 403 See supra notes 57–58 and accompanying text. VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 determine whether greater flexibility is warranted, consistent with investor protections. G. General Request for Comment The Commission requests comments regarding this analysis. We request comment on the number of small entities that would be subject to the proposed rules and whether the proposed rules would have any effects that have not been discussed. We request that commenters describe the nature of any effects on small entities subject to the proposed rules and provide empirical data to support the nature and extent of such effects. VI. Small Business Regulatory Enforcement Fairness Act For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996 (‘‘SBREFA’’),404 the Commission must advise OMB whether a proposed regulation constitutes a ‘‘major’’ rule. Under SBREFA, a rule is considered ‘‘major’’ where, if adopted, it results in or is likely to result in: • An annual effect on the economy of $100 million or more; • A major increase in costs or prices for consumers or individual industries; or • Significant adverse effects on competition, investment, or innovation. We request comment on whether our proposal would be a ‘‘major rule’’ for purposes of SBREFA. We solicit comment and empirical data on: • The potential effect on the U.S. economy on an annual basis; • Any potential increase in costs or prices for consumers or individual industries; and • Any potential effect on competition, investment, or innovation. Commenters are requested to provide empirical data and other factual support for their views to the extent possible. VII. Statutory Authority We are proposing the rules contained in this document under the authority set forth in the Securities Act, particularly sections 6, 7, 8, 10, 17(a), 19(a), and 28 thereof [15 U.S.C. 77a et seq.]; the Exchange Act, particularly, sections 2, 3, 9(a), 10, 11A(c), 12, 13, 14, 15, 17(a), 23(a), 30, and 36 thereof [15 U.S.C. 78a et seq.]; the Investment Company Act, particularly, sections 6, 23, 24, 30, and 38 thereof [15 U.S.C. 80a et seq.]; and the FAIR Act, particularly, section 2 thereof. 404 Pub. L. 104–121, Title II, 110 Stat. 857 (1996) (codified in various sections of 5 U.S.C., 15 U.S.C., and as a note to 5 U.S.C. 601). PO 00000 Frm 00043 Fmt 4701 Sfmt 4702 26829 List of Subjects 17 CFR Part 230 Advertising, Confidential business information, Investment companies, Reporting and recordkeeping requirements, Securities. 17 CFR Part 242 Brokers, Fraud, Reporting and recordkeeping requirements, Securities. 17 CFR Part 270 Confidential business information, Fraud, Investment companies, Life insurance, Reporting and recordkeeping requirements, Securities. Text of Proposed Rules and Amendments For the reasons set out in the preamble, title 17, chapter II of the Code of the Federal Regulations is proposed to be amended as follows. PART 230—GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933 1. The authority citation for part 230 continues to read, in part, as follows: ■ Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 77s, 77z–3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o–7 note, 78t, 78w, 78ll(d), 78mm, 80a–8, 80a–24, 80a– 28, 80a–29, 80a–30, and 80a–37, and Pub. L. 112–106, sec. 201(a), sec. 401, 126 Stat. 313 (2012), unless otherwise noted. * * * * * 2. Amend § 230.139 by revising the introductory text of paragraph (a) to read as follows: ■ § 230.139 Publications or distributions of research reports by brokers or dealers distributing securities. (a) Registered offerings. Under the conditions of paragraph (a)(1) or (2) of this section, a broker’s or dealer’s publication or distribution of a research report about an issuer or any of its securities shall be deemed for purposes of sections 2(a)(10) and 5(c) of the Act not to constitute an offer for sale or offer to sell a security that is the subject of an offering pursuant to a registration statement that the issuer proposes to file, or has filed, or that is effective, even if the broker or dealer is participating or will participate in the registered offering of the issuer’s securities. For purposes of the Fair Access to Investment Research Act of 2017 [Pub. L. 115–66, 131 Stat. 1196 (2017)], a safe harbor has been established for covered investment fund research reports, and the specific terms of that safe harbor are set forth in § 230.139b. * * * * * E:\FR\FM\08JNP3.SGM 08JNP3 26830 ■ Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules 3. Add § 230.139b to read as follows: amozie on DSK3GDR082PROD with PROPOSALS3 § 230.139b Publications or distributions of covered investment fund research reports by brokers or dealers distributing securities. (a) Registered offerings. Under the conditions of paragraph (a)(1) or (2) of this section, the publication or distribution of a covered investment fund research report by a broker or dealer that is not an investment adviser to the covered investment fund and is not an affiliated person of the investment adviser to the covered investment fund shall be deemed for purposes of sections 2(a)(10) and 5(c) of the Act not to constitute an offer for sale or offer to sell a security that is the subject of an offering pursuant to a registration statement of the covered investment fund that is effective, even if the broker or dealer is participating or may participate in the registered offering of the covered investment fund’s securities. This section does not affect the availability of any other exemption or exclusion from sections 2(a)(10) or 5(c) of the Act available to the broker or dealer. (1) Issuer-specific research reports. (i) At the date of reliance on this section: (A) The covered investment fund: (1) Has been subject to the reporting requirements of section 30 of the Investment Company Act of 1940 (the ‘‘Investment Company Act’’) (15 U.S.C. 80a–29) for a period of at least 12 calendar months and has filed in a timely manner all of the reports required, as applicable, to be filed for the immediately preceding 12 calendar months on Forms N–CSR (§§ 249.331 and 274.128 of this chapter), N–SAR (§§ 249.330 and 274.101 of this chapter), N–Q (§§ 249.332 and 274.130 of this chapter), N–PORT (§ 274.150 of this chapter), N–MFP (§ 274.201 of this chapter), and N–CEN (§§ 249.330 and 274.101 of this chapter) pursuant to section 30 of the Investment Company Act; or (2) If the covered investment fund is not a registered investment company under the Investment Company Act, has been subject to the reporting requirements of section 13 or section 15(d) of the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’) (15 U.S.C. 78m or 78o(d)) for a period of at least 12 calendar months and has filed in a timely manner all of the reports required to be filed for the immediately preceding 12 calendar months on Forms 10–K (§ 249.310 of this chapter) and 10– Q (§ 249.308a of this chapter), or 20–F (§ 249.220f of this chapter) pursuant to section 13 or section 15(d) of the Exchange Act; and VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 (B) The aggregate market value of voting and non-voting common equity held by non-affiliates of the covered investment fund, or, in the case of a registered open-end investment company (other than an exchangetraded fund) its net asset value (subtracting the value of shares held by affiliates), equals or exceeds the aggregate market value specified in General Instruction I.B.1 of Form S–3; and (ii) The broker or dealer publishes or distributes research reports in the regular course of its business and, in the case of a research report regarding a covered investment fund that does not have a class of securities in substantially continuous distribution, such publication or distribution does not represent the initiation of publication of research reports about such covered investment fund or its securities or reinitiation of such publication following discontinuation of publication of such research reports. (2) Industry reports. (i) The covered investment fund is subject to the reporting requirements of section 30 of the Investment Company Act (15 U.S.C. 80a–29) or, if the covered investment fund is not a registered investment company under the Investment Company Act, is subject to the reporting requirements of section 13 or section 15(d) of the Exchange Act (15 U.S.C. 78m or 78o(d)); (ii) The research report: (A) Includes similar information with respect to a substantial number of covered investment fund issuers of the issuer’s type (e.g., money market fund, bond fund, balanced fund, etc.), or investment focus (e.g., primarily invested in the same industry or subindustry, or the same country or geographic region); or (B) Contains a comprehensive list of covered investment fund securities currently recommended by the broker or dealer (other than securities of a covered investment fund that is an affiliate of the broker or dealer, or for which the broker or dealer serves as investment adviser (or for which the broker or dealer is an affiliated person of the investment adviser)); (iii) The analysis regarding the covered investment fund issuer or its securities is given no materially greater space or prominence in the publication than that given to other covered investment fund issuers or securities; and (iv) The broker or dealer publishes or distributes research reports in the regular course of its business and, at the time of the publication or distribution of the research report (in the case of a PO 00000 Frm 00044 Fmt 4701 Sfmt 4702 research report regarding a covered investment fund that does not have a class of securities in substantially continuous distribution), is including similar information about the issuer or its securities in similar reports. (b) Self-regulatory organization rules. A self-regulatory organization shall not maintain or enforce any rule that would prohibit the ability of a member to publish or distribute a covered investment fund research report solely because the member is also participating in a registered offering or other distribution of any securities of such covered investment fund; or to participate in a registered offering or other distribution of securities of a covered investment fund solely because the member has published or distributed a covered investment fund research report about such covered investment fund or its securities. For purposes of section 19(b) of the Exchange Act (15 U.S.C. 78s(b)), this paragraph (b) shall be deemed a rule under that Act. (c) Definitions. For purposes of this section: (1) ‘‘Affiliated person’’ has the meaning given the term in section 2(a) of the Investment Company Act. (2) ‘‘Covered investment fund’’ means: (i) An investment company (or a series or class thereof) registered under, or that has filed an election to be treated as a business development company under, the Investment Company Act and that has filed a registration statement under the Act for the public offering of a class of its securities, which registration statement has been declared effective by the Commission; or (ii) A trust or other person: (A) Issuing securities in an offering registered under the Act and which class of securities is listed for trading on a national securities exchange; (B) The assets of which consist primarily of commodities, currencies, or derivative instruments that reference commodities or currencies, or interests in the foregoing; and (C) That provides in its registration statement under the Act that a class of its securities are purchased or redeemed, subject to conditions or limitations, for a ratable share of its assets. (3) ‘‘Covered investment fund research report’’ means a research report published or distributed by a broker or dealer about a covered investment fund or any securities issued by the covered investment fund, but does not include a research report to the extent that the research report is published or distributed by the covered investment E:\FR\FM\08JNP3.SGM 08JNP3 Federal Register / Vol. 83, No. 111 / Friday, June 8, 2018 / Proposed Rules fund or any affiliate of the covered investment fund, or any research report published or distributed by any broker or dealer that is an investment adviser (or any affiliated person of an investment adviser) for the covered investment fund. (4) ‘‘Exchange-traded fund’’ has the meaning given the term in General Instruction A to Form N–1A (§§ 239.15A and 274.11A of this chapter). (5) ‘‘Investment adviser’’ has the meaning given the term in section 2(a) of the Investment Company Act. (6) ‘‘Research report’’ means a written communication, as defined in § 230.405 that includes information, opinions, or recommendations with respect to securities of an issuer or an analysis of a security or an issuer, whether or not it provides information reasonably sufficient upon which to base an investment decision. ■ 4. Effective May 1, 2020, amend § 230.139b by removing ‘‘N–Q (§§ 249.332 and 274.130 of this chapter),’’ in paragraph (a)(1)(i)(A)(1). PART 242—REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER MARGIN REQUIREMENTS FOR SECURITY FUTURES sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted. ■ 5. The authority citation for part 242 continues to read as follows: § 270.24b–4 Filing copies of covered investment fund research reports. Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a), 78q(b), 78q(h), 78w(a), 78dd–1, 78mm, 80a– 23, 80a–29, and 80a–37. A covered investment fund research report, as defined in paragraph (c)(3) of § 230.139b of this chapter under the Securities Act of 1933 (15 U.S.C. 77a et seq.), of a covered investment fund registered as an investment company under the Investment Company Act, shall not be subject to section 24(b) of the Act or the rules and regulations thereunder, except that such report shall be subject to such section and the rules and regulations thereunder to the extent that it is otherwise not subject to the content standards in the rules of any self-regulatory organization related to research reports, including those contained in the rules governing communications with the public regarding investment companies or substantially similar standards. 6. Section 242.101 is amended by revising paragraph (b)(1) to read as follows: ■ § 242.101. Activities by distribution participants. * * * * * (b) * * * (1) Research. The publication or dissemination of any information, opinion, or recommendation, if the conditions of § 230.138, § 230.139, or § 230.139b of this chapter are met; or * * * * * PART 270—RULE AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940 7. The authority citation for part 270 continues to read, in part, as follows: ■ amozie on DSK3GDR082PROD with PROPOSALS3 Authority: 15 U.S.C. 80a–1 et seq., 80a– 34(d), 80a–37, 80a–39, and Pub. L. 111–203, VerDate Sep<11>2014 17:21 Jun 07, 2018 Jkt 244001 26831 PO 00000 Frm 00045 Fmt 4701 Sfmt 9990 * ■ * * * * 8. Add § 270.24b–4 to read as follows: By the Commission. Dated: May 23, 2018. Brent J. Fields, Secretary. [FR Doc. 2018–11497 Filed 6–7–18; 8:45 am] BILLING CODE 8011–01–P E:\FR\FM\08JNP3.SGM 08JNP3

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 83, Number 111 (Friday, June 8, 2018)]
[Proposed Rules]
[Pages 26788-26831]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-11497]



[[Page 26787]]

Vol. 83

Friday,

No. 111

June 8, 2018

Part III





Securities and Exchange Commission





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





17 CFR Parts 230, 242, and 270





Covered Investment Fund Research Reports; Proposed Rule

Federal Register / Vol. 83 , No. 111 / Friday, June 8, 2018 / 
Proposed Rules

[[Page 26788]]


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

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 242, and 270

[Release Nos. 33-10498; 34-83307; IC-33106; File No. S7-11-18]
RIN 3235-AM24


Covered Investment Fund Research Reports

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rules.

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

SUMMARY: As directed by Congress pursuant to the Fair Access to 
Investment Research Act of 2017, the Commission is proposing a new rule 
under the Securities Act of 1933. If adopted, the proposal would 
establish a safe harbor for an unaffiliated broker or dealer 
participating in a securities offering of a ``covered investment fund'' 
to publish or distribute a ``covered investment fund research report.'' 
If the conditions for the safe harbor are satisfied, this publication 
or distribution would be deemed not to be an offer for sale or offer to 
sell the covered investment fund's securities for purposes of sections 
2(a)(10) and 5(c) of the Securities Act of 1933. The Commission is also 
proposing a new rule under the Investment Company Act of 1940. This 
proposal would exclude a covered investment fund research report from 
the coverage of section 24(b) of the Investment Company Act (or the 
rules and regulations thereunder), except to the extent the research 
report is otherwise not subject to the content standards in self-
regulatory organization rules related to research reports, including 
those contained in the rules governing communications with the public 
regarding investment companies or substantially similar standards. We 
are also proposing a conforming amendment.

DATES: Comments should be received by July 9, 2018.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment forms (https://www.sec.gov/rules/proposed.shtml); or
     Send an email to [email protected]. Please include 
File Number S7-11-18 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 S7-11-18. This file number 
should be included on the subject line if email is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
website (https://www.sec.gov/rules/proposed.shtml). Comments also are 
available for website viewing and printing in the Commission's Public 
Reference Room, 100 F Street NE, Room 1580, Washington, DC 20549, on 
official business days between the hours of 10:00 a.m. and 3:00 p.m. 
All comments received will be posted without change. Persons submitting 
comments are cautioned that we do not redact or edit personal 
identifying information from comment submissions. You should submit 
only information that you wish to make available publicly.
    Studies, memoranda or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any such materials 
will be made available on the Commission's website. To ensure direct 
electronic receipt of such notifications, sign up through the ``Stay 
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Asaf Barouk, Attorney-Adviser, John 
Lee, Senior Counsel; Amanda Hollander Wagner, Branch Chief; or Brian 
McLaughlin Johnson, Assistant Director, at (202) 551-6792, Investment 
Company Regulation Office, Division of Investment Management; Steven G. 
Hearne, Senior Special Counsel, at (202) 551-3430, Division of 
Corporation Finance; Laura Gold or Samuel Litz, Attorney-Advisers; or 
John Guidroz, Branch Chief, at (202) 551-5777, Office of Trading 
Practices, Division of Trading and Markets, Securities and Exchange 
Commission, 100 F Street NE, Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is proposing for comment new 
rule 139b [17 CFR 230.139b] under the Securities Act of 1933 [15 U.S.C. 
77a et seq.]; new rule 24b-4 [17 CFR 270.24b-4] under the Investment 
Company Act of 1940 [15 U.S.C. 80a-1 et seq.]; and a conforming 
amendment to rule 101 [17 CFR 242.101(a)] of Regulation M [17 CFR 
242.100-242.105].

Table of Contents

I. Introduction and Background
    A. Introduction
    B. FAIR Act
II. Discussion
    A. Scope of Proposed Rule 139b
    1. Definition of ``Covered Investment Fund Research Report''
    2. Definition of ``Research Report''
    3. Definition of ``Covered Investment Fund''
    4. Non-Exclusivity of Safe Harbor
    B. Conditions for the Safe Harbor
    1. Issuer-Specific Research Reports
    2. Industry Research Reports
    C. Presentation of Performance Information in Research Reports 
About Registered Investment Companies
    D. Role of Self-Regulatory Organizations
    1. SRO Content Standards and Filing Requirements for Covered 
Investment Fund Research Reports
    2. SRO Limitations
    E. Conforming Amendment
III. Economic Analysis
    A. Introduction
    B. Baseline
    1. Market Structure and Market Participants
    2. Regulatory Structure
    C. Costs and Benefits
    1. FAIR Act Statutory Mandate
    2. Proposed Rule 139b
    3. Proposed Rule 24b-4
    4. Proposed Amendment to Rule 101 of Regulation M
    5. Effects on Efficiency, Competition, and Capital Formation
    6. Alternatives Considered
IV. Paperwork Reduction Act
V. Regulatory Flexibility Act Analysis
    A. Reasons for, and Objectives of, the Proposed Action
    B. Legal Basis
    C. Small Entities Subject to the Proposed Rules
    D. Reporting, Recordkeeping and Other Compliance Requirements
    E. Duplicative, Overlapping, or Conflicting Federal Rules
    F. Significant Alternatives
    G. General Request for Comment
VI. Small Business Regulatory Enforcement Fairness Act
VII. Statutory Authority

I. Introduction and Background

A. Introduction

    As directed by the Fair Access to Investment Research Act of 
2017,\1\ we are proposing new rule 139b under the Securities Act of 
1933 (the ``Securities Act'').\2\ Proposed rule 139b includes certain 
conditions that, if satisfied, would provide that a broker's or 
dealer's (a ``broker-dealer's'') publication or distribution of a 
covered investment fund research report will be deemed for purposes of 
sections 2(a)(10) and 5(c) of the Securities Act not to constitute an 
offer for sale or offer to sell a security that is the subject of an 
offering of the

[[Page 26789]]

covered investment fund, even if the broker-dealer is participating or 
may participate in a registered offering of the covered investment 
fund's securities.\3\ Proposed rule 139b would establish a new safe 
harbor for unaffiliated broker-dealers' publication or distribution of 
covered investment fund research reports similar to the existing safe 
harbor under rule 139 applicable to research reports about other 
issuers or their securities.\4\
---------------------------------------------------------------------------

    \1\ Fair Access to Investment Research Act of 2017, Public Law 
115-66, 131 Stat. 1196 (2017) (the ``FAIR Act'').
    \2\ 15 U.S.C. 77a et seq.
    \3\ See infra text accompanying notes 32-34 (discussing our 
general approach in modeling proposed rule 139b after rule 139 [17 
CFR 230.139], and noting that we propose this approach in 
furtherance of the FAIR Act's directive to revise rule 139 to extend 
the current safe harbor available under rule 139 to broker-dealers' 
publication or distribution of covered investment fund research 
reports); see also proposed addition to rule 139(a) (``For purposes 
of the [FAIR Act], a safe harbor has been established for covered 
investment fund research reports, and the specific terms of that 
safe harbor are set forth in Rule 139b. . . .'').
    \4\ See infra notes 11-15 and accompanying text.
---------------------------------------------------------------------------

    We are also proposing new rule 24b-4 under the Investment Company 
Act of 1940 (the ``Investment Company Act''),\5\ which would exclude a 
covered investment fund research report from the filing requirements of 
section 24(b) of the Investment Company Act (or the rules and 
regulations thereunder), except to the extent that such report is 
otherwise not subject to the content standards in self-regulatory 
organization (``SRO'') rules related to research reports, including 
those contained in the rules governing communications with the public 
regarding investment companies or substantially similar standards.\6\ 
This proposed rule would have the effect of reducing the filing 
requirements currently applicable to certain communications that, by 
operation of the FAIR Act and proposed rule 139b, would now be deemed 
``covered investment fund research reports.'' \7\
---------------------------------------------------------------------------

    \5\ 15 U.S.C. 80a-1 et seq.
    \6\ As discussed below, we are proposing this rule pursuant to 
section 2(b)(4) of the FAIR Act (mandating that the Commission shall 
provide that a covered investment fund research report shall not be 
subject to section 24(b) of the Investment Company Act of 1940 (15 
U.S.C. 80a-24(b)) or the rules and regulations thereunder, except 
that such report may still be subject to such section and the rules 
and regulations thereunder to the extent that it is otherwise not 
subject to the content standards in the rules of any self-regulatory 
organization related to research reports, including those contained 
in the rules governing communications with the public regarding 
investment companies or substantially similar standards). See infra 
section II.D.1.
    \7\ See infra notes 184-187 and accompanying text.
---------------------------------------------------------------------------

    Additionally, in light of the proposal of rule 139b, we are 
proposing a conforming amendment to rule 101 of Regulation M. This 
amendment would permit distribution participants, such as brokers or 
dealers, to publish or disseminate any information, opinion, or 
recommendation relating to a covered security if the conditions of 
proposed rule 139b (or, alternatively, the conditions of rule 138 \8\ 
or rule 139 under the Securities Act) are satisfied.\9\ The proposed 
conforming amendment is intended to align the treatment of research 
under proposed rule 139b with the treatment of research under rules 138 
and 139 for purposes of Regulation M.\10\
---------------------------------------------------------------------------

    \8\ 17 CFR 230.138.
    \9\ See infra section II.E.
    \10\ See id.
---------------------------------------------------------------------------

    Rule 139 currently provides a safe harbor for the publication or 
distribution of research reports concerning one or more issuers by a 
broker-dealer participating in a registered offering of one of the 
covered issuers' securities.\11\ Specifically, rule 139 provides that a 
broker-dealer's publication or distribution of research reports--
whether about a particular issuer or multiple issuers, including within 
the same industry--that satisfy certain conditions under the rule are 
``deemed for purposes of sections 2(a)(10) and 5(c) of the [Securities] 
Act not to constitute an offer for sale or offer to sell.'' \12\ A 
broker-dealer's publication or distribution of a research report in 
reliance on rule 139 would therefore not be deemed to constitute an 
offer that otherwise could be a non-conforming prospectus in violation 
of section 5 of the Securities Act.\13\ Although the Commission has 
previously requested comment as to whether to extend rule 139 to cover 
investment company research reports,\14\ the rule's safe harbor 
currently is not available for a broker-dealer's publication or 
distribution of research reports pertaining to specific registered 
investment companies or business development companies.\15\
---------------------------------------------------------------------------

    \11\ The term ``research report'' in rule 139 under the 
Securities Act is defined as ``a written communication, as defined 
in Rule 405, that includes information, opinions, or recommendations 
with respect to securities of an issuer or an analysis of a security 
or an issuer, whether or not it provides information reasonably 
sufficient upon which to base an investment decision.'' 17 CFR 
230.139(d); see infra section II.A.2 for a discussion of the term 
``research report.''
     There are differences in how other rules and regulations define 
the term ``research report,'' including Regulation Analyst 
Certification (``Regulation AC'') under the Securities Act and the 
Securities Exchange Act of 1934 (the ``Exchange Act''), 15 U.S.C. 
78a et seq. Compare 17 CFR 242.500-505 (A ``research report'' as 
defined under Regulation AC is limited to an analysis of a security 
or an issuer, and information within the report must be ``reasonably 
sufficient upon which to base an investment decision;'' whereas, 
under rule 139, a ``research report'' includes not only an analysis 
of a security or an issuer, as in Regulation AC, but also, 
information, opinions, or recommendations regarding securities of an 
issuer, irrespective of the information within the report being 
``reasonably sufficient upon which to base an investment 
decision.''); Financial Industry Regulatory Authority (``FINRA'') 
rule 2241 (defining ``research report''); and FINRA rule 2242 
(defining ``debt research report''). See also discussion of 
Regulation AC infra at notes 57-58. We note that research reports 
published or distributed by broker-dealers in reliance on the rule 
139 safe harbor may also be subject to other rules and regulations 
under the federal securities laws, including but not limited to 
Regulation AC, as well as SRO rules governing their content and use, 
including but not limited to FINRA rules 2210, 2241, and 2242.
    \12\ Rule 139(a) under the Securities Act [17 CFR 230.139(a)].
    \13\ Sections 5(a) and 5(c) of the Securities Act generally 
prohibit any person (including broker-dealers) from using the mails 
or interstate commerce as a means to sell or offer to sell, either 
directly or indirectly, any security unless a registration statement 
is in effect or has been filed with the Commission as to the offer 
and sale of such security, or an exemption from the registration 
provisions applies. See 15 U.S.C. 77e(a) and (c). Section 5(b)(1) of 
the Securities Act requires that any ``prospectus'' relating to a 
security to which a registration statement has been filed must 
comply with the requirements of section 10 of the Securities Act. 
See 15 U.S.C. 77e(b)(1). Section 5(b)(2) of the Securities Act 
requires that any sale of securities (or delivery after sale) must 
be accompanied or preceded by a prospectus meeting the requirements 
of section 10(a) of the Securities Act. See 15 U.S.C. 77e(b)(2).
    \14\ See Securities Offering Reform, Securities Act Release No. 
8501 (Nov. 3, 2004) [69 FR 67391 (Nov. 17, 2004)] (``Securities 
Offering Reform Proposing Release'').
    \15\ For example, rule 139 is available for research reports 
regarding issuers that meet the registrant requirements for 
securities offerings on Form S-3 or Form F-3. See rule 
139(a)(1)(i)(A)(1). To the extent that commodity- or currency-based 
trusts or funds (as defined in section I.B below) register their 
securities offering pursuant to the Securities Act and meet the 
eligibility requirements of Form S-3 or F-3, as well as the other 
conditions of rule 139, the rule 139 safe harbor would be currently 
available for a broker-dealer's publication or distribution of 
research reports pertaining to these issuers.
    However, covered investment funds that are registered investment 
companies and business development companies are not able to 
register their securities offerings on Form S-3 or Form F-3. 
Registered investment companies register their securities offerings 
on forms such as Forms N-1A, N-2, N-3, N-4, and N-6. Publicly-traded 
business development companies register their securities offerings 
on Form N-2. However, section 2(a)(3) of the Securities Act provides 
a safe harbor for broker-dealers with respect to research reports 
about ``emerging growth companies,'' as defined in section 2(a)(19) 
of the Securities Act. Broker-dealers may therefore currently rely 
on the section (2)(a)(3) safe harbor with respect to research 
reports about business development companies that are emerging 
growth companies.
---------------------------------------------------------------------------

B. FAIR Act

    The FAIR Act directs us to propose and adopt rule amendments that 
would extend the current safe harbor available under rule 139 to a 
``covered investment fund research report.'' \16\ The FAIR Act also 
directs that these amendments shall be ``upon such terms, conditions, 
or requirements as the Commission may determine necessary or 
appropriate in the public interest, for the protection of

[[Page 26790]]

investors, and for the promotion of capital formation.'' \17\
---------------------------------------------------------------------------

    \16\ See section 2(a) of the FAIR Act.
    \17\ See id.
---------------------------------------------------------------------------

    Under the FAIR Act, a ``covered investment fund research report'' 
is generally a research report published or distributed by a broker-
dealer about a covered investment fund or any of the covered investment 
fund's securities.\18\ The term ``covered investment fund'' under the 
FAIR Act includes registered investment companies and business 
development companies.\19\ The term also includes other persons issuing 
securities in an offering registered under the Securities Act (i) whose 
securities are listed for trading on a national securities exchange, 
(ii) whose assets consist primarily of commodities, currencies, or 
derivative instruments that reference commodities or currencies or 
interests in the foregoing, and (iii) whose registration statement 
reflects that its securities are purchased or redeemed, subject to 
certain conditions or limitations, for a ratable share of its assets 
(such exchange-listed funds or trusts, ``commodity- or currency-based 
trusts or funds'').\20\ However, a ``covered investment fund research 
report'' excludes research reports published or distributed by the 
covered investment fund itself, any affiliate of the covered investment 
fund, or any broker-dealer that is an investment adviser (or an 
affiliated person of the investment adviser) to the covered investment 
fund.\21\
---------------------------------------------------------------------------

    \18\ See id. at section 2(f)(3). But see infra note 21 and 
accompanying text (noting that the definition of ``covered 
investment fund research report'' excludes research reports 
published or distributed by the covered investment fund or any 
affiliate of the covered investment fund, or any research report 
published or distributed by any broker or dealer that is an 
investment adviser (or an affiliated person of an investment 
adviser) for the covered investment fund).
    \19\ See id. at section 2(f)(2)(A).
    \20\ See id. at section 2(f)(2)(B).
    \21\ The FAIR Act definition of ``covered investment fund 
research report'' uses the term ``affiliate'' in connection with a 
covered investment fund and ``affiliated person'' in connection with 
an investment adviser. See section 2(f)(3) of the FAIR Act.
    The FAIR Act includes a definition for the term ``affiliated 
person,'' but not ``affiliate.'' Because the FAIR Act directs the 
Commission to revise rule 139 under the Securities Act, we interpret 
the reference to the term ``affiliate'' in the definition of 
``covered investment fund research report'' to refer to the term 
``affiliate'' as it would be interpreted under rule 139, which we 
believe is by reference to rule 405 under the Securities Act. (We 
believe this to be the case because, for example, rule 139 is 
available for research reports regarding issuers that register their 
securities on Form S-3 or F-3 (or that meet the registrant 
requirements to register their securities offerings on Form S-3 or 
Form F-3) and that meet the minimum float provisions of General 
Instruction I.B.1 of such forms. See rule 139(a)(1)(i)(A)(1)(i). 
General Instruction I.B.1, in turn, refers to the definition of 
``affiliate'' in Securities Act rule 405.) Under rule 405, the term 
``affiliate'' means an affiliate of, or person affiliated with, a 
specified person, is a person that directly, or indirectly through 
one or more intermediaries, controls or is controlled by, or is 
under common control with, the person specified. See rule 405 under 
the Securities Act [17 CFR 230.405]. The FAIR Act defines 
``affiliated person'' as having the meaning given the term in 
section 2(a) of the Investment Company Act. See section 2(f)(1) of 
the FAIR Act. Section 2(a) of the Investment Company Act defines an 
``affiliated person'' as: (A) Any person directly or indirectly 
owning, controlling, or holding with power to vote, five per centum 
or more of the outstanding voting securities of such other person; 
(B) any person five per centum or more of whose outstanding voting 
securities are directly or indirectly owned, controlled, or held 
with power to vote, by such other person; (C) any person directly or 
indirectly controlling, controlled by, or under common control with, 
such other person; (D) any officer, director, partner, copartner, or 
employee of such other person; (E) if such other person is an 
investment company, any investment adviser thereof or any member of 
an advisory board thereof; and (F) if such other person is an 
unincorporated investment company not having a board of directors, 
the depositor thereof.
---------------------------------------------------------------------------

    The FAIR Act directs us to address the application of certain 
aspects of current rule 139 to covered investment fund research 
reports. For example, one of the conditions for using the rule 139 safe 
harbor for research reports about a specific issuer is that the broker-
dealer's publication or distribution of the research report must ``not 
represent the initiation of publication of research reports about such 
issuer or its securities or reinitiation of such publication following 
discontinuation of publication of such research reports.'' \22\ Because 
many covered investment funds continuously offer their shares for sale 
(as opposed to engaging in an offering over a discrete period of time), 
it is difficult for a broker-dealer participating in such a continuous 
offering to satisfy this condition. In light of this, the FAIR Act 
prescribes that our extension of the rule 139 safe harbor, with respect 
to research reports in an offering of covered investment funds that are 
in ``substantially continuous distribution,'' cannot be conditioned on 
whether the broker-dealer's publication or distribution of such 
research reports constitutes initiation or reinitiation of research 
about the covered investment fund or its securities.\23\
---------------------------------------------------------------------------

    \22\ See rule 139(a)(1)(iii) [17 CFR 230.139(a)(1)(iii)].
    \23\ See section 2(b)(1) of the FAIR Act.
---------------------------------------------------------------------------

    The FAIR Act also permits us to impose conditions on covered 
investment fund research reports that are similar to the conditions 
imposed under rule 139.\24\ We may set a minimum public float 
requirement for covered investment funds but may not require a minimum 
public float that is greater than what is required under rule 139 
(currently, $75 million).\25\ Similarly, we may set a reporting history 
requirement for covered investment funds, but may not require a 
reporting history period for longer than what is required under rule 
139 (currently, the 12 months preceding the time of the broker-dealer's 
first reliance on the rule 139 safe harbor).\26\ Moreover, as noted 
above, we may impose additional conditions that we determine to be 
necessary or appropriate in the public interest, for the protection of 
investors, and for the promotion of capital formation.\27\
---------------------------------------------------------------------------

    \24\ See infra notes 25-27.
    \25\ See section 2(b)(2)(B) of the FAIR Act.
    \26\ Id. at section 2(b)(2)(A).
    \27\ See supra note 17 and accompanying text.
---------------------------------------------------------------------------

    Finally, the FAIR Act includes provisions concerning the ability of 
SROs to impose requirements on the use and filing of covered investment 
fund research reports.\28\ First, the FAIR Act directs us to provide 
that covered investment fund research reports will not be subject to 
section 24(b) of the Investment Company Act and the rules and 
regulations thereunder,\29\ except to the extent that such reports are 
otherwise not subject to the content standards in the rules of any SRO 
related to research reports, including those contained in the rules 
governing communications with the public regarding investment companies 
or substantially similar standards.\30\ The FAIR Act also requires us 
to provide that SROs: (i) Cannot prohibit the ability of a broker-
dealer to publish or distribute a covered investment fund

[[Page 26791]]

research report solely because the broker-dealer is participating in a 
registered offering or other distribution of any securities of the 
covered investment fund; and (ii) cannot prohibit the ability of a 
broker-dealer to participate in a registered offering or other 
distribution of securities of the covered investment fund solely 
because the broker-dealer has published or distributed a research 
report about that covered investment fund or its securities.\31\
---------------------------------------------------------------------------

    \28\ See sections 2(b)(3)-(4), 2(c)(2) of the FAIR Act; see also 
discussion at text accompanying notes 29-31 infra.
    \29\ Section 24(b) of the Investment Company Act makes it 
unlawful for any registered open-end company (or any registered unit 
investment trust, any registered face-amount certificate company, or 
any underwriter of any of the preceding companies), in connection 
with a public offering of any security of which such company is an 
issuer, to transmit, among other things, sales literature addressed 
to or intended for distribution to prospective investors unless the 
sales literature is filed with the Commission. See 15 U.S.C. 80a-
24(b). Rule 24b-3 under the Investment Company Act deems these 
materials to have been filed with the Commission if filed with 
FINRA. See 17 CFR 270.24b-3.
    \30\ See section 2(b)(4) of the FAIR Act. However, the FAIR Act 
also includes a provision clarifying that the Act will not be 
construed as limiting an SRO's authority to require the filing of 
communications with the public ``the purpose of which is not to 
provide research and analysis of covered investment funds.'' See 
section 2(c)(2) of the FAIR Act. In addition, the FAIR Act provides 
that the Act does not limit SROs' authority to examine or supervise 
a member's practices in connection with its publication or 
distribution of covered investment fund research reports for 
compliance with applicable provisions of the federal securities laws 
and SRO rules related to research reports, including rules governing 
communications with the public. See section 2(c)(2) of the FAIR Act.
    \31\ See section 2(b)(3) of the FAIR Act.
---------------------------------------------------------------------------

II. Discussion

    In the sections that follow, we discuss in detail the scope and 
conditions of proposed rule 139b, the operation and effect of proposed 
rule 24b-4,\32\ and the proposed conforming amendment to rule 101 of 
Regulation M.
---------------------------------------------------------------------------

    \32\ This discussion appears in section II.D infra.
---------------------------------------------------------------------------

    Proposed rule 139b's framework is modeled after and generally 
tracks rule 139. However, proposed rule 139b differs from rule 139 in 
certain respects. Some of these differences are specifically directed 
or contemplated by the FAIR Act.\33\ Other differences, while not 
specifically directed by the FAIR Act, clarify and tailor the 
provisions of rule 139 more directly or specifically to the context of 
broker-dealers' publication or distribution of covered investment fund 
research reports.\34\ For the reasons described below, we believe that 
the provisions of proposed rule 139b that differ from the provisions of 
rule 139, and that are not specifically contemplated in the FAIR Act, 
are necessary or appropriate in the public interest, for the protection 
of investors, and for the promotion of capital formation.
---------------------------------------------------------------------------

    \33\ See, e.g., infra section II.A.1 (discussing the ``affiliate 
exclusion'' (defined below)).
    \34\ See, e.g., infra section II.B.1.a (discussing reporting 
history and timeliness requirements for issuer-specific reports).
---------------------------------------------------------------------------

A. Scope of Proposed Rule 139b

    Proposed rule 139b would establish a safe harbor for the 
publication or distribution of ``covered investment fund research 
reports'' by unaffiliated broker-dealers (as described below) 
participating in a securities offering of a ``covered investment 
fund.'' Under the safe harbor, such publication or distribution would 
be deemed not to constitute an offer for sale or offer to sell the 
covered investment fund's securities for purposes of sections 2(a)(10) 
and 5(c) of the Securities Act. The safe harbor would be available even 
if the broker-dealer is participating or may participate in a 
registered offering of the covered investment fund's securities. We are 
proposing to define the term ``covered investment fund research 
report,'' as well as the ``covered investment fund'' and ``research 
report'' components of this definition.
1. Definition of ``Covered Investment Fund Research Report''
    Under the FAIR Act, the term ``covered investment fund research 
report'' means a research report published or distributed by a broker 
or dealer about a covered investment fund or any securities issued by 
the covered investment fund, but does not include a research report to 
the extent that the research report is published or distributed by the 
covered investment fund or any affiliate of the covered investment 
fund, or any research report published or distributed by any broker or 
dealer that is an investment adviser (or an affiliated person of an 
investment adviser) for the covered investment fund (the ``affiliate 
exclusion'').\35\ Proposed rule 139b incorporates the same definition 
as is set forth in the FAIR Act.\36\
---------------------------------------------------------------------------

    \35\ See section 2(f)(3) of the FAIR Act.
    \36\ See proposed rule 139b(c)(3); see also supra note 21 
(discussing the terms ``affiliate'' and ``affiliated person'' in the 
FAIR Act definition of ``covered investment fund research report''); 
proposed rule 139b(c)(5) (defining the term ``investment adviser'' 
for purposes of the proposed rule).
---------------------------------------------------------------------------

    The FAIR Act's affiliate exclusion prohibits two separate 
categories of research reports from being deemed to be ``covered 
investment fund research reports'' that a broker-dealer may publish or 
distribute under the contemplated safe harbor. The first category 
covers research reports published or distributed by the covered 
investment fund or any affiliate of the covered investment fund. We 
believe this exclusion would prevent such persons from indirectly using 
the safe harbor to avoid the applicability of the Securities Act 
prospectus requirements and other provisions applicable to written 
offers by such persons.
    The second category covers research reports published or 
distributed by any broker or dealer that is an investment adviser (or 
an affiliated person of an investment adviser) for the covered 
investment fund. This second exclusion addresses the concern that a 
broker-dealer that is a fund's adviser or an affiliated person of a 
fund's adviser may have financial incentives that could give rise to a 
conflict of interest. For example, a broker-dealer that is an 
affiliated person of a fund's adviser may have an incentive to promote 
the covered investment fund's securities relative to other securities 
because sales of the covered investment fund's securities would benefit 
not only the fund, but also could benefit the broker-dealer.\37\ This 
second exclusion therefore helps to establish a certain level of 
independence in the activity of publishing and distributing covered 
investment fund research reports and therefore could help mitigate 
these potential conflicts of interest.
---------------------------------------------------------------------------

    \37\ We note that broker-dealers may have incentives to 
recommend certain covered investment funds to clients even when the 
broker-dealer is not the fund's investment adviser (or an affiliated 
person of the investment adviser). For example, when a covered 
investment fund's investment adviser has entered into revenue 
sharing arrangements with a broker-dealer, the broker-dealer may 
have incentives to recommend to its clients the purchase of this 
fund's securities relative to the securities of other covered 
investment funds (whose investment advisers have not entered into 
revenue sharing agreements with the broker-dealer). We also note 
that certain covered investment fund research reports also may be 
subject to additional rules and regulations under the federal 
securities laws, as well as certain SRO rules, that are designed to 
help address certain conflicts of interest and abuses identified 
with analyst research. See, e.g., Sarbanes-Oxley Act of 2002, Public 
Law 107-204, 116 Stat. 745 (2002) (``Sarbanes-Oxley Act''), 
Regulation AC, and FINRA rules 2210, 2241, 2242. The Sarbanes-Oxley 
Act, Regulation AC, and a global research analyst settlement 
required structural changes and increased disclosures in connection 
with certain abuses identified with analyst research. See section 
501 of the Sarbanes-Oxley Act; Regulation Analyst Certification, 
Securities Act Release No. 8193 (Feb. 20, 2003) [68 FR 9481 (Feb. 
27, 2003)] (``Regulation AC Adopting Release''); Global Research 
Analyst Settlement, Litigation Release No. 18438 (Oct. 31, 2003) 
(``Lit. Rel. No. 18438''); 2010 Modifications to Global Research 
Analyst Settlement, Litigation Release No. 21457 (Mar. 19, 2010) 
(``Lit. Rel. No. 21457'').
---------------------------------------------------------------------------

    We believe that it would be inappropriate for any person covered by 
the affiliate exclusion, or for any person acting on its behalf, to 
publish or distribute a research report indirectly that the person 
could not publish or distribute directly under the proposed rule.\38\ 
For example, if a broker-dealer were to publish or distribute a 
research report that included materials that were specifically 
authorized or approved by a person covered by the affiliate exclusion, 
expressly for the purpose of inclusion in a research report, this could 
inappropriately circumvent the affiliate exclusion in proposed rule 
139b. In this case, the person covered by the affiliate exclusion would 
be publishing or distributing communications indirectly through the 
third-party broker-dealer that otherwise would have to be included in a 
statutory prospectus meeting the requirements of section 10 of the 
Securities Act. One of the factors to consider in evaluating whether a 
research report has been published or

[[Page 26792]]

distributed by a person covered by the affiliate exclusion is the 
extent of such person's involvement in the preparation, distribution, 
or publication of the research report.\39\
---------------------------------------------------------------------------

    \38\ See, e.g., section 48(a) of the Investment Company Act [15 
U.S.C. 80a-47(a)]; section 208(d) of the Investment Advisers Act of 
1940 [15 U.S.C. 80b-8(d)].
    \39\ Such determinations would necessarily be based on the 
extent to which a person covered by the affiliate exclusion, or any 
person acting on its behalf, has been involved in the preparation of 
the information or explicitly or implicitly endorsed or approved the 
information. The Commission has referred to these as the 
entanglement theory and the adoption theory, respectively, and these 
are helpful guideposts in establishing whether a research report 
about a covered investment fund may be deemed published or 
distributed by the fund. See Securities Offering Reform, Securities 
Act Release No. 8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)] 
(``Securities Offering Reform Adopting Release'') (noting that 
``[l]iability under the entanglement theory depends upon the level 
of pre-publication involvement in the preparation of the 
information''). See Use of Electronic Media, Securities Act Release 
No. 7856 (Apr. 28, 2000) [65 FR 25843 (May 4, 2000)] (interpretive 
release on the use of electronic media); Asset-Backed Securities, 
Securities Act Release No. 8518 (Dec. 22, 2004) [70 FR 1506 (Jan. 5, 
2005)] (adopting asset-backed securities regulations).
---------------------------------------------------------------------------

    We request comment on the proposed definition of ``covered 
investment fund research report.''
     Should we define ``covered investment fund research 
report'' as specified in the FAIR Act, as proposed? Why or why not? 
What modifications, if any, to this definition do commenters recommend? 
Solely for purposes of the proposed affiliate exclusion, should we use 
a definition of ``affiliate'' that differs from the definition of this 
term in rule 405 under the Securities Act? If so, should we interpret 
the term ``affiliate'' in this context to mean an ``affiliated person'' 
as defined in the Investment Company Act? If not, what other definition 
should we use?
     Should we include a provision in rule 139b specifying that 
the affiliate exclusion would make the safe harbor unavailable if a 
broker-dealer were to publish or distribute a research report that 
includes materials that were specifically authorized or approved by a 
person covered by the affiliate exclusion (or a person acting on its 
behalf) for purposes of inclusion in a research report? Why or why not? 
If not, is the guidance discussed above on this point \40\ appropriate 
and helpful to the public in understanding the proposed affiliate 
exclusion? Is there any other guidance that we should provide that 
would be helpful to promote clarity with respect to the proposed 
affiliate exclusion?
---------------------------------------------------------------------------

    \40\ See supra paragraph accompanying notes 38-39.
---------------------------------------------------------------------------

     Broker-dealers may have incentives--in particular, arising 
from the compensation arrangements between registered investment 
companies and their distributing broker-dealers--to recommend certain 
covered investment funds to clients even when the broker-dealer is not 
the fund's investment adviser (or an affiliated person of the 
investment adviser).\41\ While certain covered investment fund research 
reports may be subject to additional rules and regulations under the 
federal securities laws, as well as certain SRO rules, that are 
designed to help address certain conflicts of interest,\42\ these 
additional rules and regulations would not necessarily be applicable 
with respect to all covered investment fund research reports under 
proposed rule 139b.\43\ Moreover, while these rules and regulations 
address conflicts of interest, certain of the conflicts they address 
may not be prevalent in the investment company context (e.g., FINRA 
rules 2241 and 2242 address, among other things, investment-banking-
related conflicts). Are we correct that there are conflicts of interest 
that could arise with respect to broker-dealers' publication or 
distribution of covered investment fund research reports (in 
particular, research reports about registered investment company 
issuers) that would not be mitigated by proposed rule 139b's exclusion 
of research reports published or distributed by a broker-dealer that is 
an investment adviser for the covered investment fund (or an affiliated 
person of the adviser)? If not, why not? If so, how should we address 
these conflicts? Should we add restrictions or conditions to the safe 
harbor to further mitigate potential conflicts? If so, what types of 
additional restrictions or conditions would be appropriate? For 
example, should we require a broker-dealer to describe in a research 
report the revenue-sharing or other distribution arrangements it has 
with a covered investment fund as a condition to relying on the 
proposed safe harbor? Should the existence of a revenue-sharing 
agreement or other particular type of distribution arrangement 
disqualify a broker-dealer from being able to publish or distribute a 
research report about a covered investment fund in reliance on the 
proposed safe harbor? If so, what types and why?
---------------------------------------------------------------------------

    \41\ See supra note 37 and accompanying text; see also infra 
paragraphs accompanying notes 262-269.
    \42\ See id.
    \43\ For example, as discussed above, there are differences in 
how the FAIR Act and proposed rule 139b, and other rules and 
regulations, define the term ``research report,'' and therefore the 
scope of other rules and regulations that govern broker-dealers' 
publication and distribution of research reports does not correspond 
in every respect to the scope of proposed rule 139b. See infra 
section II.A.2 (discussing the definition of ``research report'' in 
proposed rule 139b); see supra note 11 (discussing the differences 
in the definition of ``research report'' in Regulation AC and FINRA 
rules 2241 and 2242).
---------------------------------------------------------------------------

     Alternatively, should we require broker-dealers that rely 
on proposed rule 139b to maintain policies and procedures designed to 
mitigate conflicts that are raised by the distribution of covered 
investment funds (in particular, covered investment funds that are 
registered investment companies) and not addressed by the Commission's 
rules or SRO rules (such as FINRA rules 2241 and 2242)? To the extent 
that Commission and SRO rules do not require disclosure of conflicts of 
interest in covered investment fund research reports, should we require 
broker-dealers that rely on the proposed rule 139b safe harbor to 
disclose conflicts of interest in a salient way in covered investment 
fund research reports? If so, what should the content and format 
requirements be with respect to such disclosure?
2. Definition of ``Research Report''
    We are proposing to define the term ``research report'' in rule 
139b as a written communication, as defined in rule 405 under the 
Securities Act, that includes information, opinions, or recommendations 
with respect to securities of an issuer or an analysis of a security or 
an issuer, whether or not it provides information reasonably sufficient 
upon which to base an investment decision.\44\ This definition is 
identical to the corresponding definition of ``research report'' in 
rule 139.\45\ We are not proposing to include a definition of 
``research report'' in rule 139b that is identical to that in the FAIR 
Act for two reasons, discussed in more detail below. First, we believe 
that the definition we propose is consistent with the FAIR Act, because 
we would interpret it to have

[[Page 26793]]

the same meaning as the definition of ``research report'' in the FAIR 
Act.\46\ Second, we believe that proposing a definition of ``research 
report'' in rule 139b that is identical to the existing definition of 
``research report'' in rule 139 would reduce potential interpretive 
confusion for market participants who are familiar with the rule 139 
definition.
---------------------------------------------------------------------------

    \44\ See proposed rule 139b(c)(6).
     Rule 405 defines ``written communication'' to mean that 
``[e]xcept as otherwise specifically provided or the context 
otherwise requires, a written communication is any communication 
that is written, printed, a radio or television broadcast, or a 
graphic communication as defined in [rule 405].'' 17 CFR 230.405.
    \45\ See rule 139(d) [17 CFR 230.139(d)]. Rule 139 defines 
``research report'' to mean ``a written communication, as defined in 
Rule 405, that includes information, opinions, or recommendations 
with respect to securities of an issuer or an analysis of a security 
or an issuer, whether or not it provides information reasonably 
sufficient upon which to base an investment decision.'' See rule 
139(d) [17 CFR 230.139(d)]. A ``written communication,'' as defined 
in rule 405, includes a ``graphic communication.'' As further 
defined in rule 405, a ``graphic communication'' includes all forms 
of electronic media, including electronic communications except 
those, which at the time of the communication, originate in real-
time to a live audience and does not originate in recorded form or 
otherwise as a graphic communication, although it is transmitted 
through graphic means. See rule 405 [17 CFR 230.405].
    \46\ See infra notes 49-50 and accompanying text.
---------------------------------------------------------------------------

    The FAIR Act defines the term ``research report'' as having the 
meaning given to that term under section 2(a)(3) of the Securities Act 
but specifies that the term ``shall not include an oral 
communication.'' \47\ Section 2(a)(3) of the Securities Act, in turn, 
defines ``research report'' to mean ``a written, electronic, or oral 
communication that includes information, opinions, or recommendations 
with respect to securities of an issuer or an analysis of a security or 
an issuer, whether or not it provides information reasonably sufficient 
upon which to base an investment decision.'' \48\
---------------------------------------------------------------------------

    \47\ See section 2(f)(6) of the FAIR Act.
    \48\ 15 U.S.C. 77b(a)(3).
---------------------------------------------------------------------------

    The proposed rule 139b definition of ``research report'' tracks the 
FAIR Act definition of ``research report,'' except that while it does 
include ``electronic communications,'' it does not expressly reference 
that term. For the following reasons, we believe that this difference 
would have no effect on the types of communications that would qualify 
as research reports under the proposed safe harbor. Current Commission 
rules make clear that all electronic communications (other than 
telephone and other live communications) are graphic and, therefore, 
written communications for purposes of the Securities Act.\49\ 
Therefore, the proposed rule 139b definition's reference to a ``written 
communication,'' as defined in rule 405, would include a ``graphic 
communication,'' which in turn would include electronic communications 
(other than telephone and other live communications).\50\
---------------------------------------------------------------------------

    \49\ See Securities Offering Reform Adopting Release, supra note 
39, at nn.96-97 and accompanying text; infra note 50. Among other 
things, the Securities Offering Reform Adopting Release amended the 
definition of ``research report'' in rule 139 to make clear that it 
continues to apply to information, opinions, or recommendations 
contained in written communications. See id., at text following 
n.363.
    As the Commission noted in the Securities Offering Reform 
Adopting Release, the intention of addressing electronic 
communications under the Securities Act is ``to encompass new 
technologies . . . [and] promote consistent understanding of what 
constitutes such a communication in view of the technological 
developments.'' See Securities Offering Reform Adopting Release, 
supra note 39, at 44732.
    \50\ See supra note 45 (discussing the current definition of 
``research report'' in rule 139, which references a ``written 
communication'' as defined in rule 405, which definition in turn 
incorporates the term ``graphic communication'').
---------------------------------------------------------------------------

    By using the same definition of ``research report'' in rule 139 and 
proposed rule 139b we avoid creating ambiguity that may result if 
market participants are unable to understand, based on the text of the 
rules, that the term ``research report,'' though defined in two 
different ways, would be interpreted identically.
    We request comment on the proposed definition of ``research 
report.''
     Should we use the definition of ``research report'' in 
rule 139 as we have proposed rather than as specified in the FAIR Act? 
Is our proposed approach appropriate? Is defining ``research report'' 
as proposed consistent with section 2(f)(6) of the FAIR Act? Would the 
proposed definition of ``research report'' have the intended result of 
assuring that the definitions of ``research report'' under the FAIR Act 
and rule 139b would be interpreted identically? Why or why not?
     Instead of using the rule 139 definition of ``research 
report,'' as proposed, would it be preferable for the Commission to 
incorporate the FAIR Act definition of ``research report'' into 
proposed rule 139b? If so, why?
     What, if any, additional modifications to the proposed 
definition of ``research report'' would promote clarity? Should we 
incorporate any additional modifications to the proposed definition for 
any other purpose?
3. Definition of ``Covered Investment Fund''
    The FAIR Act defines the term ``covered investment fund'' to 
include registered investment companies, business development 
companies, and certain commodity- or currency-based trusts or 
funds.\51\ We are proposing to define the term ``covered investment 
fund'' in rule 139b in substantially the same manner as the FAIR Act, 
with the addition that we propose to specify in this definition that 
the term ``investment company'' includes ``a series or class thereof.'' 
\52\
---------------------------------------------------------------------------

    \51\ See supra notes 19-20 and accompanying text. Based on the 
definition in section 2(f)(2) of the FAIR Act, the term ``covered 
investment fund'' would not include an investment company that is 
registered solely under the Investment Company Act, such as certain 
master funds in a master-feeder structure. See id.
    \52\ See proposed rule 139b(c)(2). This approach reflects the 
approach taken in other Commission rules that define the term 
``fund'' to include a separate series of an investment company. See, 
e.g., rule 22e-4(a)(4) under the Investment Company Act [17 CFR 
270.22e-4(a)(4)]; rule 22c-1(a)(3)(v)(A) under the Investment 
Company Act [17 CFR 270.22c-1(a)(3)(v)(A)] (effective Nov. 19, 
2018).
---------------------------------------------------------------------------

    We request comment on the proposed definition of ``covered 
investment fund.''
     Should we define ``covered investment fund'' substantially 
the same as this term is defined in the FAIR Act as proposed? Why or 
why not? Should we specify in the definition, as proposed, that the 
term ``investment company'' includes a ``series or class thereof''? 
What modifications, if any, to this definition do commenters recommend?
     Are there any types of funds, trusts, or other pooled 
investment vehicles that would not be included within the proposed 
definition of ``covered investment fund'' that we should consider 
including in the definition? If so, why?
4. Non-Exclusivity of Safe Harbor
    Broker-dealers publishing or distributing research reports for some 
covered investment funds, such as commodity- or currency-based trusts 
or funds that have a class of securities registered under the Exchange 
Act, may be able to rely on existing rule 139.\53\ We do not intend for 
proposed rule 139b to preclude a broker-dealer from relying on existing 
rule 139 where appropriate. In order to clarify that a broker-dealer 
may rely on existing research safe harbors, proposed rule 139b provides 
that the rule does not affect the availability of any other exemption 
or exclusion from sections 2(a)(10) or 5(c) of the Securities Act that 
may be available to a broker-dealer.\54\ A broker-dealer therefore 
would be able to rely on proposed rule 139b to publish or distribute a 
covered investment fund research report or could choose to rely instead 
on any other available exemption or exclusion from sections 2(a)(10) or 
5(c) of the Securities Act,

[[Page 26794]]

including those provided by rules 137,\55\ 138, and 139, as applicable.
---------------------------------------------------------------------------

    \53\ Section 803(b)(2)(F) of the Small Business Credit 
Availability Act, which was enacted on March 23, 2018 as sections 
801-803 of the 2018 Consolidated Appropriations Act, directs the 
Commission to amend rules 138 and 139 to specifically include a 
business development company as an issuer to which those rules 
apply. Section 803(b) of the Small Business Credit Availability Act 
directs the Commission to make these revisions to rules 138 and 139, 
as well as the other rule revisions that section 803(b)(2) of the 
Act describes, within one year of enactment, and these revisions 
would be addressed in a Commission action that is separate from the 
proposal that this release describes.
    \54\ See proposed rule 139b(a) (providing, in part, that the 
rule does not affect the availability of any other exemption or 
exclusion from sections 2(a)(10) or 5(c) of the Act available to the 
broker or dealer); see also proposed addition to rule 139(a) (for 
purposes of the Fair Access to Investment Research Act of 2017 [Pub. 
L. 115-66, 131 Stat. 1196 (2017)], a safe harbor has been 
established for covered investment fund research reports, and the 
specific terms of that safe harbor are set forth in Rule 139b (Sec.  
230.139b)).
    \55\ 17 CFR 230.137.
---------------------------------------------------------------------------

    We request comment on the non-exclusivity provision in proposed 
rule 139b.
     Should other exemptions, exclusions, or safe harbors from 
sections 2(a)(10) or 5(c) of the Securities Act for research reports, 
such as rules 137, 138, or 139, continue to be available to broker-
dealers as proposed? Why or why not? Should we make any additional 
clarifications? If so, what clarifications should we make?

B. Conditions for the Safe Harbor

    The Commission has previously acknowledged the value of research 
reports in providing the market and investors with information about 
reporting issuers.\56\ To mitigate the risk of research reports being 
used to circumvent the prospectus requirements of the Securities 
Act,\57\ the Commission has placed conditions on a broker-dealer's 
publication or distribution of research reports.\58\ Under rule 139, 
these conditions include restrictions on who may rely on the rule and 
on the issuers to which the research may relate, as well as a 
requirement that such reports be published in the regular course of a 
broker-dealer's business. These conditions vary depending on whether a 
research report covers a specific issuer (``issuer-specific research 
reports'') or a substantial number of issuers in an industry or sub-
industry (``industry research reports'').
---------------------------------------------------------------------------

    \56\ See Securities Offering Reform Adopting Release, supra note 
39.
     For example, the Commission has recognized that, for companies 
that are well-followed, the research-report-related rules ``enhance 
the efficiency of the markets by allowing a greater number of 
research reports to provide a continuous flow of essential corporate 
information into the marketplace.'' See Research Reports, Securities 
Act Release No. 6550 (Sept. 19, 1984) [49 FR 37569 (Sept. 25, 1984)] 
(``1984 Adopting Release'').
    \57\ See supra note 13 and accompanying text (noting that the 
rule 139 safe harbor permits a broker-dealer to publish or 
distribute a research report without this publication or 
distribution being deemed to constitute an offer that otherwise 
could be a non-conforming prospectus in violation of section 5 of 
the Securities Act).
    See, also, e.g., Securities Offering Reform Adopting Release, 
supra note 39 (discussing how the Sarbanes-Oxley Act, Regulation AC, 
and a global research analyst settlement required structural changes 
and increased disclosures in the early 2000s in connection with 
certain abuses identified with analyst research); discussion at 
supra note 37 (discussing certain rules and regulations under the 
federal securities laws, as well as certain SRO rules, that are 
designed to help address certain conflicts of interest and abuses 
identified with analyst research).
    \58\ Many research reports that broker-dealers publish or 
distribute in reliance on the rule 139 safe harbor may also be 
subject to other federal securities rules and regulations under the 
Exchange Act and SRO rules governing their content and use. See 
supra note 57.
---------------------------------------------------------------------------

    Consistent with the FAIR Act's directive to revise rule 139 to 
extend the rule's safe harbor to covered investment fund research 
reports, proposed rule 139b seeks to address concerns that could 
accompany broker-dealers' publication or distribution of these research 
reports. Rule 139b proposes conditions for both issuer-specific reports 
and industry research reports that must be satisfied in order for a 
broker-dealer to rely on the safe harbor.\59\ The conditions are 
intended to track the conditions already in place under rule 139 to the 
extent practicable. We believe that any deviations from the 
requirements of rule 139 are consistent with the FAIR Act's 
directives.\60\ Tracking the requirements in rule 139 to the extent 
practicable also provides efficiencies for broker-dealers familiar with 
the requirements of rule 139.
---------------------------------------------------------------------------

    \59\ Proposed rule 139b(a)(1)-(2).
    \60\ See supra paragraph accompanying notes 32-34.
---------------------------------------------------------------------------

1. Issuer-Specific Research Reports
a. Reporting History and Timeliness Requirements
    In order for a broker-dealer to include a covered investment fund 
in a research report published or distributed in reliance on the 
proposed safe harbor, we propose that the fund must meet certain 
reporting history requirements. Specifically, we are proposing that any 
such covered investment fund must have been subject to relevant 
requirements under the Investment Company Act and/or the Exchange Act 
to file certain periodic reports for at least 12 calendar months prior 
to a broker-dealer's reliance on proposed rule 139b.\61\ We also are 
proposing that any such covered investment fund must have filed certain 
periodic reports in a timely manner during the immediately preceding 12 
calendar months. Specifically, covered investment funds that are 
registered investment companies would need to have been subject to the 
reporting requirements of the Investment Company Act for a period of at 
least 12 calendar months prior to reliance on the proposed rule and to 
have filed in a timely manner all required reports, as applicable, on 
Forms N-CSR,\62\ N-SAR,\63\ N-Q,\64\ N-PORT,\65\ N-MFP,\66\ and N-CEN 
\67\ during the immediately preceding 12 months.\68\ If the covered 
investment fund is not a registered investment company, it would need 
to have been subject to the reporting requirements under section 13 or 
15(d) of the Exchange Act for a period of at least 12 calendar months 
and to have filed all required reports in a timely manner on Forms 10-K 
\69\ and 10-Q \70\ and 20-F \71\ during the immediately preceding 12 
months.\72\ The proposed reporting history requirements are consistent 
with current rule 139.\73\ The timeliness

[[Page 26795]]

component of the proposed requirement also tracks rule 139.\74\
---------------------------------------------------------------------------

    \61\ Proposed rule 139b(a)(1)(i)(A). We believe that this 
proposed condition also gives effect to FAIR Act section 2(e), which 
makes the safe harbor contemplated by the FAIR Act unavailable with 
respect to broker-dealers' publication or distribution of research 
reports about closed-end registered investment companies or business 
development companies during these covered investment fund issuers' 
first year of operation. See section 2(e) of the FAIR Act (The safe 
harbor under subsection (a) of the FAIR Act shall not apply to the 
publication or distribution by a broker or a dealer of a covered 
investment fund research report, the subject of which is a business 
development company or a registered closed-end investment company, 
during the time period described in 17 CFR 230.139(a)(1)(i)(A)(1), 
except where expressly permitted by the rules and regulations of the 
Securities and Exchange Commission under the Federal securities 
laws.); see also infra note 74 and accompanying text (discussing 
rule 139(a)(1)(i)(A)(1)).
    \62\ 17 CFR 249.331 and 17 CFR 274.128.
    \63\ 17 CFR 249.330 and 17 CFR 274.101.
    \64\ 17 CFR 249.332 and 17 CFR 274.130.
    \65\ 17 CFR 274.150. Form N-PORT will be filed with the 
Commission on a monthly basis, but only information reported for the 
third month of each fund's fiscal quarter on Form N-PORT will be 
publicly available (and not until 60 days after the end of the 
fiscal quarter). See Investment Company Reporting Modernization, 
Investment Company Act Release No. 32314 (Oct. 13, 2016) [81 FR 
81870 (Nov. 18, 2016)] (``Reporting Modernization Release''). 
Therefore, we would consider Form N-PORT to have been timely filed 
for purposes of the proposed timeliness requirement if the public 
filing of Form N-PORT every third month is timely filed.
    \66\ 17 CFR 274.201.
    \67\ 17 CFR 249.330 and 17 CFR 274.101.
    \68\ Proposed rule 139b(a)(1)(i)(A)(1). Form N-SAR will be 
rescinded on June 1, 2018, which is the compliance date for Form N-
CEN. Form N-Q will be rescinded May 1, 2020. Larger fund groups will 
begin submitting reports on Form N-PORT by April 30, 2019, and 
smaller fund groups by April 30, 2020. See Reporting Modernization 
Release, supra note 65; Investment Company Reporting Modernization, 
Investment Company Act Release No. 32936 (Dec. 8, 2017) [82 FR 58731 
(Dec. 14, 2017)]. At the time of these compliance dates, covered 
investment funds would no longer be required to file reports N-SAR 
and N-Q, and filing these reports would not be required as a 
condition to rely on the rule 139b safe harbor. Accordingly, we 
propose that rule 139b, if adopted, would be amended effective May 
1, 2020 by removing the reference to Form N-Q. See infra section VII 
(instruction 4 under Text of Proposed Rules and Amendments).
    \69\ 17 CFR 249.310.
    \70\ 17 CFR 249.308a.
    \71\ 17 CFR 249.220f.
    \72\ Proposed rule 139b(a)(1)(i)(A)(2).
    \73\ Rule 139(a)(1)(i)(A)(2) [17 CFR 230.139(a)(1)(i)(A)(2)] (As 
of the date of reliance on the section, has filed all periodic 
reports required during the preceding 12 months on Forms 10-K (Sec.  
249.310), 10-Q (Sec.  249.308a), and 20-F (Sec.  249.220f) pursuant 
to section 13 or section 15(d) of the Securities Exchange Act of 
1934 (15 U.S.C. 78m or 78o(d)).). In addition, the reporting history 
requirement is also a consequence of rule 139(a)(1)(i)(A)(1), which 
requires that an issuer included in an issuer-specific research 
report (other than a foreign private issuer) either must have filed 
a registration statement on Form S-3 or Form F-3, or met the 
registrant requirements of Form S-3 or Form F-3, as eligibility to 
register on these forms incorporates a reporting history 
requirement. Rule 139(a)(1)(i)(A)(1) and (a)(1)(i)(B)(1) [17 CFR 
230.139(a)(1)(i)(A)(1) and (a)(1)(i)(B)(1)]. In order to be eligible 
for registration on Form S-3 or Form F-3, the registrant must have 
been subject to the requirements of section 12 or 15(d) of the 
Exchange Act and have filed all materials required to be filed 
pursuant to section 13, 14 or 15(d) for a period of at least 12 
calendar months immediately preceding the filing of the Form S-3 or 
Form F-3. See General Instruction I.A.3(a) to Form S-3 and General 
Instruction I.A.2 to Form F-3.
    \74\ The timely reporting component in rule 139 is a consequence 
of the rule 139 requirement that issuers be eligible to register on 
Form S-3 or Form F-3. See supra note 73 (discussing rule 
139(a)(1)(i)(A)(1)); see also General Instruction I.A.3(b) to Form 
S-3 and General Instruction I.A.2 to Form F-3 (each providing that 
the registrant must have filed the reports specified in the 
instruction ``in a timely manner'').
---------------------------------------------------------------------------

    As the Commission has previously recognized in the context of Form 
S-3 and F-3 issuers, satisfaction of the applicable reporting history 
and public float requirements suggests the presence of a sufficiently 
broad market following for the issuer's securities and, consequently, 
an adequate mix of information to inform investors as to material 
risks.\75\ Consistent with this view, we believe the proposed reporting 
history and timely reporting requirements would facilitate investors' 
analysis of issuer-specific covered investment fund research reports 
and aid them in making informed investment decisions.\76\ The 
Commission believes that it is appropriate to require a 12-month 
reporting history for covered investment fund issuers that may be 
included in issuer-specific research reports, rather than a shorter 
duration.\77\ As under rule 139, this approach would provide investors 
with publicly-available information about the issuers included in a 
research report for a full year. The proposed approach also has the 
benefit of maintaining consistency between rule 139b and the long-
established reporting history conditions of rule 139.\78\
---------------------------------------------------------------------------

    \75\ See, e.g., Revisions To The Eligibility Requirements For 
Primary Securities Offerings On Forms S-3 and F-3, Securities Act 
Release No. 8878 (Dec. 19, 2007) [72 FR 73533 (Dec. 27, 2007)] (``S-
3 Revisions Adopting Release''); Securities Offering Reform 
Proposing Release, supra note 14.
    \76\ See, e.g., Securities Offering Reform Proposing Release, 
supra note 14.
    \77\ As noted above, the FAIR Act specifically contemplates that 
we set a reporting history requirement for covered investment fund 
issuers that may be included in covered investment fund research 
reports, but we may not require a reporting history period for 
longer than what is required under rule 139(a)(1)(i)(A)(1). See 
supra note 26.
    The reporting history period required under rule 
139(a)(1)(i)(A)(1) is currently the preceding 12 months from the 
time of the broker-dealer's reliance on the rule 139 safe harbor. 
Rule 139(a)(1)(i)(A)(1) requires that an issuer included in an 
issuer-specific research report (other than a foreign private 
issuer) either must have filed a registration statement on Form S-3 
or Form F-3, or met the registrant requirements of Form S-3 or Form 
F-3, as eligibility to register on these forms incorporates a 
reporting history requirement. Under these eligibility requirements, 
the registrant must have been subject to the requirements of section 
12 or 15(d) of the Exchange Act and have filed all materials 
required to be filed pursuant to section 13, 14 or 15(d) for a 
period of at least 12 calendar months immediately preceding the 
filing of the Form S-3 or Form F-3. See discussion at supra note 73.
    In addition, rule 139(a)(1)(i)(A)(2) separately requires that, 
as of the date of reliance on the rule 139 safe harbor, the 
registrant must have filed all periodic reports required during the 
preceding 12 months on Forms 10-K, 10-Q, and 20-F. See id.
    \78\ See supra paragraph accompanying notes 32-34.
---------------------------------------------------------------------------

    We recognize, however, that in the context of covered investment 
funds that are open-end registered investment companies, use of a 
reporting history of only 12 months could result in certain performance 
and other information that may be relevant to investors not yet being 
available in the fund's prospectus at the time the broker-dealer 
publishes or distributes a research report on that fund. This is 
because the disclosure requirements for a registered investment 
company, or a series thereof, are based in part on how long the fund 
has been operational. For example, for a newly-registered covered 
investment fund that is an open-end registered investment company, a 
bar chart pursuant to Item 4 of Form N-1A is not required to be 
included in the fund's prospectus until the fund has been operational 
for one full calendar year.\79\ We note, however, that other 
information for such a fund, such as principal investment strategies 
and estimated expenses, would be available at the time the fund 
launches. We request comment below on whether--and if so, how--the 
proposed reporting history and timeliness requirements could be more 
tailored to covered investment funds.
---------------------------------------------------------------------------

    \79\ For example, under the requirements of Form N-1A, a fund 
that launched on January 4 and has an August 31 fiscal year-end 
would not be required to include a bar chart, which reflects 
calendar year-end information, until almost three years after launch 
(less a few days). However, other performance information about such 
a fund would be required to appear in reports filed on Form N-PORT 
(which will be made public quarterly, see supra notes 65, 68) and 
the fund's annual reports, and also could appear in rule 482 
advertisements.
---------------------------------------------------------------------------

    We request comment on the proposed reporting history and timeliness 
requirements.
     Are the proposed reporting requirements an appropriate 
condition for issuer-specific covered investment fund research reports 
whose publication or distribution would be covered under the rule 139b 
safe harbor?
     Should the proposed reporting requirements for issuer-
specific covered investment fund research reports track the existing 
reporting requirements for issuer-specific reports under rule 139 
(e.g., the length of reporting history, required reports, and 
timeliness component)? If not, how should they differ? Is the proposed 
requirement for a 12-month periodic reporting history the right amount 
of time in the context of covered investment funds? For example, should 
the reporting history requirement instead provide that an issuer that 
is a registered open-end investment company must have filed a 
prospectus reflecting at least a full calendar year of performance 
information prior to the time that a broker-dealer relies on the 
proposed safe harbor, and would this approach be consistent with 
section 2(b)(2)(A) of the FAIR Act? Under proposed rule 139b, issuers 
that are registered investment companies must have timely filed reports 
on Forms N-CSR, N-SAR, N-Q, N-PORT, N-MFP, and N-CEN, as 
applicable,\80\ for the immediately preceding 12 calendar months, and 
issuers that are not registered investment companies must have timely 
filed reports on Forms 10-K and 10-Q or 20-F for the immediately 
preceding 12 calendar months, in order to be included in a research 
report for whose publication or distribution the proposed safe harbor 
would be available. Should we require a different set of periodic 
reports to be timely filed, other than what we propose? For example, 
should the requirement be based on a limited subset of the reports? Why 
or why not?
---------------------------------------------------------------------------

    \80\ See supra note 68 (noting that we are proposing to remove 
references to Form N-Q on the date that Form N-Q is rescinded).
---------------------------------------------------------------------------

b. Minimum Public Market Value Requirement
    In order for broker-dealers to use the proposed rule 139b safe 
harbor to publish or distribute issuer-specific research reports, we 
also are proposing that the covered investment fund that is the subject 
of a report must satisfy a minimum public market value threshold at the 
date of reliance on the proposed rule (the ``minimum public market 
value requirement''). Specifically, we are proposing that the aggregate 
market value of a covered investment fund,\81\ or the net asset value 
in the case of a registered open-end investment company (other than an 
exchange-

[[Page 26796]]

traded fund (``ETF'')),\82\ must equal or exceed the aggregate market 
value required by General Instruction I.B.1 to Form S-3.\83\ This 
amount is currently $75 million.\84\ Proposed rule 139b also specifies 
that both aggregate market value and net asset value would be 
calculated net of the value of shares held by affiliates.\85\ The 
proposed minimum public market value requirement generally tracks the 
minimum public float and aggregate market value requirements under rule 
139, modified as appropriate to apply to covered investment fund 
issuers.\86\ As discussed above, the FAIR Act specifically permits us 
to set a minimum public float requirement for covered investment funds, 
as long as the minimum public float is not greater than what is 
required by rule 139.\87\
---------------------------------------------------------------------------

    \81\ The aggregate market value is the aggregate market value of 
voting and non-voting common equity held by non-affiliates of the 
covered investment fund. See proposed rule 139b(a)(1)(i)(B).
    \82\ See proposed rule 139b(a)(1)(i)(B), proposed rule 
139b(c)(4) (defining ``exchange-traded fund'' for purposes of the 
proposed rule to have the meaning given the term in General 
Instruction A to Form N-1A).
    \83\ Because the proposed rule refers to General Instruction 
I.B.1 to Form S-3, we would generally consider that, pursuant to 
these instructions, aggregate market value would be ``computed by 
use of the price at which the common equity was last sold, or the 
average of the bid and asked prices of such common equity, in the 
principal market for such common equity as of a date within 60 days 
prior to the date of filing.'' General Instruction I.B.1 to Form S-
3. The definition of ``market price'' in the General Instructions of 
Form N-1A contemplates valuing an ETF's shares similarly. See 
General Instruction A to Form N-1A.
    For a registered open-end investment company other than an ETF, 
net asset value would be computed using the investment company's 
current net asset value, as used in determining its share price. See 
rule 22c-1 under the Investment Company Act [17 CFR 270.22c-1] 
(requiring registered open-end investment companies, their principal 
underwriters, and dealers in the investment company's shares (and 
certain others) to sell and redeem the investment company's shares 
at a price determined at least daily based on the current net asset 
value next computed after receipt of an order to buy or redeem).
    For covered investment funds that are not actively traded (such 
as non-traded closed-end funds and non-traded business development 
companies), we anticipate that, for purposes of proposed rule 139b, 
net asset value and aggregate market value would be calculated based 
on the fund's last publicly-disclosed share price (for non-traded 
business development companies, this would be the common equity 
share price).
    \84\ General Instruction I.B.1 to Form S-3.
    \85\ See proposed rule 139b(a)(1)(i)(B) (specifying for purposes 
of this provision that ``aggregate market value'' is the aggregate 
market value of voting and non-voting common equity held by non-
affiliates of the covered investment fund, and that ``net asset 
value'' is calculated subtracting the value of shares held by 
affiliates).
    This requirement tracks the minimum public float requirement 
under rule 139, as discussed below. See infra note 86 and 
accompanying text. As guidance, for purposes of this calculation, we 
believe that shares held by affiliates generally should be 
determined with reference to the security ownership information 
listed in the covered investment fund's registration statement. See, 
e.g., Item 11(m) of Form S-1; Item 18 of Form N-1A.
    \86\ See proposed rule 139b(a)(1)(i)(B); rule 
139(a)(1)(i)(A)(1)(i) and (a)(1)(i)(B)(2)(i) [17 CFR 
230.139(a)(1)(i)(A)(1)(i) and (a)(1)(i)(B)(2)(i)]. For registered 
open-end investment companies other than ETFs, the proposed 
threshold is expressed in terms of net asset value rather than 
aggregate market value, to reflect market structure differences 
between registered open-end investment companies (other than ETFs) 
and all other covered investment funds.
    \87\ See supra note 25 and accompanying text.
---------------------------------------------------------------------------

    Historically, the Commission has used public float as an 
approximate measure of a security's market following, through which the 
market absorbs information that is reflected in the price of the 
security.\88\ We continue to view as significant the relationship 
between public float, information dissemination to the market, and 
following by investment institutions.\89\ In the context of covered 
investment funds, we would expect market information to be most limited 
for new funds (which the reporting history and timeliness requirements 
could help to address) and for funds that are marketed to a niche 
segment of investors (which the minimum public market value requirement 
could help to address).\90\ The proposed public market value 
requirement is designed to protect investors by excluding research 
reports on covered investment funds with a relatively small amount of 
total assets, and hence a limited market following. We believe that it 
is appropriate to include a $75 million public market value requirement 
for issuers that may be included in issuer-specific research reports, 
rather than some lower threshold. The proposed minimum public market 
value threshold is the same as the parallel threshold in rule 139, 
which we believe would increase compliance efficiencies among broker-
dealers relying on the rule 139 and proposed rule 139b safe 
harbors.\91\ Moreover, a significantly lower minimum public market 
value threshold may not adequately protect investors, as we expect the 
information environment to be more limited for smaller funds than for 
larger funds.\92\
---------------------------------------------------------------------------

    \88\ See, e.g., S-3 Revisions Adopting Release, supra note 75; 
see also Securities Offering Reform Proposing Release, supra note 14 
(discussing public float of a certain level as a factor indicating 
that an issuer has a demonstrated market following).
    \89\ See, e.g., S-3 Revisions Adopting Release, supra note 75.
    \90\ See infra section III.C.2.c.
    \91\ See infra discussion following note 299.
    \92\ See infra section III.C.6.a.
---------------------------------------------------------------------------

    We request comment on the proposed minimum public market value 
requirement.
     Is the proposed minimum public market value requirement an 
appropriate restriction for issuer-specific covered investment fund 
research reports whose publication or distribution would be covered 
under the proposed rule 139b safe harbor?
     Should the proposed minimum public market value 
requirement track the minimum float requirements under rule 139? Why or 
why not? If so, is tying the proposed minimum public market value 
requirement to the Form S-3 General Instruction I.B.1 appropriate, as 
in rule 139? Why or why not? Should the aggregate market value 
threshold be lower? Are there other requirements we should consider? 
Why or why not?
     Is it appropriate for the proposed requirement to refer to 
``aggregate market value'' for covered investment funds, and ``net 
asset value'' in the case of a registered open-end investment company 
(other than an ETF)? Should the proposed requirement instead refer to 
``net asset value'' for ETFs? Is there another measure of market value 
that is more appropriately tailored for covered investment fund 
research reports?
     Should we include different or more specific instructions 
about how covered investment funds would compute aggregate market value 
and net asset value? For example, should we specify that an ETF's 
aggregate market value be calculated with reference to the definition 
of ``market price'' in Form N-1A rather than General Instruction I.B.1 
of Form S-3? \93\ Should we include more specific instructions about 
how a covered investment fund that is not actively traded should 
compute aggregate market value and net asset value? \94\
---------------------------------------------------------------------------

    \93\ See supra note 83.
    \94\ See id.
---------------------------------------------------------------------------

     Would the proposed minimum public market value requirement 
promote the dissemination into the market of an appropriate amount of 
research about covered investment funds? Conversely, would it unduly 
impede analyst coverage of covered investment fund issuers, and could 
this in turn affect the market following for these issuers? Is the 
approach we are proposing consistent with section 2(b)(2)(B) of the 
FAIR Act?
c. Regular-Course-of-Business Requirement
    The proposed rule also would condition eligibility for the safe 
harbor on a broker-dealer's publication or distribution of research 
reports ``in the regular course of its business'' \95\ (the ``regular-
course-of-business'' requirement).
---------------------------------------------------------------------------

    \95\ Proposed rule 139b(a)(1)(ii).
---------------------------------------------------------------------------

    Although the proposed regular-course-of-business requirement is 
generally similar to the existing provisions of rule 139, it differs in 
one

[[Page 26797]]

respect as required by the FAIR Act. Rule 139 provides, in addition to 
the requirement that a broker-dealer ``publish[] or distribute[] 
research reports in the regular course of its business,'' that such 
publication or distribution may not represent either the initiation of 
publication of research reports about the issuer or its securities or 
the reinitiation of such publication following a discontinuation 
thereof (the ``initiation or reinitiation'' requirement).\96\ The FAIR 
Act, however, provides that the safe harbor shall not apply the 
``initiation or reinitiation'' requirement to a report concerning a 
covered investment fund with a class of securities ``in substantially 
continuous distribution.'' \97\ Proposed rule 139b reflects this 
requirement by incorporating the ``initiation or reinitiation'' 
requirement from current rule 139 but specifying that it applies only 
to research reports regarding a covered investment fund that does not 
have a class of securities in substantially continuous 
distribution.\98\ Determining whether a class of securities is in 
substantially continuous distribution would be based on an analysis of 
the relevant facts and circumstances. We request comment below on 
whether there are any types of covered investment funds or classes of 
securities that raise particular questions as to the presence or 
absence of a ``substantially continuous distribution.'' We also request 
comment as to whether market participants would benefit from further 
Commission guidance on this point.
---------------------------------------------------------------------------

    \96\ Rule 139(a)(1)(iii) [17 CFR 230.139(a)(1)(iii)].
    \97\ Section 2(b)(1) of the FAIR Act.
    \98\ See proposed rule 139b(a)(1)(ii).
---------------------------------------------------------------------------

    Since rule 139 was first adopted, the regular-course-of-business 
requirement has been a condition for a broker-dealer's publication or 
distribution of research reports in reliance on the rule.\99\ We 
believe requiring that research reports be published or distributed in 
the regular course of a broker-dealer's business, consistent with the 
requirements of rule 139, could reduce the potential that covered 
investment fund research reports will be used to circumvent the 
prospectus requirements of the Securities Act. Moreover, we are 
concerned about certain potential consequences of broker-dealers' 
ability, under proposed rule 139b, to publish or distribute 
communications as research reports that have traditionally been viewed 
by the investing public as advertisements or sales material related to 
registered investment companies or business development companies. The 
safe harbor provided under rule 139 is currently not available for a 
broker-dealer's publication or distribution of research reports 
pertaining to specific registered investment companies or business 
development companies.\100\ Therefore, a research report about a 
covered investment fund that is a registered investment company 
currently must comply with the requirements of Securities Act rule 
482.\101\ Given the definition of ``research report'' under the FAIR 
Act,\102\ however, certain communications that are currently treated as 
covered investment fund advertisements under Securities Act rule 482 
also could fall under the proposed rule 139b definition of ``research 
report.''
---------------------------------------------------------------------------

    \99\ See Adoption of Rules Relating to Publication of 
Information and Delivery of Prospectus by Broker-Dealers Prior to or 
After the Filing of a Registration Statement Under the Securities 
Act of 1933, Securities Act Release No. 5105 (Nov. 19, 1970) [35 FR 
18456 (Dec. 4, 1970)] (``1970 Adopting Release'').
    \100\ See supra notes 11-15 and accompanying text.
    \101\ 17 CFR 230.482. An investment company advertisement that 
complies with rule 482 is deemed to be a section 10(b) prospectus 
(also known as an ``advertising prospectus'' or ``omitting 
prospectus'') for purposes of section 5(b)(1) of the Securities Act. 
As a section 10(b) prospectus, an investment company advertisement 
is subject to liability under section 12(a)(2) of the Securities 
Act, as well as the antifraud provisions of the federal securities 
laws.
    \102\ Section 2(f)(6) of the FAIR Act.
---------------------------------------------------------------------------

    Investors, particularly retail investors, may be unaware of the 
differences in regulatory status and purpose among the various types of 
communications regarding registered investment companies and business 
development companies. This may result in investors not being able to 
readily discern what constitutes a research report and what constitutes 
an advertisement about these issuers. Context helps investors evaluate 
and weigh the information presented to them. For example, investors 
likely know that advertising directly promotes sales of a particular 
product. A broker-dealer publishing or distributing a research report, 
on the other hand, may do so with multiple purposes for multiple 
audiences. While a research report may have the effect of promoting 
sales of the securities of the issuer that the research report 
features, it may serve a number of market functions as well, such as 
promoting market trading, educating a particular audience, or providing 
a service to clients.\103\
---------------------------------------------------------------------------

    \103\ See infra section III.C.1.b.
---------------------------------------------------------------------------

    We believe that broker-dealers that publish or distribute research 
reports in the regular course of business are more likely to publish 
analysis that investors recognize as research. For example, these 
broker-dealers are more likely to have compliance structures in place, 
with relevant policies and procedures, governing their publication of 
research and (as applicable) their distribution of registered 
investment company advertisements. Similarly, if a broker-dealer were 
to publish or distribute research reports in the regular course of its 
business, the broker-dealer may be more likely to have a research 
department with research analysts who regularly cover particular 
issuers or industries. This commitment in resources and infrastructure 
makes it more likely that the market recognizes the broker-dealer as a 
provider of research-related communications. A research report 
published or distributed by a research analyst in the research 
department at a broker-dealer that regularly covers that issuer or 
industry would therefore be a factor indicating that the regular-
course-of-business requirement has been satisfied for purposes of 
proposed rule 139b.\104\ Additional factors may include whether the 
broker-dealer maintains policies and procedures governing its research 
protocols and whether the broker-dealer regularly publishes or 
distributes research on any other type of company or business other 
than covered investment funds.
---------------------------------------------------------------------------

    \104\ We believe it is appropriate to include the regular-
course-of-business requirement because it is important that the 
broker-dealer have a history of publishing or distributing a 
particular type of research. If a broker or dealer begins publishing 
research about a different type of security around the time of a 
public offering of an issuer's security and does not have a history 
of publishing research on those types of securities, such 
publication or distribution could be viewed as a way to provide 
information about the publicly-offered securities in circumvention 
of the provisions of section 5 of the Securities Act. See Securities 
Offering Reform Adopting Release, supra note 39.
---------------------------------------------------------------------------

    We request comment on the proposed regular-course-of-business 
requirement.
     Is the proposed regular-course-of-business requirement 
appropriate in the context of covered investment fund research reports?
     Would the proposed regular-course-of-business requirement 
allow an appropriate flow of analyst-generated information to the 
market?
     Should we define ``regular course of business'' in 
proposed rule 139b more specifically in the context of research reports 
on registered investment companies or business development companies? 
Today, due to the unavailability of rule 139, we understand that 
broker-dealers are generally not in the business of publishing and 
distributing what we consider issuer-specific research reports on 
registered investment companies or business development companies 
(although some broker-dealers have

[[Page 26798]]

published and distributed communications styled as ``research reports'' 
in compliance with rule 482, and some broker-dealers have published and 
distributed research reports on other issuers in reliance on the rule 
139 safe harbor). Does this raise questions as to how to apply a 
regular-course-of-business requirement to research reports regarding 
these issuers that we should address in the proposed rule or through 
additional Commission guidance? If so, what further definitions or 
guidance should we consider? Would the proposed regular-course-of-
business requirement promote the publication or distribution of 
research reports on covered investment funds that investors recognize 
as research?
     What facts and circumstances suggest that a covered 
investment fund has a class of securities in ``substantially continuous 
distribution''? Are there any types of covered investment funds that 
raise specific questions about whether or not they have a class of 
securities in substantially continuous distribution, either generally 
or in particular circumstances? For example, do all open-end management 
investment companies, and those closed-end interval funds that make 
periodic repurchase offers pursuant to rule 23c-3, have a class of 
securities in substantially continuous distribution, while other 
closed-end investment companies do not? Why or why not? Are there other 
types of funds with a class of securities in substantially continuous 
distribution, or are there specific circumstances that should 
definitively constitute substantially continuous distribution? Would 
market participants benefit from Commission guidance as to how one 
would make a determination that a covered investment fund has a class 
of securities in substantially continuous distribution?
     Alternatively, should we define the term ``substantially 
continuous distribution'' in rule 139b, and if so, how? Should this 
definition include certain types of funds (e.g., open-end management 
investment companies, closed-end interval funds that make periodic 
repurchase offers pursuant to rule 23c-3, and other types of funds that 
are engaged in continuous offerings pursuant to Securities Act rule 
415(a)(1)(ix) or others that conduct continuous offerings as shelf 
takedowns pursuant to rule 415(a)(1)(x))? If so, what funds and under 
what circumstances? Are there any specific factors that we should 
incorporate in proposed rule 139b in order to determine whether a 
covered investment fund is in substantially continuous distribution?
     Because a safe harbor is generally not currently available 
for broker-dealers' publication or distribution of covered investment 
fund research reports,\105\ should the proposed regular-course-of-
business requirement be modified to address how broker-dealers that 
have not previously published or distributed research reports could 
satisfy this requirement? If we were to modify the proposed regular-
course-of-business requirement to incorporate factors indicating that a 
broker-dealer has created a history of publishing or distributing 
research reports in the regular course of business, what should these 
factors be, and why? Alternatively, should rule 139b provide a ``start-
up'' period to allow broker-dealers to establish a regular course of 
business of publishing research reports? For example, should the rule 
provide that a broker-dealer that could not satisfy the regular-course-
of-business requirement could nonetheless rely on rule 139b for a 
specified period of time (e.g., one year) to establish a regular course 
of business of publishing research reports? Without such a provision, 
would the regular-course-of-business requirement pose challenges for 
broker-dealers that had not previously published research reports 
because of the absence of an applicable safe harbor? If we do not 
modify the proposed requirement in this way, should we provide further 
guidance regarding broker-dealers that have not previously published or 
distributed research reports?
---------------------------------------------------------------------------

    \105\ See supra notes 11-15 and accompanying text.
---------------------------------------------------------------------------

     Should the proposed regular-course-of-business requirement 
incorporate any more specific requirements regarding the person(s) 
preparing a covered investment fund research report (e.g., a 
requirement that the person who prepares the research report must be 
employed by the broker-dealer to prepare research in the normal course 
of his or her duties)?
2. Industry Research Reports
    Our proposed conditions for industry research reports parallel 
those set forth in rule 139 and are intended to provide appropriate 
parameters to address the risk of circumvention of the prospectus 
requirements of the Securities Act.\106\
---------------------------------------------------------------------------

    \106\ See supra notes 57-58 and accompanying text; see also 
paragraph accompanying notes 32-34.
---------------------------------------------------------------------------

a. Reporting Requirement
    Under the proposed safe harbor, each covered investment fund 
included in an industry research report must be subject to the 
reporting requirements of section 30 of the Investment Company Act (or, 
for covered investment funds that are not registered investment 
companies under the Investment Company Act, the reporting requirements 
of section 13 or section 15(d) of the Exchange Act). This proposed 
reporting requirement generally tracks an existing requirement for 
industry research reports under rule 139 \107\ but has been modified so 
that it would be applicable to industry research reports that include 
covered investment fund issuers. Like the parallel provision of rule 
139, the proposed reporting requirement helps assure that there is 
publicly available information about the relevant issuers and that 
investors are able to use such information in making their investment 
decisions.
---------------------------------------------------------------------------

    \107\ See rule 139(a)(2)(i) [17 CFR 230.139(a)(2)(i)] (``The 
issuer is required to file reports pursuant to section 13 or section 
15(d) of the Securities Exchange Act of 1934 or satisfies the 
conditions in paragraph (a)(1)(i)(B) of this section.'').
---------------------------------------------------------------------------

    We request comment on the reporting requirement in proposed rule 
139b.
     Is the proposed reporting requirement appropriate? Why or 
why not?
     As discussed above, proposed rule 139b's framework, 
including its scope and conditions, generally tracks rule 139.\108\ 
Therefore, as in rule 139, the conditions applicable to industry and 
issuer-specific research reports differ. For example, as proposed, rule 
139b (like rule 139) would not require the issuers included in an 
industry research report to satisfy the minimum market value thresholds 
discussed in section II.B.1.b above. Is there any reason we should 
extend all of the conditions for issuer-specific research reports (or a 
subset of these conditions, to the extent they are not already 
reflected in proposed rule 139b) to industry reports, even if this 
approach would diverge from the approach taken in rule 139? Are the 
concerns underlying the proposed conditions for broker-dealers' 
publication or distribution of covered investment fund research reports 
the same for issuer-specific research reports and industry research 
reports? Are there any other concerns specific to industry research 
reports that we should consider?
---------------------------------------------------------------------------

    \108\ See supra paragraph accompanying notes 32-34.
---------------------------------------------------------------------------

b. Regular-Course-of-Business Requirement
    We are also proposing that a broker-dealer be required to publish 
or distribute research reports in the regular course of its business in 
order to rely on the proposed safe harbor.\109\ The

[[Page 26799]]

proposed regular-course-of-business requirement for industry research 
reports similarly applies to issuer-specific research reports,\110\ and 
it also tracks an existing requirement for industry research reports 
under rule 139.\111\
---------------------------------------------------------------------------

    \109\ Proposed rule 139b(a)(2)(iv) (the broker or dealer 
publishes or distributes research reports in the regular course of 
its business and, at the time of the publication or distribution of 
the research report (in the case of a research report regarding a 
covered investment fund that does not have a class of securities in 
substantially continuous distribution) is including similar 
information about the issuer or its securities in similar reports).
    \110\ See supra section II.B.1.c.
    \111\ See rule 139(a)(2)(v) [17 CFR 230.139(a)(2)(v)].
---------------------------------------------------------------------------

    Like the parallel provision in rule 139, the proposed regular-
course-of-business requirement for industry research reports includes a 
``similar information'' requirement. To satisfy this requirement, at 
the time a broker-dealer publishes or distributes an industry research 
report, the broker-dealer would have to include similar information, in 
similar reports, about the issuer covered in the industry report (or 
its securities).\112\ However, unlike rule 139, we are proposing that 
the ``similar information'' requirement apply only to circumstances in 
which a broker-dealer is publishing or distributing a research report 
regarding a covered investment fund that does not have a class of 
securities in substantially continuous distribution. As discussed 
above, the FAIR Act provides that the safe harbor shall not apply the 
``initiation or reinitiation'' requirement to a research report 
concerning a covered investment fund with a class of securities ``in 
substantially continuous distribution.'' \113\ We believe that the 
proposed ``similar information'' requirement is akin to the proposed 
``initiation or reinitiation'' requirement, in that both would have the 
effect of limiting a broker-dealer's ability to rely on the proposed 
safe harbor to publish or distribute a research report about a 
particular covered investment fund if the broker-dealer had not 
previously published research on that issuer. Therefore, as in the 
proposed ``initiation or reinitiation'' requirement, we are proposing 
to exclude covered investment funds from the ``similar information'' 
requirement if they have a class of securities in substantially 
continuous distribution.\114\
---------------------------------------------------------------------------

    \112\ Proposed rule 139b(a)(2)(iv).
    \113\ See supra notes 97-98 and accompanying text.
    \114\ See id.
---------------------------------------------------------------------------

    As discussed above, we believe that the proposed regular-course-of-
business requirement could reduce the possibility that broker-dealers' 
publication or distribution of covered investment fund research reports 
may be used to circumvent the prospectus requirements of the Securities 
Act. We also believe that broker-dealers that publish or distribute 
research reports in the regular course of business are more likely to 
publish reports incorporating analysis that investors recognize as 
research and to have appropriate compliance structures in place 
governing their publication of research.\115\ We continue to believe, 
in the context of proposed rule 139b as well as in rule 139, that a 
regular-course-of-business requirement is equally appropriate for 
issuer-specific research reports and industry research reports.
---------------------------------------------------------------------------

    \115\ See supra section II.B.1.c.
---------------------------------------------------------------------------

    We request comment on the proposed regular-course-of-business 
requirement.
     Is the proposed regular-course-of-business requirement 
appropriate? Why or why not?
     In the context of covered investment fund research 
reports, would the proposed ``similar information'' requirement unduly 
restrict broker-dealers' ability to rely on the proposed safe harbor? 
Why or why not?
     Would any of the questions, concerns, or issues discussed 
above with respect to the proposed regular-course-of-business 
requirement in the context of issuer-specific research reports be 
equally applicable in the context of industry research reports? Why or 
why not?
c. Content Requirements for Industry Research Reports
    The proposed rule would also condition eligibility for the safe 
harbor for industry research reports on certain content requirements. 
Specifically, under the proposed rule, industry research reports either 
must include similar information about a substantial number of covered 
investment fund issuers of the same type or investment focus (the 
``industry representation requirement''),\116\ or alternatively contain 
a comprehensive list of covered investment fund securities currently 
recommended by the broker or dealer (the ``comprehensive list 
requirement'').\117\
---------------------------------------------------------------------------

    \116\ Proposed rule 139b(a)(2)(ii)(A).
    \117\ Proposed rule 139b(a)(2)(ii)(B).
---------------------------------------------------------------------------

Industry Representation Requirement
    The proposed industry representation requirement imposes a 
requirement similar to one contained in rule 139 to covered investment 
fund research reports.\118\ The Commission has stated that ``where a 
publication covers a broad range of companies in an industry and is 
issued not on a sporadic but on a regular schedule, the possibility 
that such a publication could condition the market is lessened.'' \119\ 
Furthermore, the possibility of market conditioning is lessened ``where 
research reports discussing the registrant contain similar information, 
opinions or recommendations with respect to a substantial number of 
other companies in the registrant's industry.'' \120\ We believe that 
these observations are applicable today in the context of covered 
investment fund industry research reports, and therefore we propose 
that rule 139b include an industry representation requirement.
---------------------------------------------------------------------------

    \118\ Rule 139 requires an industry research report to include 
``similar information with respect to a substantial number of 
issuers in the issuer's industry or sub-industry.'' Rule 
139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)]. See infra note 121 and 
accompanying text.
    \119\ Research Reports, Securities Act Release No. 6492 (Oct. 6, 
1983) [48 FR 46801 (Oct. 14, 1983)] (``1983 Proposing Release''); 
see also supra notes 57-58 and accompanying text (discussing the 
role of rule 139 in helping to mitigate the risk that research 
reports might be used to circumvent the prospectus requirements of 
the Securities Act). See also The Regulation of Securities 
Offerings, Securities Act Release No. 7607A (Nov. 13, 1998) [63 FR 
67174 (Dec. 4, 1998)] (proposal to modernize and clarify the 
regulatory structure for offerings under the Securities Act of 
1933).
     We note that, in some cases, concerns about market conditioning 
in the context of research reports about covered investment funds 
may be substantially similar to these concerns in the context of 
operating company issuers. For example, for covered investment funds 
that are not in continuous distribution, ``gun-jumping'' concerns, 
i.e., the failure to comply with restrictions on communications when 
a securities offering is being contemplated or is in process 
(similar to those that are applicable to operating companies) could 
be applicable. For covered investment funds that are in continuous 
distribution, on the other hand, we understand the role of the 
conditions of rule 139b more generally as to help mitigate the risk 
that research reports could be used to circumvent the Securities 
Act's prospectus requirements.
    \120\ See 1983 Proposing Release, supra note 119. As a 
corollary, the Commission has noted that ``The opportunity for the 
abuses Section 5 was enacted to correct may still be present, 
however, where a research report covers only a few companies 
constituting a sub-industry group or where an entire industry is 
composed of a small number of companies.'' See id.
---------------------------------------------------------------------------

    Accordingly, we are proposing to replicate the language from rule 
139's industry representation requirement in rule 139b, with 
modifications designed to apply the language to the covered investment 
fund context. Under rule 139's corresponding requirement, an industry 
research report must include ``similar information with respect to a 
substantial number of issuers in the issuer's industry or sub-
industry.'' \121\ When this section of rule 139 first was proposed, the 
Commission explained that the term ``industry'' in this context refers 
to a broad category of similar businesses, such as the airline or steel

[[Page 26800]]

industries.\122\ In adopting the rule, the Commission added ``sub-
industry'' to the rule text in order to clarify that the safe harbor 
would apply to research reports covering a smaller number of companies 
in a particular industry.\123\ While operating companies are typically 
grouped based on their business category, entities that are included in 
the definition of ``covered investment fund'' are typically grouped 
based either on their type or investment focus.\124\ Therefore, the 
proposed industry representation requirement would require an industry 
research report to include similar information about a substantial 
number of issuers either of the same type (e.g., ETFs or mutual funds 
that are large cap funds, bond funds, balanced funds, money market 
funds, etc.) or investment focus (e.g., primarily invested in the same 
industry or sub-industry, or the same country or geographic 
region).\125\ We believe that this proposed requirement tracks rule 139 
to the extent practicable and appropriate.
---------------------------------------------------------------------------

    \121\ Rule 139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)].
    \122\ 1983 Proposing Release, supra note 119.
    \123\ 1984 Adopting Release, supra note 56.
    \124\ See Investment Company Names, Investment Company Act 
Release No. 24828 (Jan. 17, 2001) [66 FR 8509 (Feb. 1, 2001)] 
(registered investment companies are typically categorized based on 
industry (e.g., sector funds or country or geographic region)).
    \125\ Proposed rule 139b(a)(2)(ii)(A).
---------------------------------------------------------------------------

Comprehensive List Requirement
    Under the proposed rule, a broker-dealer's publication or 
distribution of an industry research report that conforms to the 
comprehensive list requirement, rather than the industry representation 
requirement, also would be eligible for the rule's safe harbor.\126\ 
Rule 139 contains a similar provision,\127\ and we are proposing to 
replicate the language from rule 139's comprehensive list requirement 
in rule 139b, with some modifications owing to the difference in 
context and the FAIR Act's affiliate exclusion.\128\
---------------------------------------------------------------------------

    \126\ Proposed rule 139b(a)(2)(ii)(B).
    \127\ Rule 139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)].
    \128\ Proposed rule 139b(a)(2)(ii)(B).
---------------------------------------------------------------------------

    Like the proposed industry representation requirement, the proposed 
comprehensive list requirement is designed to result in industry 
research reports that cover a broad range of investment companies or 
securities.\129\ We are proposing that a comprehensive list of 
recommended issuers appearing in an industry research report could not 
include any covered investment fund issuer that is an affiliate of the 
broker-dealer, or for which the broker-dealer serves as investment 
adviser (or is an affiliated person of the investment adviser), as this 
could implicate the proposed affiliate exclusion.\130\ As discussed in 
the context of the proposed industry representation requirement, we 
believe that including a broad range of issuers in a research report 
lessens concerns over market conditioning.\131\ At the same time, the 
proposed comprehensive list requirement would permit a different 
presentation of research about multiple covered investment funds than 
the industry representation requirement would permit.\132\ We 
understand that the two types of presentations could serve different 
research needs.
---------------------------------------------------------------------------

    \129\ 1983 Proposing Release, supra note 119. We note that when 
the Commission originally adopted rule 139 in 1970, this rule only 
provided a safe harbor for research reports that included ``a 
comprehensive list of securities, opinions or recommendations 
concerning the issuer'' and did not provide a parallel safe harbor 
for issuer-specific research reports. See 1970 Adopting Release, 
supra note 99.
    \130\ See proposed rule 139b(a)(2)(ii)(B) (excluding from the 
comprehensive list securities of a covered investment fund that is 
an affiliate of the broker or dealer, or for which the broker or 
dealer serves as investment adviser (or for which the broker or 
dealer is an affiliated person of the investment adviser)); see also 
supra section II.A.1.
    \131\ See supra notes 119-120 and accompanying text.
    \132\ Under proposed rule 139b, a ``comprehensive list'' 
research report would have to include a list of all of the broker's 
currently-recommended covered investment fund securities, whereas an 
``industry representation'' report would not be required to list 
each currently-recommended security (but instead could cover a more 
limited number of issuers as long as a ``substantial number'' of 
covered investment fund issuers of the same type or investment focus 
were included). See also requests for comment infra at the end of 
this section II.B.2.c (requesting comment on how these types of 
research reports might be used and the content that would be 
included in each type of research report).
---------------------------------------------------------------------------

    We request comment on the proposed content requirements for 
industry research reports.
     Are the proposed industry representation requirement and 
the proposed comprehensive list requirement appropriate? Why or why 
not?
     How would the publication or distribution of industry 
research reports help investors, and do commenters anticipate that 
industry research reports would be published or distributed more or 
less frequently than issuer-specific research reports? Do commenters 
anticipate that broker-dealers would be more likely to publish or 
distribute industry research reports that comply with the industry 
representation requirement, or alternatively the comprehensive list 
requirement, or both, in relying on the proposed rule 139b safe harbor?
     Are there other conditions that we should consider in 
addition to the proposed industry representation requirement and the 
proposed comprehensive list requirement? For example, should we require 
that there must be a minimum number of funds included in an industry 
research report for it to qualify under the industry representation 
requirement, particularly in light of the fact that there may be only a 
few funds that track a particular sub-industry or geographic region or 
country? If so, what should that minimum number be? Is there another 
approach to industry research report content requirements that would be 
more appropriately tailored to covered investment fund research 
reports?
     The proposed industry representation requirement would be 
based on the ``type'' or ``investment focus'' of the issuers covered in 
the research report. Are these the appropriate terms to achieve 
comparisons of similar entities in industry research reports? Why or 
why not? Are there other more appropriate terms that could be used to 
specify subsets of covered investment funds that would be included in 
industry research reports (e.g., category, asset class, strategy, 
topic, or investment policy)? Should we include more specific 
definitions for the terms ``type'' and ``investment focus'' in rule 
139b, and if so, what should these definitions be? Should we instead 
identify categories that can qualify for the industry report 
provisions, such as ``legal structure'' (e.g., ETF, mutual fund, 
business development company, interval fund), ``asset class'' (e.g., 
international equity, domestic equity, international fixed income, 
domestic fixed income), ``investment focus'' (e.g., sector, industry, 
sub-industry, geographic region), or ``strategy'' (e.g., passive, 
active, market-cap-weighted, smart beta, capital preservation, capital 
appreciation)?
     The proposed comprehensive list requirement would require 
the research report to contain a list of covered investment funds that 
are ``currently recommended'' by the broker-dealer. Is it clear what is 
meant by the terms ``comprehensive list'' and ``currently recommended'' 
under proposed rule 139b? Would broker-dealers seeking to rely on the 
proposed safe harbor understand that we interpret these terms in the 
context of rule 139b to have the same meaning as they do in the context 
of rule 139? For example, would the term ``currently recommended'' be 
interpreted as meaning ``available for sale by the broker-dealer,'' 
``given a `buy' recommendation by the broker-dealer,'' or something 
else? Should we further define either of the terms ``comprehensive 
list'' or ``currently

[[Page 26801]]

recommended'' as they appear in rule 139b (or, within rule 139b, as 
these terms apply to certain types of covered investment funds such as 
registered investment companies), and if so, how?
     Do commenters anticipate that, if a broker-dealer were to 
rely on the proposed rule 139b safe harbor to publish or distribute 
research reports that meet the proposed comprehensive list requirement, 
there would be a sufficient number of ``currently recommended'' covered 
investment funds to produce an appropriately broad array of funds 
included in the report given the affiliate exclusion?
     We are proposing that a comprehensive list could not 
include any covered investment fund issuer that is an affiliate of the 
broker-dealer, or for which the broker-dealer serves as investment 
adviser (or is an affiliated person of the investment adviser), as this 
could implicate the proposed affiliate exclusion. Should rule 139b 
instead provide that a comprehensive list of recommended issuers could 
include issuers that are affiliates of the broker-dealer that is 
publishing or distributing the research report under certain 
circumstances? If so, what information, if any, should a broker-dealer 
be permitted to include about affiliated issuers such that the list can 
be described as ``comprehensive'' while continuing to address the goals 
of the affiliate exclusion? For example, should the rule provide that 
these issuers could be included in a comprehensive list if the research 
report were to identify which issuers in the list, if any, were 
affiliated with the broker-dealer? In addition, or in the alternative, 
should we permit these issuers to be included in a comprehensive list 
if disclosure about the affiliated issuers were limited, for example, 
to basic identifying information such as the name of the covered 
investment fund, its type and investment focus, and its ticker symbol 
(if applicable)? As another example, should the rule require that if a 
comprehensive list includes affiliated issuers and includes performance 
information, the performance information must be presented in 
accordance with rule 482 in order to address the concern that the 
broker-dealer may be incentivized to present more favorably the 
performance of its affiliated covered investment funds? \133\
---------------------------------------------------------------------------

    \133\ See infra section 0.
---------------------------------------------------------------------------

d. Presentation Requirement for Industry Research Reports
    Proposed rule 139b also would condition the safe harbor for 
industry research reports on a presentation requirement. Under the 
proposed rule, analysis of any covered investment fund issuer or its 
securities included in an industry research report could not be given 
materially greater space or prominence in the publication than that 
given to any other covered investment fund issuer or its 
securities.\134\
---------------------------------------------------------------------------

    \134\ Proposed rule 139b(a)(2)(iii).
---------------------------------------------------------------------------

    The proposed presentation requirement tracks a parallel ``no 
greater space or prominence'' requirement in rule 139.\135\ The 
Commission has stated that the ``no greater space or prominence'' 
language is necessary to mitigate the risk of conditioning the market 
\136\ but also that the materiality standard within this presentation 
requirement provides flexibility.\137\ We believe that the concerns 
underlying the rule 139 presentation requirements apply equally in the 
context of covered investment fund research reports. We believe that, 
if the proposed rule were to permit a broker-dealer to rely on the safe 
harbor even if it were to publish or distribute an industry research 
report that gives materially greater space or prominence to one issuer 
than to others, this would create an avenue for circumventing the 
conditions associated with issuer-specific research reports. The 
industry should already be familiar with this long-established and 
well-understood condition, and therefore we believe implementing a 
similar presentation condition for industry research reports on covered 
investment funds would be straightforward.
---------------------------------------------------------------------------

    \135\ Rule 139(a)(2)(iv) [17 CFR 230.139(a)(2)(iv)].
    \136\ 1983 Proposing Release, supra note 119.
    \137\ Id.
---------------------------------------------------------------------------

    We request comment on the proposed presentation requirement for 
industry research reports.
     Is the proposed presentation requirement appropriate for 
covered investment fund industry research reports? Why or why not?
     Is the proposed presentation requirement sufficiently 
clear? Should we provide guidance as to what compliance with this 
requirement would entail?
     Would this requirement unduly restrict design flexibility 
for research reports, or impede broker-dealers' ability to provide 
material information in research reports?
     Should we consider additional presentation requirements 
for covered investment fund research reports? Is there another approach 
that would be more appropriately tailored?

C. Presentation of Performance Information in Research Reports About 
Registered Investment Companies

    Specific statutory provisions and rules apply to advertising the 
performance of registered investment companies.\138\ An advertisement 
about a covered investment fund that is a registered investment company 
is deemed a section 10(b) prospectus (also known as an ``advertising 
prospectus'' or ``omitting prospectus'') for purposes of section 
5(b)(1) of the Securities Act so long as it complies with rule 
482.\139\ Therefore, under the current regulatory framework, a broker-
dealer's publication or distribution of a research report that complies 
with the requirements of rule 482 would not be deemed a non-conforming 
prospectus in violation of section 5 of the Securities Act.\140\
---------------------------------------------------------------------------

    \138\ See, e.g., section 24(g) of the Investment Company Act [15 
U.S.C. 80a-24(g)] (directing the Commission to adopt rules or 
regulations that permit registered investment companies to use 
prospectuses that (i) include information the substance of which is 
not included in the statutory prospectus, and (ii) are deemed to be 
permitted by section 10(b) of the Securities Act); rule 34b-1 under 
the Investment Company Act [17 CFR 270.34b-1] (requiring that, in 
order not to be misleading, investment company sales literature must 
include certain information, including with respect to performance 
information by incorporating certain related provisions of rule 482 
of the Securities Act); rule 156 of the Securities Act [17 CFR 
230.156] (providing guidance on what statements or omissions of 
material fact may be misleading in investment company sales 
literature); rule 482 of the Securities Act [17 CFR 230.482] 
(setting forth that for an investment company advertisement to be 
deemed a prospectus under section 10(b) of the Securities Act, it 
must meet certain requirements thereunder, including with respect to 
standardized performance information presentation).
    \139\ See supra note 101 and accompanying text.
    \140\ See supra notes 13, 101 and accompanying text. FINRA 
content standards also would generally require a member's 
publication or distribution of such a communication (to the extent 
it presents performance data as permitted by rule 482) to include 
certain of the standardized performance information specified under 
rule 482. See FINRA rule 2210(d)(5)(A).
---------------------------------------------------------------------------

    Given the breadth of the definition of ``research report'' under 
the FAIR Act (and the definition of ``research report'' that we propose 
under rule 139b), certain communications by broker-dealers that 
historically have been treated as advertisements for registered 
investment companies under rule 482 now could be considered covered 
investment fund research reports subject to the proposed rule 139b safe 
harbor.\141\ Among other things, rule 482 requires standardized 
presentation of performance data included in registered open-end 
investment company

[[Page 26802]]

advertisements.\142\ Alternatively, if other performance measures are 
presented, they must be accompanied by certain standardized performance 
data.\143\ Because a broker-dealer's publication or distribution of a 
covered investment fund research report under proposed rule 139b would 
be deemed not to constitute an offer for purposes of sections 2(a)(10) 
and 5(c) of the Securities Act, a covered investment fund research 
report would no longer need to be deemed to be a section 10(b) 
prospectus (such as an advertising prospectus under rule 482) for 
purposes of section 5(b)(1) of the Securities Act. In addition, some 
communications that previously were considered supplemental sales 
literature that must be accompanied or preceded by a statutory 
prospectus under rule 34b-1 under the Investment Company Act now could 
be considered covered investment fund research reports (which need not 
be preceded or accompanied by a statutory prospectus).\144\ Rule 34b-1 
incorporates many of the rule 482 requirements relating to performance 
disclosure and makes these requirements applicable to supplemental 
sales literature.\145\ We are concerned that this shift in regulatory 
treatment of research reports about registered investment companies 
could result in investor confusion if a communication were not easily 
recognizable as research as opposed to an advertising prospectus or 
supplemental sales literature. Although there are multiple provisions 
in proposed rule 139b that aim to limit the risk that broker-dealers 
could use the proposed safe harbor to circumvent the prospectus 
requirements of the Securities Act,\146\ there could be circumstances 
where, under the proposed rule, broker-dealers could publish or 
distribute communications that historically have been viewed as 
registered investment company advertisements or selling materials.
---------------------------------------------------------------------------

    \141\ See supra note 102 and accompanying text.
    \142\ See rule 482(d)(1)-(4) (for open-end investment companies 
other than money market funds) and rule 482(e) (for money market 
funds).
    \143\ See rule 482(d)(5). These other performance measures are 
not subject to any prescribed method of computation, but must 
reflect all elements of return and be accompanied by quotations of 
standardized measures of total return as provided for in paragraphs 
(d)(3) and (d)(4) of the rule. Rule 482(d)(5) also includes other 
requirements for the inclusion of non-standardized performance data, 
such as presentation and prominence requirements.
    \144\ See rule 34b-1 under the Investment Company Act. Rule 34b-
1 provides that any advertisement, pamphlet, circular, form letter, 
or other sales literature addressed to or intended for distribution 
to prospective investors that is required to be filed with the 
Commission by section 24(b) of the Investment Company Act will have 
omitted to state a fact necessary in order to make the statements 
made therein not materially misleading unless it includes certain 
specified information.
    \145\ See rule 34b-1(b)(1)-(2).
    \146\ See, e.g., supra sections II.A.1 (affiliate exclusion) and 
II.B.1.c (regular course of business requirement). Certain covered 
investment fund research reports that meet the definition of 
``research report'' in Regulation AC would be subject to the 
requirements of Regulation AC. Similarly, covered investment fund 
research reports that meet the definition of ``research report'' in 
FINRA rule 2241 or the definition of ``debt research report'' in 
FINRA rule 2242 would be subject to the content requirements in 
those rules as applicable. See supra note 58; infra section II.D.1.
---------------------------------------------------------------------------

    Research reports published under rule 139 are not required to 
present performance information in any particular fashion. To the 
extent the rules we are proposing today diverge from rule 139, these 
differences are designed to implement the FAIR Act or tailor existing 
provisions of rule 139 to the context of covered investment fund 
research reports. Therefore, unlike registered open-end investment 
company advertisements that must comply with the requirements of 
Securities Act rule 482, covered investment fund research reports would 
not be required to present investment performance data in a 
standardized manner.\147\ However, we have long recognized that 
investors tend to consider investment performance to be a particularly 
significant factor in evaluating or comparing investment 
companies.\148\ The Commission has previously identified a number of 
circumstances in which performance could be disclosed in a misleading 
manner.\149\ If a broker-dealer publishes or distributes a covered 
investment fund research report in reliance on the safe harbor--and 
presents performance information in a manner inconsistent with rule 
482--retail investors could be confused about the comparability of the 
performance to that presented in the prospectuses, sales literature, 
and advertisements of the fund and its competitors.\150\ In addition, 
the possibility exists that the requirements of rule 482 or rule 34b-1 
could be circumvented by recasting registered investment company 
advertisements or selling materials as research reports. We request 
comment below as to whether, in light of these concerns, it would be 
appropriate to require that covered investment fund research reports 
that include performance information present that information in 
accordance with the requirements in rule 482 or rule 34b-1.
---------------------------------------------------------------------------

    \147\ See supra notes 142-143 and accompanying text.
    \148\ As the Commission has previously noted ``[a]lthough there 
are many factors other than performance that an investor should 
consider in deciding whether to invest in a particular fund, many 
investors consider performance to be one of the most significant 
factors when evaluating mutual funds.'' See Amendments to Investment 
Company Advertising Rules, Securities Act Release No. 8101 (May 17, 
2002) [67 FR 36712 (May 24, 2002)] (``Rule 482 Amendments Proposing 
Release'') (proposing release for amendments to investment company 
advertising rules).
    \149\ See id. (such circumstances include: Advertising 
performance without providing adequate disclosure of unusual 
circumstances that have contributed to performance; advertising 
performance without providing adequate disclosure of the performance 
period, that more current performance information is available, or 
that more current performance may be lower than advertised 
performance; and advertising performance based on selective dates or 
time periods in order to showcase fund performance as of those 
specific dates or time periods without providing disclosure that 
would permit an investor to evaluate the significance of the 
performance).
    \150\ Additional conditions that might lessen potential investor 
confusion are if a research report that presents performance 
information other than in accordance with the provisions of rule 482 
were to: 1) adequately explain how the performance presentation 
differs from that which would be required under rule 482, and/or 2) 
include a statement noting that the document is a research report, 
and is not an investment company advertisement that is subject to 
the requirements of rule 482. We request comment on these and other 
conditions below.
---------------------------------------------------------------------------

    In addition, all covered investment fund research reports under the 
proposed safe harbor would remain subject to the antifraud provisions 
of the federal securities laws.\151\ The Commission has previously 
articulated guidance on factors to be weighed in considering whether 
statements involving a material fact in registered investment company 
advertisements and sales literature, which are also subject to the 
antifraud provisions of the federal securities laws, could be 
misleading.\152\ This guidance provided factors to be weighed when 
determining whether fund performance in sales literature is adequately 
disclosed.\153\ The guidance factors in rule 156 \154\ are

[[Page 26803]]

informative in evaluating whether any presentations of registered 
investment company performance in these research reports could be 
misleading because they reflect principles (such as providing 
information to investors that is informative and that does not create 
unrealistic investor expectations \155\) that would help guide this 
analysis.
---------------------------------------------------------------------------

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

    Rule 139 includes an instruction on the use of projections of an 
issuer's sales and earnings.\156\ This instruction provides that a 
projection ``constitutes an analysis or information falling within the 
definition of research report'' and includes certain conditions 
associated with the use of projections.\157\ We are not incorporating 
this or a similar instruction in proposed rule 139b for a number of 
reasons. FINRA content standards governing communications with the 
public generally prohibit a broker-dealer from using performance 
projections.\158\ In addition, rule 156 notes as guidance that 
statements and illustrations about a registered fund's future 
performance in sales literature could be misleading depending on the 
context in which they are made, and lists considerations to weigh in 
making this evaluation. The projection instruction in rule 139--which 
refers to ``sales'' and ``earnings''--also appears inapplicable to 
covered investment funds. A covered investment fund's returns will be 
based on the returns of the fund's investments and fund expenses, among 
other factors, as opposed to ``earnings'' and ``sales.''
---------------------------------------------------------------------------

    \156\ See ``Instruction'' to rule 139 [17 CFR 230.139].
    \157\ See id. The instruction provides that, when a broker or 
dealer publishes or distributes projections of an issuer's sales or 
earnings in reliance on rule 139(a)(2), it must: (1) Have previously 
published or distributed projections on a regular basis in order to 
satisfy the ``regular course of its business'' condition; (2) at the 
time of publishing or disseminating a research report, be publishing 
or distributing projections with respect to that issuer; and (3) for 
purposes of rule 139(a)(2)(ii), include projections covering the 
same or similar periods with respect to either a substantial number 
of issuers in the issuer's industry or sub-industry or substantially 
all issuers represented in the comprehensive list of securities 
contained in the research report.
    \158\ See FINRA rule 2210(d)(1)(F).
---------------------------------------------------------------------------

    We request comment on whether we should adopt any additional 
conditions in rule 139b or issue guidance to help mitigate the 
potential for investor confusion regarding research reports about 
registered investment companies.
     Do commenters anticipate that certain issuer-specific 
covered investment fund research reports could be confused with 
registered investment company advertisements and sales materials? If 
so, what additional conditions could prevent investor confusion, 
including, for example, legends?
     If commenters anticipate that certain covered investment 
fund research reports could be confused with registered investment 
company advertisements and sales materials, what additional conditions 
or guidance factors would help mitigate investor confusion? For 
example, should we incorporate any of the rule 156 guidance factors, 
which are weighed in considering whether statements in investment 
company sales literature could be misleading? Why or why not? 
Alternatively, should we provide any additional guidance regarding 
considerations to be weighed in considering whether research reports 
about registered investment companies (including any performance 
information presented in these research reports) could be misleading? 
Should any additional guidance be limited either to issuer-specific 
research reports or to industry research reports?
     Do commenters anticipate that broker-dealers would include 
performance information in covered investment fund research reports 
about registered open-investment investment companies in a manner 
inconsistent with the requirements for the presentation of total return 
or yield in rule 482 (``non-482 performance information'')? \159\ We 
request that commenters provide specific examples of non-482 
performance information that they would consider using in a research 
report about an open-end investment company, and why they would use 
this information.
---------------------------------------------------------------------------

    \159\ As discussed above, rule 482 also permits the inclusion of 
performance measures in an open-end registered investment company 
advertisement that are not subject to any prescribed method of 
computation, provided (among other things) that these other 
performance measures are accompanied by certain standardized 
performance data. See supra note 143 and accompanying text.
---------------------------------------------------------------------------

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

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

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

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

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

[[Page 26804]]

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

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

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

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

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

    \166\ See supra paragraph accompanying notes 156-158.
---------------------------------------------------------------------------

D. Role of Self-Regulatory Organizations

1. SRO Content Standards and Filing Requirements for Covered Investment 
Fund Research Reports
SRO Content Standards
    The FAIR Act contemplates that SRO content standards applicable to 
research reports would apply to covered investment fund research 
reports.\167\ Specifically, the FAIR Act provides that, unless covered 
investment fund research reports are subject to the content standards 
in the rules of any SRO related to research reports, these research 
reports may still be subject to the filing requirements of section 
24(b) of the Investment Company Act for the review of investment 
company sales literature.\168\ As discussed in more detail below, we 
are proposing rule 24b-4 to implement this provision of the FAIR Act. 
Proposed rule 24b-4 provides that a covered investment fund research 
report about a registered investment company will not be subject to 
section 24(b) of the Investment Company Act (or the rules and 
regulations thereunder), except to the extent the research report is 
otherwise not subject to the content standards in SRO rules related to 
research reports, including those contained in the rules governing 
communications with the public regarding investment companies or 
substantially similar standards.\169\
---------------------------------------------------------------------------

    \167\ See section 2(b)(4) of the FAIR Act (A covered investment 
fund research report shall not be subject to section 24(b) of the 
Investment Company Act of 1940 (15 U.S.C. 80a-24(b)) or the rules 
and regulations thereunder, except that such report may still be 
subject to such section and the rules and regulations thereunder to 
the extent that it is otherwise not subject to the content standards 
in the rules of any self-regulatory organization related to research 
reports, including those contained in the rules governing 
communications with the public regarding investment companies or 
substantially similar standards.).
    This provision is relevant only to covered investment funds that 
are investment companies subject to section 24(b) of the Investment 
Company Act. For example, registered closed-end investment 
companies, business development companies, and commodity- or 
currency-based trusts or funds are covered investment funds that are 
not subject to section 24(b) of the Investment Company Act. A 
covered investment fund that is not subject to section 24(b) of the 
Investment Company Act would have no obligations under that section 
even if research reports concerning the covered investment fund were 
not subject to the content standards in the rules of any self-
regulatory organization related to research reports.
    \168\ See id.
    \169\ See proposed rule 24b-4.
---------------------------------------------------------------------------

    Currently, the SRO content standards relevant to communications 
that would be considered covered investment fund research reports under 
proposed rule 139b include the applicable content standards of FINRA 
rules 2210, 2241(c)(1), and 2242(c)(1).\170\ FINRA's rule governing 
communications with the public (FINRA rule 2210) contains general 
content standards that apply broadly to member communications,\171\ 
including broker-dealer research reports. These general content 
standards require, among other things, that all member communications 
``must be based on principles of fair dealing and good faith, must be 
fair and balanced, and must provide a sound basis for evaluating the 
facts in regard to any particular security or type of security, 
industry or service.'' \172\
---------------------------------------------------------------------------

    \170\ See infra note 174 (discussing the scope of these rules in 
more detail, including noting that the scope of certain provisions 
of FINRA rule 2210, and the scope of FINRA rules 2241(c)(1) and 
2242(c)(2) generally, apply only to a certain subset of 
communications that would be considered covered investment fund 
research reports under proposed rule 139b).
    \171\ See FINRA rule 2210(d)(1).
    \172\ See FINRA rule 2210(d)(1)(A). FINRA rule 2210's general 
content standards also provide, among other things, that FINRA 
members may not ``make any false, exaggerated, unwarranted, 
promissory or misleading statement or claim in any communication'' 
nor ``publish, circulate or distribute any communication that the 
member knows or has reason to know contains any untrue statement of 
a material fact or is otherwise false or misleading.'' See FINRA 
rule 2210(d)(1)(B).
---------------------------------------------------------------------------

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

[[Page 26805]]

excluding covered investment fund research reports from section 24(b) 
of the Investment Company Act so long as they continue to be subject to 
the general content standards in FINRA rule 2210(d)(1) (or 
substantially similar SRO rules). Accordingly, by operation of proposed 
rule 24b-4, covered investment fund research reports under proposed 
rule 139b that otherwise would be subject to section 24(b) of the 
Investment Company Act would not be subject to that section so long as 
they remain subject to the general content standards of FINRA rule 
2210(d)(1).\174\ This interpretation is consistent with our belief that 
it is important for SRO content standards to continue to apply to 
covered investment fund research reports, especially if, as discussed 
below, research reports about registered investment companies would no 
longer be required to be filed pursuant to section 24(b) of the Act or 
rule 497 under the Securities Act,\175\ and therefore would no longer 
be subject to routine review.\176\
---------------------------------------------------------------------------

    \173\ Section 2(b)(4) of the FAIR Act.
    \174\ A subset of communications that would fall within the 
definition of ``covered investment fund research report'' under 
proposed rule 139b also would be subject to additional content-
related requirements under FINRA rules that are applicable to 
certain research reports, but that are more narrowly applicable than 
the general content standards of FINRA rule 2210(d)(1). However, 
under our interpretation, whether or not these additional content 
standards apply to any given covered investment fund research report 
would not determine the applicability of section 24(b) to that 
research report under proposed rule 24b-4. A different 
interpretation could lead to results that we believe could be 
inconsistent with section 2(b)(4) of the FAIR Act (i.e., if only 
communications that are subject to additional FINRA content 
standards discussed in this footnote (e.g., those applicable to 
retail communications) were excluded from section 24(b) filing 
requirements).
     Additional FINRA content-related requirements include the 
content standards of FINRA rule 2210 that apply only to retail 
communications (or retail communications and correspondence, as 
those terms are defined in FINRA rule 2210(a)). See, e.g., FINRA 
rules 2210(d)(2) (Comparisons), 2210(d)(3) (Disclosure of Member's 
Name). Accordingly, covered investment fund research reports that 
would meet the definition of institutional communications would not 
be subject to some of the content standards of FINRA rule 2210.
     These additional requirements also include the content 
standards incorporated in FINRA rules 2241 and 2242, which apply to 
certain research reports defined in these FINRA rules. The scope of 
FINRA rules 2241 and 2242 only includes research reports or debt 
research reports as defined in these rules, and the definitions of 
``research report'' and ``debt research report'' in these rules are 
different than the definitions of ``research report'' set forth in 
rule 139 and proposed rule 139b. Under FINRA rule 2241, ``research 
report'' is defined as any written (including electronic) 
communication that includes an analysis of equity securities of 
individual companies or industries (other than an open-end 
registered investment company that is not listed or traded on an 
exchange) and that provides information reasonably sufficient upon 
which to base an investment decision; similarly, under FINRA rule 
2242, ``debt research report'' is defined as any written (including 
electronic) communication that includes an analysis of a debt 
security or an issuer of a debt security and that provides 
information reasonably sufficient upon which to base an investment 
decision, excluding communications that solely constitute an equity 
research report as defined in [FINRA] rule 2241(a)(11).'' See FINRA 
rules 2241(a)(11), 2242(a)(3).
    \175\ See infra discussion at notes 177-181 and accompanying 
text.
    \176\ Broker-dealer communications that are excluded from, or 
otherwise not subject to FINRA's filing requirements may still be 
reviewed by FINRA, for example, through examinations, targeted 
sweeps or spot-checks. FAIR Act section 2(c)(2) provides that 
nothing in the Act shall be construed as in any way limiting ``the 
authority of any self-regulatory organization to examine or 
supervise a member's practices in connection with such member's 
publication or distribution of a covered investment fund research 
report for compliance with applicable provisions of the Federal 
securities laws or self-regulatory organization rules related to 
research reports, including those contained in rules governing 
communications with the public.'' See also, e.g., FINRA rule 
2210(c)(6) (``In addition to the foregoing requirements, each 
member's written (including electronic) communications may be 
subject to a spot-check procedure. Upon written request from 
[FINRA's Advertising Regulation] Department, each member must submit 
the material requested in a spot-check procedure within the time 
frame specified by the Department.'').
---------------------------------------------------------------------------

Filing Requirements for Covered Investment Fund Research Reports
    The FAIR Act, as implemented by proposed rule 24b-4, would modify 
the filing requirements that currently apply to certain broker-dealer 
communications regarding registered investment companies. As discussed 
above, research reports about registered investment companies have 
historically not been included within the scope of rule 139.\177\ 
Therefore, a research report or other communication about a covered 
investment fund that is a registered investment company, particularly 
one that contains performance information, would ordinarily have to 
comply with rule 482.\178\ Today, registered investment company sales 
literature, including rule 482 omitting prospectus advertisements, are 
required to be filed with the Commission under section 24(b) of the 
Investment Company Act \179\ and rule 497 under the Securities 
Act.\180\ Rule 24b-3 under the Investment Company Act and rule 497(i) 
deem these materials to have been filed with the Commission if filed 
with FINRA.\181\
---------------------------------------------------------------------------

    \177\ See supra notes 11-15 and accompanying text.
    \178\ See FINRA rule 2210(d)(5) (providing that non-money market 
fund open-end management company performance data as permitted by 
rule 482 in retail communications and correspondence must disclose 
standardized performance information and, to the extent applicable, 
certain sales charge and expense ratio information); see also supra 
note 140.
    \179\ See supra note 29.
    \180\ 17 CFR 230.497. Rule 497 generally requires investment 
company prospectuses, including investment company advertisements 
deemed to be a section 10(b) prospectus pursuant to rule 482, to be 
filed with the Commission.
    \181\ See supra notes 29, 180.
---------------------------------------------------------------------------

    As discussed in the Economic Analysis below, we anticipate that 
certain communications that historically have been treated as 
investment company sales literature, including rule 482 ``omitting 
prospectus'' advertisements, would be published or distributed by a 
broker-dealer as covered investment fund research reports pursuant to 
the rule 139b safe harbor.\182\ Such communications that previously had 
been subject to the filing requirements of section 24(b) no longer 
would be subject to these requirements by operation of proposed rule 
24b-4 because they would be subject to the general content standards of 
FINRA rule 2210(d)(1).\183\
---------------------------------------------------------------------------

    \182\ See infra section III.C.3.
    \183\ See supra notes 11-15 and accompanying text.
     A communication that previously had been subject to the filing 
requirements of rule 497 also would no longer be subject to the rule 
497 filing requirements if it were published or distributed by a 
broker-dealer as a covered investment fund research report, because 
it would no longer be considered to be a section 10(b) prospectus. 
See supra paragraph accompanying notes 141-146.
---------------------------------------------------------------------------

    FINRA rule 2210 requires the filing of certain communications, 
including retail communications that promote or recommend a specific 
registered investment company or family of registered investment 
companies.\184\ However, FINRA provides a number of exclusions from the 
filing requirements.\185\ For example, with respect to research reports 
(as that term is defined in FINRA rule 2241),\186\ FINRA currently 
excludes from filing those that concern only securities that are listed 
on a national securities exchange, other than research reports required 
to be filed with the Commission pursuant to section 24(b) of the 
Investment Company Act.\187\ Because covered investment fund research 
reports would no longer be required to be filed with the Commission 
pursuant to section 24(b),

[[Page 26806]]

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

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

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

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

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

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

E. Conforming Amendment

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

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

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

III. Economic Analysis

A. Introduction

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

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

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

B. Baseline

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

[[Page 26807]]

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

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

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

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

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

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

BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TP08JN18.000


[[Page 26808]]


[GRAPHIC] [TIFF OMITTED] TP08JN18.001

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

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

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

[[Page 26809]]

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

    \208\ See supra note 199.
    [GRAPHIC] [TIFF OMITTED] TP08JN18.002
    
    We are requesting comments on our characterization of the covered 
investment fund market and data to help us further describe this market 
and current market practices.
     Do commenters agree with our characterization of the 
covered investment fund market? Do commenters agree with our 
characterization of ownership patterns? Are there ways to improve our 
estimates?
     Do commenters believe that our estimates of institutional 
ownership of covered investment funds are accurate? If not, are there 
ways to improve our estimates? Do commenters believe that our estimates 
of institutional ownership of different types of covered investment 
fund shares (e.g., mutual funds, ETFs, ETPs, BDCs) include shares held 
in street name where the beneficial owners are retail investors?
     Do commenters believe that our estimates of institutional 
holdings of covered investment funds represent securities held for 
investment or securities held for other purposes (e.g. market-making 
inventory, proprietary trading)?
b. Broker-Dealers
    The broker-dealers directly affected by the proposed rules are 
those who participate in registered offerings of covered investment 
funds while at the same time publishing or distributing information 
about those funds. The Commission does not have comprehensive data on 
the number or characteristics of broker-dealers currently publishing 
and distributing communications about covered investment funds, the 
extent of their communications, and their distribution arrangements 
with covered investment funds. Therefore we rely on inferences based on 
the data that are available \209\ and make certain assumptions when 
characterizing the baseline.
---------------------------------------------------------------------------

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

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

[[Page 26810]]

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

    \210\ We believe that broker-dealers that do not participate in 
the distribution of covered investment funds are less likely to 
publish or distribute research reports about such funds and--to the 
extent that they do--may not derive significant benefits from the 
safe harbor of proposed rule 139b.
    \211\ See supra section III.B.1.a.
    \212\ The sum of FOCUS Supplemental Statement of Income items: 
13970 (``revenues from sales of investment company shares''), 11094 
(``12b-1 fees''), and 11095 (``mutual fund revenue other than 
concessions or 12b-1 fees'').
    \213\ We describe these dealers as ``affected,'' but note that 
the degree to which they are affected will vary based on individual 
characteristics. Other things being equal, we expect broker-dealers 
that are currently more active in the marketing of covered 
investment funds would be more affected.
    \214\ This suggests that the degree to which the ``affected'' 
broker-dealers are affected by the proposed rule will also vary 
widely.
    \215\ Estimates are based on staff analysis of FOCUS filings.
    [GRAPHIC] [TIFF OMITTED] TP08JN18.003
    
    We are seeking comment on our assumptions used in characterizing 
this market.
     Do commenters agree with our estimates of the immediately-
affected broker-dealers based on revenue from sales of investment 
company shares? If not, what other proxy would be more appropriate?
c. Research on Covered Investment Funds
    The Commission does not have comprehensive data on broker-dealers 
that publish or distribute research reports on entities that would be 
included within the definition of ``covered investment fund'' under 
proposed rule 139b.\216\ The Commission estimates that in 2017, there 
were 1,417 broker-dealers that reported revenues from the distribution 
of covered investment funds.\217\ We assume that these broker-dealers 
would have incentives to publish or distribute research reports about 
covered investment funds. However, due to the large number of covered 
investment funds, we do not expect that many broker-dealers' in-house 
research departments (if they have such

[[Page 26811]]

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

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

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

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

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

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

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

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

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

[[Page 26812]]

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

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

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

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

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

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

C. Costs and Benefits

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

[[Page 26813]]

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

    \241\ See supra section II.D.1.
    \242\ See supra note 232.
    \243\ See supra section II.D.1.
    \244\ We note, however, that we would not expect any lower costs 
of compliance for any research reports that currently are structured 
as rule 34b-1 supplemental sales literature (and are not rule 482 
advertising prospectuses), because supplemental sales literature is 
not an ``offer'' to which prospectus liability under section 
12(a)(2) of the Securities Act would attach.
---------------------------------------------------------------------------

    Because there is limited historical experience dealing specifically 
with broker-dealers' research reports on covered investment funds, 
there is little in the way of direct empirical evidence on the value of 
such reports to investors. Prior research on the informativeness of 
broker-dealers' research on operating companies suggests that broker-
dealers can produce research that positively contributes to the 
information content of market prices,\245\ and--perhaps more 
importantly--that broker-dealers may enjoy a comparative advantage in 
its production.\246\ However, other studies have questioned the 
investment value of such research to investors\247\ or its continued 
relevance.\248\
---------------------------------------------------------------------------

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

    We are cautious in drawing implications from these findings to 
broker-dealers' research on covered investment funds. While analysts 
researching operating companies generally endeavor to identify 
mispricing--to forecast the idiosyncratic component of firms' future 
returns--covered investment funds represent portfolios of securities, 
and many covered investment funds are priced at net asset value 
(``NAV'').\249\ Although individual securities within a covered 
investment fund's portfolio may be individually viewed as ``mispriced'' 
by a research analyst, diversification effects will tend to drown out 
such effects at the fund level and minimize idiosyncratic variation in 
investors' return on their investment in the fund. Therefore, any 
``investment value'' \250\ of research on covered investment funds 
would likely be rooted in analysts' ability to predict broader market 
movements. Such ability is generally believed to be rather rare.\251\ 
We therefore believe that the value to investors of information in 
broker-dealers' research reports will largely be limited to the 
synthesis or discovery of factual information about fund 
characteristics, fees, or other transactions costs. For example, 
investors may find analysts' views of a fund's management, objectives, 
risk exposures, tracking error, volatility, tax efficiency, fees, or 
other fund characteristics to be valuable. Such analysis could be 
valuable a source of information for investors evaluating relative fund 
performance.\252\
---------------------------------------------------------------------------

    \249\ Closed-end funds, for example, are not priced on a NAV 
basis and their (mis-) pricing has long served as a puzzle in the 
finance literature. See, e.g., Charles M.C. Lee, Andrei Schleifer, & 
Richard H. Thaler, Investor Sentiment and the Closed-End Fund 
Puzzle, 46 The Journal of Finance 1 (Mar. 1991). Similar pricing 
issues may arise in BDCs.
    \250\ We mean this in the sense of providing a signal about 
future investment performance.
    \251\ See, e.g., Kent Daniel, Mark Grinblatt, Sheridan Titman, & 
Russ Wermers, Measuring Mutual Fund Performance with Characteristic-
Based Benchmarks, 52 The Journal of Finance 3, 1035-1058 (July 
1997).
    \252\ See, e.g., W.J. Armstrong, Egemen Genc & Marno Verbeek, 
Going for Gold: An Analysis of Morningstar Analyst Ratings, 
Management Science (Aug. 2017).
---------------------------------------------------------------------------

    We believe that the quantity of information available to potential 
investors of covered investment funds would increase as a result of 
broker-dealers' increased publication and distribution of covered 
investment fund research reports. The proposed rules will also allow 
for greater flexibility in the type of information that broker-dealers 
may communicate to customers.\253\ To the extent that this new 
information is valuable, it will benefit investors by providing them 
with additional information to help shape investment decisions. 
Finally, we believe that important negative information about a covered 
investment fund, such as high fees, high risk exposure, or an 
inefficient portfolio strategy will be more likely to be publicized as 
a result of increased competition among information providers, with 
attendant benefits to investors.\254\
---------------------------------------------------------------------------

    \253\ Currently such communications would be subject to rule 482 
requirements, including standards on the presentation of performance 
information. See supra section II.C.
    \254\ See Matthew Gentzkow & Jesse M. Shapiro, Media Bias and 
Reputation, 114 Journal of Political Economy 2, 280-316 (Apr. 1, 
2006).
---------------------------------------------------------------------------

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

[[Page 26814]]

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

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

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

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

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

[[Page 26815]]

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

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

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

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

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

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

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

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

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

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

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

[[Page 26816]]

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

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

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

    \291\ See Dugar and Nathan Article, supra note 255.
    \292\ See Michaely and Womack Article, supra note 256.
    \293\ See Lin and McNichols Article, supra note 255.
    \294\ Institutional market participants generally attribute bias 
in sell-side analysts' research reports to conflicts of interest. 
See Michaely and Womack Article, supra note 256.
    \295\ See Michael B. Mikhail, Beverly R. Walther & Richard H. 
Willis, When Security Analysts Talk, Who Listens?, 82 The Accounting 
Review 5, 1227-1253 (2007) (``Mikhail Walther and Willis Article''). 
See also Diane Del Guercio & Paula A. Tkac, Star Power: The Effect 
of Morningstar Ratings on Mutual Fund Flow, 43 Journal of Financial 
and Quantitative Analysis 4, 907-936 (Dec. 2008) (retail investors 
in mutual funds are very sensitive to fund rankings). See 
Christopher R. Blake & Matthew R. Morey, Morningstar Ratings and 
Mutual Fund Performance, 35 The Journal of Financial and 
Quantitative Analysis 3, 451-483 (2000) (mutual fund ranking have 
little predictive power for future performance).
    \296\ See id. and Malmendier and Shanthikumar Article, supra 
note 285.
    \297\ See Mikhail Walther and Willis Article, supra note 295. 
See also Malmendier and Shanthikumar Article, supra note 285. See 
also Amanda Cowen, Boris Groysberg & Paul Healy, Which Types of 
Analyst Firms Are More Optimistic?, 41 Journal of Accounting and 
Economics 1, 119-146 (Apr. 1, 2006) (finding that analysts at retail 
brokerage firms are more optimistic than those serving only 
institutional investors). See Xuanjuan Chen, Tong Yao & Tong Yu, 
Prudent Man or Agency Problem? On the Performance of Insurance 
Mutual Funds, 16 Journal of Financial Intermediation 2, 175-203 
(Apr. 1, 2007) (underperformance of mutual funds sponsored by 
insurance companies is attributed to inadequate monitoring by less 
sophisticated retail customers who are subject to cross-selling 
efforts by their insurer). See also Daniel Bergstresser, John M.R. 
Chalmers, and Peter Tufano, Assessing the Costs and Benefits of 
Brokers in the Mutual Fund Industry, 22 Review of Financial Studies 
10, 4129-4156 (Oct. 2009) (broker-sold mutual funds deliver lower 
risk-adjusted returns (even before subtracting distribution fees) 
than direct-sold funds). See also Diane Del Guercio & Jonathan 
Reuter, Mutual Fund Performance and the Incentive to Generate Alpha, 
69 The Journal of Finance 4, 1673-1704 (Aug. 1, 2014) 
(underperformance of actively managed mutual funds is attributed to 
the underperformance of funds sold by brokers; the authors find 
little evidence for underperformance in the subset of funds that are 
sold directly to investors).
---------------------------------------------------------------------------

    We request comment generally on the costs that we anticipate may 
arise from proposed rule 139b and proposed rule 24b-4 as a result of 
the FAIR Act's statutory mandate.
     Do commenters generally agree with our assessment of the 
costs that we expect to result from the proposed rules?
     Do commenters expect conflicts of interest to materially 
affect research reports on covered investment funds? If so, in what 
way? If not, why not?
2. Proposed Rule 139b
    As discussed above, proposed rule 139b conditions eligibility for 
the safe harbor on satisfaction of several conditions.\298\ These 
conditions are generally modeled on and resemble similar provisions in 
rule 139 (with differences from rule 139 that the FAIR Act specifically 
directs, or that tailor the provisions of rule 139 more directly or 
specifically to the context of covered investment fund research 
reports).\299\ We believe that modeling proposed rule 139b on rule 139 
will benefit market participants through regulatory consistency and 
reduced opportunities for investor confusion. We address these 
conditions in turn in the sections that follow.
---------------------------------------------------------------------------

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

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

[[Page 26817]]

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

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

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

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

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

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

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

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

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

[[Page 26818]]

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

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

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

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

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

    \316\ The regular course of business requirement generically 
would require ``research reports'' to be published or distributed in 
the regular course of a broker-dealer's business and would not be 
limited to covered investment fund research reports. We request 
comment about what the regular course of business requirement means 
in the context of covered investment fund research reports. See 
supra section II.B.1.c (requests for comments).
    \317\ See supra notes 250-251 and accompanying text.
---------------------------------------------------------------------------

    Due to the aforementioned distinctions in the information 
environment and business rationale, we believe that the regular-course-
of-business requirement in the context of proposed rule 139b may be 
more challenging to apply in practice than the regular-course-of-
business requirement in the context of rule 139. Accordingly, the 
potential benefits of this requirement in proposed rule 139b may be 
limited. The effects of the regular-course-of-business requirement 
would be clearer in cases where, in the case of issuer-specific 
research reports, the proposed bright-line ``initiation or 
reinitiation'' requirement applies (i.e., where the covered investment 
fund does not have a class of securities in substantially continuous 
distribution). For such cases, the regular-course-of-business 
requirement as proposed would condition the availability of the safe 
harbor on the research report not representing the initiation or 
reinitiate of coverage by the broker-dealer publishing or distributing 
said research report. As the universe of covered investment funds is 
dominated by funds with a class of securities that could be considered 
to be in substantially continuous distribution,\318\ the bright-line 
test of the regular course of business requirement would impact only a 
small subset of funds.
---------------------------------------------------------------------------

    \318\ See supra note 98 and accompanying text.
---------------------------------------------------------------------------

    We are also seeking commenters' views on our analysis:
     Is our assessment of the difficulties associated with 
establishing whether research reports about covered investment funds 
are published in the regular course of business accurate? If not, what 
factors will be indicative of the regular-course-of-business 
requirement having been satisfied?
     Are there additional benefits associated with this 
requirement that we have not considered?
     Are there additional costs associated with this 
requirement that we have not considered?
c. Reporting History and Minimum Market Value Requirements for Issuers 
Appearing in Issuer-Specific Research Reports
    Under proposed rule 139b, a broker-dealer's publication or 
distribution of issuer-specific research reports would not qualify for 
the safe harbor unless the covered investment fund included in the 
report satisfies a minimum public market value threshold of $75 
million.\319\ Issuers would also be required to have been subject to 
the reporting requirements of the Investment Company Act (for covered 
investment funds that are registered investment companies) or the 
reporting requirements under section 13 or 15(d) of the Exchange Act 
(for covered investment funds that are not registered investment 
companies) for a period of at least 12 calendar months prior to 
reliance on the proposed rule as well as to have timely filed all 
required reports during the preceding 12 months.\320\
---------------------------------------------------------------------------

    \319\ See proposed rule 139b(a)(1)(i)(B).
    \320\ Including Forms N-CSR, N-SAR, N-Q, N-PORT, N-MFP, and N-
CEN as applicable for registered investment companies, and Forms 10-
K, 10-Q, and 20-F as applicable for covered investment funds that 
are not registered investment companies. See proposed rule 
139b(a)(1)(i)(A).
---------------------------------------------------------------------------

    The covered investment funds market is dynamic.\321\ In 2016, more 
than six hundred covered investment funds entered the market, while 
more than seven hundred exited. The entry and exit of covered 
investment funds creates a situation in which a younger covered 
investment fund may not be widely followed by market participants.\322\

[[Page 26819]]

Thus, for covered investment funds, the universe of young--and 
potentially less-followed--issuers is large. Moreover, securities 
issued by covered investment funds may not be subject to significant 
levels of market scrutiny. Unlike securities issued by operating 
companies (that generally have diverse groups of investors, including 
institutional investors, money managers, arbitrageurs, activist 
investors, and short sellers), covered investment funds are primarily 
held by retail investors.\323\ As covered investment fund shares are 
not a major component of institutional investors' portfolios, we 
believe that they are less likely to garner wide-spread attention from 
the types of sophisticated institutional investors most capable of 
subjecting them to scrutiny.\324\
---------------------------------------------------------------------------

    \321\ See supra section III.B.1.a.
    \322\ In contrast, there were fewer than one hundred U.S. IPOs 
for operating companies in 2016. See Jay Ritter, Initial Public 
Offerings: Updated Statistics (Aug. 8, 2017), available at https://site.warrington.ufl.edu/ritter/files/2017/08/IPOs2016Statistics.pdf.
    \323\ See supra section III.B.1.a.
    \324\ See supra note 290.
---------------------------------------------------------------------------

    We believe that in the context of covered investment funds, where 
we expect limited market discipline from institutional investors and 
where large numbers of new funds are created each year, the information 
available to investors could be sparse. In such an environment, a 
single ``research report'' about a covered investment fund could have a 
disproportionate effect on retail investors' beliefs about the fund 
and--in the case of a biased research reports--have a negative effect 
on investor welfare. We believe that conditioning the availability of 
the safe harbor on the aforementioned reporting history and market 
valuation requirements would help restrict the availability of the safe 
harbor in situations where we expect the information environment to be 
most limited: for new funds and for funds with niche markets. Moreover, 
we believe modeling the reporting history and minimum public market 
valuation requirements on those in rule 139 reduces regulatory 
complexity and opportunities for investor confusion.
    Because young and small covered investment funds are relatively 
common, the costs associated with these conditions on the availability 
of a safe harbor may be significant. In particular, as shown in Table 
1, the $75 million minimum public market valuation condition would 
limit the availability of the safe harbor with respect to broker-
dealers' publication or distribution of research reports for 
approximately one-third of all covered investment funds.\325\ Research 
reports about nearly half of extant ETFs, ETPs and BDCs would not 
qualify for the safe harbor.\326\ Availability of the safe harbor would 
be least impacted for research reports on open end-mutual funds and 
closed-end funds.\327\
---------------------------------------------------------------------------

    \325\ 31% of all covered investment funds have public market 
valuations less than $75 million.
    \326\ 41% of ETF and ETPs and 42% of BDCs have public market 
valuations less than $75 million. See Table 1.
    \327\ 30% of open-end mutual funds and 12% of closed-end funds 
have public market valuations less than $75 million. See Table 1.
---------------------------------------------------------------------------

    Although young and small funds represent a very small fraction of 
covered investment fund assets, they are relatively large in 
number.\328\ Because nearly one-third of covered investment funds would 
not satisfy the eligibility criteria for the proposed safe harbor, we 
believe that those funds would be less likely to receive coverage by 
broker-dealers insofar as the inability to rely on the proposed safe 
harbor reduces broker-dealers' willingness to publish and distribute 
research reports.
---------------------------------------------------------------------------

    \328\ See Table 1.

Table 1--Covered Investment Funds With Public Market Value Less Than $75
   Million, and the Fraction of Covered Investment Fund Assets Held by
    These Funds. For Each Covered Investment Fund Type, We Report the
  Percentage of Funds of That Type With a Public Market Value Below $75
  Million and the Percentage of Covered Investment Fund Assets Held in
Funds With Public Market Values Below $75 million. Mutual Fund, ETF, and
  ETP Statistics Based on Data From CRSP Mutual Fund Database (2017Q3).
  Closed-end Fund Statistics Based on Data From CRSP Monthly Stock File
 (Dec. 2017). BDC Statistics Based on Commission's Listing of Registered
   BDCs, and Regulatory Filings (2016) Compiled by Compustat and Audit
                                Analytics
------------------------------------------------------------------------
                                                Funds with public market
                                                   value <$75 million
         Covered investment fund type          -------------------------
                                                 Number of   Fund assets
                                                 funds (%)       (%)
------------------------------------------------------------------------
Open-end......................................           30           <1
Closed-end....................................           12           <1
ETFs and ETPs.................................           41           <1
BDC...........................................           42            1
                                               -------------------------
    Total.....................................           31           <1
------------------------------------------------------------------------

    We are also seeking commenters' views on our analysis:
     Are there additional benefits associated with these 
requirements that we have not considered?
     Are there additional costs associated with these 
requirements that we have not considered?
d. Reporting Requirement for Issuers Appearing in Industry Reports
    Under proposed rule 139b an industry research report could only 
include covered investment funds that are required to file reports 
pursuant to section 30 of the Investment Company Act (or, for covered 
investment funds that are not registered investment companies under the 
Investment Company Act, required to file reports pursuant to section 13 
or section 15(d) of the Exchange Act).\329\ As discussed above, these 
proposed conditions generally track parallel conditions under rule 139, 
but have been modified so that they would be applicable with respect to 
covered investment fund issuers. We do not expect these conditions to 
have economic effects beyond marginally improving economic efficiency 
by more closely aligning regulations with their intended context.
---------------------------------------------------------------------------

    \329\ Proposed rule 139b(a)(2)(i). As discussed previously, each 
issuer included in an issuer-specific research report also would be 
required to be subject to these reporting requirements, as well as 
the requirement to have filed in a timely manner all of the periodic 
reports required to be filed during the preceding 12 months. See 
supra section II.B.1.a. We note that this condition limits industry 
reports published or distributed in reliance on rule 139b to covered 
investment funds that file their reports pursuant to section 30 of 
the Investment Company Act or section 13 or section 15(d) of the 
Exchange Act.
---------------------------------------------------------------------------

    We are also seeking commenters' views on our analysis:
     Are there additional benefits associated with these 
requirements that we have not considered?
     Are there additional costs associated with these 
requirements that we have not considered?
e. Content and Presentation Requirements for Industry Research Reports
    Under proposed rule 139b, the content and presentation standards 
for industry research reports of rule 139 would be tailored to the 
context of covered investment funds. Under proposed rule 139b (and rule 
139), issuers appearing in industry research reports are subject to 
fewer conditions than issuers that are subjects of issuer-specific 
research reports.\330\ We believe that in the absence of content and 
presentation requirements such as those

[[Page 26820]]

we propose today, an industry research report could be used to 
circumvent the conditions associated with the safe harbor available for 
issuer-specific research reports. We therefore believe that the 
proposed content and presentation standards have benefits similar to 
those of the parallel content and presentation requirements in rule 
139, and provide meaningful limits for issuer-specific research 
reports.\331\
---------------------------------------------------------------------------

    \330\ See supra section II.B.2.
    \331\ See supra notes 118-119, and paragraph accompanying note 
136.
---------------------------------------------------------------------------

    We believe the compliance costs imposed by these requirements on 
the production of industry research reports would be low, particularly 
as broker-dealers are already familiar with similar conditions in rule 
139, making implementation of presentation conditions for industry 
research reports on covered investment funds less burdensome.
    We are also seeking commenters' views on our analysis:
     Do commenters believe that there are there additional 
benefits associated with the content and presentation standards that we 
have not considered?
     Do commenters believe that there additional costs 
associated with content and presentation requirements that we have not 
considered?
     Do commenters agree with our assessment of the compliance 
costs? Are there certain types of broker-dealers for which these 
compliance costs will be higher (or lower)?
3. Proposed Rule 24b-4
    Proposed rule 24b-4 would exclude a covered investment fund 
research report from the coverage of section 24(b) of the Investment 
Company Act and the rules and regulations thereunder, except to the 
extent that such report is not subject to the content provisions of SRO 
rules related to research reports, including those contained in the 
rules governing communications with the public regarding investment 
companies or substantially similar standards. As discussed above, this 
proposed rule is meant to implement section 2(b)(4) of the FAIR Act, 
which we interpret to exclude covered investment fund research reports 
from section 24(b) of the Investment Company Act so long as they 
continue to be subject to the general content standards in FINRA rule 
2210(d)(1).\332\ For covered investment fund research reports that are 
published or distributed by FINRA member firms, all such research 
reports would be subject to the content standards of FINRA rule 
2210(d)(1), and thus we would interpret these research reports to be 
excluded from the Commission's filing requirements under the proposed 
rule.\333\
---------------------------------------------------------------------------

    \332\ See supra note 174 and accompanying text.
    \333\ See id.
---------------------------------------------------------------------------

    As discussed above, where covered investment fund research reports 
would no longer be required to be filed with the Commission pursuant to 
section 24(b), proposed rule 24b-4 could have the effect of narrowing 
the types of communications regarding registered investment companies 
that would be filed with FINRA (under current FINRA rule 2210).\334\ 
However, we believe that administrative processes related to handling 
regulatory reviews of communications subject to filing requirements 
impose costs on broker-dealers, which in turn can reduce their 
willingness to publish and distribute such communications. 
Consequently, although we do not believe that limiting these filing 
requirements as required by the FAIR Act represents a first-order 
economic effect of the proposed rules, we believe that doing so will 
reduce administrative costs for broker-dealers publishing or 
distributing covered investment fund research reports. At the same 
time, as discussed above, we believe that eliminating these filing 
requirements may have the result that some communications that are 
currently subject to FINRA's filing requirements would no longer be 
subject to routine review.\335\ While these communications may still be 
reviewed by FINRA--for example, through examinations, targeted sweeps, 
or spot-checks--we believe that an effect of the FAIR Act, as 
implemented through proposed rule 24b-4, may be to reduce the 
monitoring by FINRA and the Commission of broker-dealers' 
communications with customers for compliance with the applicable rules 
and regulations.\336\
---------------------------------------------------------------------------

    \334\ See id.
    \335\ See supra section II.D.1.
    \336\ But see supra note 188 and accompanying text (noting that 
the FAIR Act's rules of construction provide that the Act shall not 
be construed as limiting the authority of an SRO to require the 
filing of communications with the public if the purpose of such 
communications ``is not to provide research and analysis of covered 
investment funds''); see also section 2(c)(2) of the FAIR Act.
---------------------------------------------------------------------------

    We are seeking comments on the costs and benefits of proposed rule 
24b-4:
     Do commenters agree with our characterization of the costs 
and benefits? Are there additional costs and benefits that we should 
consider?
     Do commenters expect non-FINRA member firms to publish or 
distribute covered investment fund research reports that would not be 
subject to the content standards of FINRA rule 2210(d)(1)?
4. Proposed Amendment to Rule 101 of Regulation M
    As discussed above, rule 101 of Regulation M prohibits a person who 
participates in a distribution from attempting to induce others to 
purchase securities covered by the rule during a specified period.\337\ 
However, rule 101 provides an exception for research activities that 
satisfy the conditions of Securities Act rule 138 or rule 139. The 
proposed conforming amendment would expand this exception to include 
research activities that satisfy the conditions of proposed rule 139b. 
We believe that broker-dealers would generally be unable to make use of 
the proposed rule 139b safe harbor absent the proposed conforming 
amendment. Consequently, we do not consider its effects separately.
---------------------------------------------------------------------------

    \337\ See supra section II.E.
---------------------------------------------------------------------------

5. Effects on Efficiency, Competition, and Capital Formation
    The primary effects on economic efficiency and capital formation 
resulting from proposed rules 139b and 24b-4 obtain from the statutory 
mandates of the FAIR Act. Because financial intermediaries such as 
broker-dealers are generally assumed to possess some comparative 
advantage in the production of information about securities, efficiency 
considerations would--in the absence of significant market 
imperfections--dictate that broker-dealers should be active in the 
production of such information. To the extent that the increase in 
broker-dealers' production of research reports about covered investment 
funds--that we expect to occur as a result of the FAIR Act's statutory 
mandates \338\--is valuable to investors, we expect it to increase 
allocative efficiency, with attendant positive consequences on capital 
formation. As noted earlier, the existence of the safe harbor could 
provide increased opportunities for broker-dealers to publish and 
distribute research on funds from which they derive financial 
benefits.\339\ To the extent that this could limit the value investors 
derive from research reports that broker-dealers publish and 
distribute, any potential gains to efficiency and improvements to 
capital formation could be reduced (or eliminated).
---------------------------------------------------------------------------

    \338\ See supra section III.C.1.a.
    \339\ See supra section III.C.1.b.
---------------------------------------------------------------------------

    Beyond the aforementioned broader effects on efficiency and capital 
formation resulting from the FAIR Act's statutory mandates, we believe 
that the specific conditions on the availability of the safe harbor in 
proposed rule 139b

[[Page 26821]]

will generally further economic efficiency and facilitate capital 
formation by reducing the potential for retail investors to receive 
research reports whose publication or distribution may be motivated by 
these financial incentives that could cause a conflict of interest. We 
believe that the affiliate exclusion and related guidance will have the 
largest impact because it addresses the greatest conflicts of interests 
in this context: Those arising from broker-dealers in investment 
advisory relationships.\340\ In addition, we believe that the 
Commission's various tailoring of the proposed rules to the covered 
investment fund context will yield marginal efficiency improvements 
from reductions in regulatory ambiguity.
---------------------------------------------------------------------------

    \340\ See supra section III.C.2.a.
---------------------------------------------------------------------------

    With respect to competition, we believe that expansion of the rule 
139 safe harbor will increase competition in the market for research 
reports on covered investment funds. Under the baseline, the market for 
research reports on covered investment funds is dominated by a small 
number of independent research firms, with few broker-dealers producing 
original research about such funds.\341\ We believe that the 
availability of the safe harbor will encourage some broker-dealers to 
publish proprietary research on covered investment funds. However, due 
to the high costs associated with maintaining research departments 
capable of covering the large covered investment fund universe,\342\ we 
believe that most broker-dealers will continue to rely on content 
licensed from independent firms.\343\ We also believe that there are 
competitive implications stemming from the guidance we have given to 
address possible circumvention of the proposed affiliate 
exclusion.\344\ This guidance may have the effect of placing smaller 
broker-dealers-- who may not operate at a scale large enough to sustain 
a research department--at a competitive disadvantage. These smaller 
broker-dealers may find that they are unable to compete with larger 
broker-dealers in the provision of ``original'' research about covered 
investment funds.
---------------------------------------------------------------------------

    \341\ See supra section III.B.1.c.
    \342\ See supra section III.B.1.a.
    \343\ We expect that broker-dealers that choose to publish 
research on covered investment funds will generally not license it 
to their competitors.
    \344\ See supra section III.C.2.a.
---------------------------------------------------------------------------

    We are seeking comments on our analysis of the proposed rules' 
effects on efficiency, competition, and capital formation:
     Are there other significant effects on efficiency, 
competition, or capital formation that we have not considered?
     What competitive effects, if any, would the proposed 
reporting history and minimum market value requirements have on smaller 
covered investment funds? Do commenters believe these requirements 
would adversely affect the type and amount of analysis available to 
investors on these funds?
6. Alternatives Considered
    We considered several alternative approaches to implementing the 
FAIR Act mandates that could satisfy the requirements of the FAIR Act. 
We summarize these here.
a. Conditions on Issuers Appearing in Issuer-Specific Research Reports
    As discussed above, we believe that conditioning the availability 
of the safe harbor on the proposed $75 million minimum public market 
value requirement would promote investor protection by limiting 
research reports to issuers that have a demonstrated market 
following.\345\ However, we acknowledge that it would mean that 
research reports about significant numbers of smaller covered 
investment funds would not qualify for inclusion in research reports 
under the safe harbor. We believe that this will reduce the effect of 
the proposed rules on the availability of research reports about 
smaller covered investment funds.\346\
---------------------------------------------------------------------------

    \345\ See supra section II.B.1.b.
    \346\ See supra section III.C.2.c.
---------------------------------------------------------------------------

    Depending on the distribution of covered investment funds' public 
market values, a somewhat lower threshold could significantly increase 
the number of covered investment funds that qualify for inclusion in 
research reports without materially increasing the number of qualifying 
funds without a demonstrated market following and thus undermining 
investor protection. Conversely, a significantly higher threshold could 
further promote investor protection without significantly decreasing 
the number of qualifying funds (however, as discussed below, we did not 
consider this alternative because the FAIR Act prevents us from 
conditioning the availability of the safe harbor on a minimum public 
market value requirement that is greater than what is required under 
rule 139).
BILLING CODE 8011-01-P

[[Page 26822]]

[GRAPHIC] [TIFF OMITTED] TP08JN18.004

    We have considered a range of alternative minimum public market 
values thresholds. Figure 5 plots the percentage of covered investment 
funds whose public market valuations would fall under each alternative 
threshold. As shown in the figure, material increases in the 
availability of the safe harbor are only achievable through large 
reductions to the threshold. This is due to large numbers of funds 
being very small: as shown in Figure 6, over 600 covered investment 
funds have a public market valuation of $5 million or less. However, we 
do not believe that a significantly lower threshold would be effective 
at promoting investor protection because, as discussed above in section 
III.C.2.c, we expect the information environment to be more limited for 
smaller funds than for larger funds.

[[Page 26823]]

[GRAPHIC] [TIFF OMITTED] TP08JN18.005

BILLING CODE 8011-01-C
    The FAIR Act prevents us from conditioning the availability of the 
safe harbor on a minimum public market value requirement that is 
greater than what is required under rule 139.\347\ This effectively 
prevents us from conditioning the availability of the safe harbor for 
research reports on the subject covered investment fund having a public 
float of more than $75 million. Consequently, we do not consider higher 
minimum public market value thresholds. We seek information from 
commenters to assist us in assessing the economic impacts of a lower 
minimum threshold.
---------------------------------------------------------------------------

    \347\ See supra note 25 and accompanying text.
---------------------------------------------------------------------------

     Would a public float threshold of less than $75 million 
for covered investment funds appropriately exclude those funds with a 
market following that is too small to permit investors to evaluate 
covered investment fund research reports? What factors should govern 
such an alternative threshold and where should it be set?
b. Conditions on Issuers Appearing in Industry Research Reports
(1) Applying Uniform Conditions on Issuers Appearing in Issuer-Specific 
and Industry Research Reports
    With respect to conditions affecting the availability of the safe 
harbor for industry research reports, we considered applying to 
industry research reports the same requirements as would apply to 
issuer-specific research reports. As with the restrictions on issuer-
specific research reports, similarly restricting industry research 
reports could help ensure that funds included in research reports are 
well-followed, and could restrict the availability of the safe harbor 
in situations where we expect the information environment to be most 
limited: for new funds and for funds with niche markets.
    In the context of research reports about covered investment funds, 
cost-benefit considerations for including additional conditions on 
industry reports differ slightly from those that apply in the context 
of traditional research reports about equity and debt securities. In 
the context of research reports about equity and debt securities, 
analysis of an industry, in the case of operating companies, may 
require the discussion of specific firms within that industry. For 
example, a discussion about a mature industry (e.g., automobiles) may 
require discussion of a disruptive new entrant (e.g., autonomous 
vehicle start-up). In the context of the rule 139 safe harbor, the new 
entrant may not satisfy the

[[Page 26824]]

reporting history and minimum float requirements. This would reasonably 
prevent an issuer-specific research report about the new entrant from 
qualifying for the safe harbor. However, it would not further the goal 
of facilitating coverage of the industry to limit the safe harbor for 
industry reports to reports that do not discuss the new entrant: 
analysis of the industry may require discussion of specific issuers 
that would not qualify for inclusion in issuer-specific research 
reports.
    In the context of covered investment funds, a similar rationale 
would not apply as broadly. The proposed rule 139b content requirements 
for industry research reports would reference covered investment fund 
issuers of the same ``type or investment focus,'' rather than the 
issuers' ``industry or sub-industry'' (i.e., a broad category of 
similar businesses).\348\ Although it is clear that an industry 
research report about some covered investment fund types (e.g., 
emerging growth bonds) may have reasons to include a discussion of 
issuers that may not be eligible for inclusion in issuer-specific 
reports (e.g., best-performing new fund), it is not clear that such 
reasons would rise to the level of requiring the discussion of such 
issuers. Unlike the effects of an operating company issuer's on its 
``industry,'' the effects of a covered investment fund issuer on its 
fund ``type'' is very limited.
---------------------------------------------------------------------------

    \348\ See supra section II.B.2.c.
---------------------------------------------------------------------------

(2) Allowing Affiliates To Appear in Comprehensive List of Recommended 
Issuers
    We considered providing that a comprehensive list of recommended 
issuers may include issuers that are affiliates of the broker-dealer 
that is publishing or distributing the research report under certain 
circumstances, including: If affiliates were identified; if disclosure 
about the affiliated issuers were limited; or if any performance 
information included in a list that includes affiliated issuers were 
presented in accordance with rule 482.\349\ Generally, we believe that 
including such provisions would benefit broker-dealers that play a 
significant role both as investment advisers to, and as distributors 
of, covered investment funds. However, as discussed above, we believe 
that broker-dealers publishing or distributing research reports about 
affiliated funds would have the potential for the most significant 
conflicts of interest.\350\ Moreover, permitting affiliated funds to be 
included in such comprehensive lists could result in confusion: broker-
dealers would be able to offer recommendations for affiliated funds in 
industry research reports, but there would be no safe harbor enabling 
them to publish or distribute issuer-specific research reports (which 
could provide the basis for such recommendations) as a result of the 
affiliate exclusion.
---------------------------------------------------------------------------

    \349\ See id.
    \350\ See supra section III.C.1.b.
---------------------------------------------------------------------------

    In proposed rule 139b, we have chosen not to incorporate these 
alternative conditions on issuers appearing in industry research 
reports. As discussed above, we are proposing that a comprehensive list 
of recommended issuers appearing in an industry research report could 
not include any covered investment fund that is an affiliate of the 
broker-dealer, or for which the broker-dealer serves as investment 
adviser (or is an affiliated person of the investment adviser), as this 
could implicate the proposed affiliate exclusion.\351\ However we are 
seeking comment on the economic effects of such alternative conditions.
---------------------------------------------------------------------------

    \351\ See supra note 130 and accompanying text.
---------------------------------------------------------------------------

     Do commenters believe that the value of industry research 
reports about covered investment funds would be adversely affected if 
discussion of funds not satisfying the conditions applicable to issuer-
specific research reports was precluded? If so, under what 
circumstances?
     Do commenters believe that the value of industry research 
reports about covered investment funds would be improved if different 
conditions were applied to issuers appearing in such reports? If so, 
which conditions?
     Do commenters believe that allowing affiliated funds to 
appear in comprehensive lists of recommended issuers would have 
additional costs or benefits?
     Do commenters believe that conflicts of interests 
resulting from an advisory relationship would be likely to affect 
industry research reports featuring a comprehensive list?
     Do commenters believe that allowing the inclusion of 
affiliated funds in industry research reports featuring a comprehensive 
list, when proposed rule 139b would not permit a broker-dealer relying 
on the safe harbor to publish or distribute an issuer-specific research 
report about an affiliated fund, would result in investor confusion?
c. Approach to Regular-Course-of-Business Requirement
    As discussed in section III.B.3.b, in principle we expect a 
regular-course-of-business requirement to reduce opportunities for the 
safe harbor to be used in ways that lead to investor confusion. 
However, we also believe that in the context of covered investment 
funds, establishing whether a report is published in the ``regular 
course of business'' could present more challenges than in the rule 139 
context of research reports about the securities of operating 
companies.\352\ Thus, we considered various alternative approaches to 
the proposed regular-course-of-business requirements.\353\ 
Specifically, we have considered that this requirement be defined more 
specifically to address, for example, circumstances in which a broker-
dealer has not previously published or distributed research 
reports.\354\ For example, we considered whether rule 139b should 
provide a ``start-up'' period to allow broker-dealers to establish a 
regular course of business of publishing research reports.\355\ We have 
also considered requiring that the regular-course-of-business 
requirement incorporate more specific requirements regarding the 
persons preparing such reports (e.g., that they must be employed by a 
broker-dealer to prepare such research in the regular course of his or 
her duties).\356\
---------------------------------------------------------------------------

    \352\ See supra section II.B.2.b.
    \353\ See supra section II.B.1.c (requests for comments).
    \354\ See id.
    \355\ See id.
    \356\ See id.
---------------------------------------------------------------------------

    Conditioning availability of the safe harbor on a broker-dealer's 
having published research reports for a given period of time, or on the 
broker-dealer having operated for some amount of time, could lead to 
the publication of reports that are more likely to be recognized as 
research.\357\ Moreover, we believe that broker-dealers with a longer 
operating history and those who have published research reports--
relying on the existing rule 139 safe harbor or otherwise without 
relying on the safe harbor--will have made greater investments in their 
reputations. Such investments increase the reputational costs 
associated with the publication of research reflecting conflicts of 
interest, which as discussed above could mitigate the effects of 
conflicts of interest on research reports.\358\
---------------------------------------------------------------------------

    \357\ See id.
    \358\ See Chemmanur and Fulghieri Article, supra note 282; see 
also supra section III.C.1.b. However, we note that the efficacy of 
an institutional reputation mechanism has not found empirical 
support in related settings. See Fang and Yasuda Article, supra note 
281 (where sell-side research analysts' reputation mitigates 
manifestation of conflicts of interest from underwriting 
relationships, while institutional reputation does not).

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

[[Page 26825]]

    In proposed rule 139b, we have chosen not to incorporate these 
alternative approaches to the regular-course-of-business requirement. 
While we note the potential benefits of the approaches outlined above 
in enhancing the value that covered investment fund research reports 
may provide investors, we also understand that these alternatives may 
restrict the flow of relevant information to investors, and we are not 
proposing more prescriptive approaches to the regular-course-of-
business requirement at this time. However, we are seeking comment on 
the economic effects of such alternative conditions.
     Do commenters believe that these alternative approaches to 
the regular-course-of-business requirement would result in additional 
costs and benefits that we have not considered? What is the magnitude 
of these costs and benefits?
d. Presentation of Performance Information
    Given the definition of ``research report'' under the FAIR Act (and 
the definition of ``research report'' that we propose under rule 139b), 
certain communications by broker-dealers that historically have been 
treated as advertisements for registered investment companies under 
rule 482 now could be distributed as covered investment fund research 
reports under the proposed rule 139b safe harbor.\359\ Rule 482 imposes 
restrictions on the presentation of performance data included in 
registered open-end investment company advertisements.\360\ A covered 
investment fund research report that is published or distributed by a 
broker-dealer in reliance on the proposed rule 139b safe harbor would 
not need to adhere to rule 482's requirements.
---------------------------------------------------------------------------

    \359\ See supra note 141 and accompanying text. Similarly, 
``research reports'' regarding covered investment funds that broker-
dealers today might publish or distribute as ``supplemental sales 
literature'' under Investment Company Act rule 34b-1 (which must be 
preceded or accompanied by a statutory prospectus) could be 
distributed as covered investment fund research reports under 
proposed rule 139b. See supra note 144 and accompanying text.
    \360\ As discussed above, rule 482 requires standardized 
presentation of performance data that is included in registered 
open-end fund advertisements. Alternatively, if other performance 
measures are presented, they must be accompanied by certain 
standardized performance data. See supra notes 142-143 and 
accompanying text.
     Research reports that are published or distributed as rule 34b-
1 supplemental sales literature also would be subject to 
requirements relating to the standardized presentation of 
performance information, because rule 34b-1 incorporates many of the 
rule 482 requirements relating to performance disclosure. See supra 
note 145 and accompanying text.
---------------------------------------------------------------------------

    The above shift in the regulatory treatment of communications about 
registered investment companies could result in investors receiving 
communications about covered investment funds where the character of 
the communication (i.e., bona fide research versus advertising) is 
unclear and presentation of performance data is not subject to the 
restrictions of rule 482. Conflicts of interest resulting from broker-
dealers' financial incentives could affect the manner in which 
performance data is presented in research reports, potentially leading 
to misleading presentation of performance data. In addition, investors 
could be confused if performance is presented differently in an 
advertisement and in a research report, particularly if the research 
report doesn't adequately disclose the methodologies used to produce 
the performance that could explain the differences. Retail investors, 
in particular, may be unable to assess the non-standardized performance 
figures when considering their investment decisions.
    While proposed rule 139b does not require that the performance of 
issuers included in covered investment fund research reports be 
presented in any particular fashion, we believe that certain guidance 
factors would assist a broker-dealer in evaluating whether any 
presentation of registered investment company performance in research 
reports could be misleading.\361\ These include consideration of the 
factors discussed in rule 156.\362\ We also note above that, if a 
covered investment fund research report were to substantially resemble 
a rule 482 advertisement, but present performance information in a 
manner inconsistent with the provisions of rule 482, retail investors 
may not be able to readily discern what constitutes a research report 
and what constitutes an advertisement.\363\
---------------------------------------------------------------------------

    \361\ See supra section II.C.
    \362\ See id.
    \363\ See id.
---------------------------------------------------------------------------

    We have also considered the alternative approach of incorporating 
certain performance presentation standards of rule 482 and/or the 
guidance factors of rule 156 (concerning misleading statements in 
investment company sales literature) in the text of rule 139b.\364\ We 
also considered incorporating certain performance presentation 
requirements for when other performance measures that are not subject 
to any prescribed method of communication appear in covered investment 
fund research reports.\365\ We also considered requiring that the 
methodology used to calculate the registered investment company's total 
return or yield be disclosed if these performance measures are not 
presented in a research report in a manner that is consistent with the 
requirements in rule 482. We also considered requirements relating to 
nonrecurring fees,\366\ and requirements on the timeliness of 
performance data,\367\ similar to the requirements for these items in 
rule 482.\368\ In addition, we considered incorporating the factors set 
forth in rule 156 (or a subset thereof) into the rule.\369\
---------------------------------------------------------------------------

    \364\ See rule 482(d)(1)-(4).
    \365\ See rule 482(d)(5).
    \366\ See rule 482(b)(3)(ii).
    \367\ See rule 482(g).
    \368\ See, e.g., rules 482(b)(3)(ii) and (g).
    \369\ See supra section II.C (request for comments).
---------------------------------------------------------------------------

    We also considered a requirement in proposed rule 139b to 
incorporate general narrative disclosure into a research report about a 
registered investment company, aimed at reducing potential investor 
confusion. For example, we could have required such research reports to 
incorporate a legend stating that the document is a research report and 
is not subject to the Commission's regulations applicable to sales and 
advertising. We also could have required such a research report to 
incorporate similar disclosure without requiring that it be structured 
as a legend (which would require the disclosure of similar concepts but 
would not require any particular wording).
    A main benefit associated with an alternative incorporating some or 
all of the aforementioned provisions into proposed rule 139b is reduced 
potential for confusion between (i) registered investment company 
advertisements and selling materials covered by rule 482 and (ii) 
advertisements or selling materials being recast as research 
reports.\370\ Additionally, incorporating some or all of the 
aforementioned provisions into proposed rule 139b would reduce 
potential for investor confusion resulting from divergent standards in 
the presentation of performance data.
---------------------------------------------------------------------------

    \370\ See supra note 150 and accompanying text.
---------------------------------------------------------------------------

    Because fees can represent a significant drag on investment 
returns,\371\ because different performance measures may be more or 
less favorable at different times, and because retail investors are 
known to be sensitive to past performance data,\372\

[[Page 26826]]

we believe that the manner in which past performance data is presented 
can be an important factor driving investors' investment decisions. As 
discussed above, even unaffiliated broker-dealers may have incentives, 
stemming from funds' distribution arrangements, to promote a covered 
investment fund, or to promote certain funds over others.\373\ When 
broker-dealers publish or distribute research reports on covered 
investment funds, their choices with respect to how fees are disclosed, 
which performance measures are quoted, and for what time periods could 
be affected by these considerations. This in turn can adversely affect 
investors, particularly non-sophisticated investors. To the extent that 
any of the alternative approaches discussed above would limit 
opportunities for selective performance disclosure, this would curtail 
opportunities to circumvent the requirements of rule 482.
---------------------------------------------------------------------------

    \371\ See, e.g., Mark M. Carhart, On Persistence in Mutual Fund 
Performance, 52 The Journal of Finance 1, 57-82 (Mar. 1997).
    \372\ See Erik R. Sirri & Peter Tufano, Costly Search and Mutual 
Fund Flows, 53 The Journal of Finance 5, 1589-1622 (Oct. 1, 1998).
    \373\ See supra section III.C.1.b.
---------------------------------------------------------------------------

    If opportunities for selective performance disclosure were limited, 
this also could reduce investor confusion, because there would be fewer 
opportunities for the performance disclosure in registered investment 
company advertisements and research reports to diverge. There also 
could be less potential for investor confusion when comparing research 
reports about different covered investment funds, or obtained from 
different broker-dealers. These results would benefit investors. The 
extent of the benefit would depend on these measures' effectiveness in 
ensuring consistent disclosure and/or alerting investors to factors 
that could influence their understanding of the disclosure in a 
research report. The extent of the benefit also would depend on the 
audience who will be reading research reports about registered 
investment companies. As discussed above, we assume that retail 
investors would generally be less likely to be able to identify sources 
of bias (and disregard or discount bias) in communications about 
covered investment funds than institutional investors and therefore 
could benefit from limitations on selective performance 
disclosure.\374\
---------------------------------------------------------------------------

    \374\ But see discussion infra in this section III.C.6.d, 
discussing the potential benefits of allowing non-standardized 
information in the total mix of information available to investors, 
particularly for sophisticated investors.
---------------------------------------------------------------------------

    The most significant costs associated with this alternative would 
likely result from its effect on the content of broker-dealers' 
research reports. An alternative that limits the prominence afforded to 
performance measures that are calculated using a methodology that 
differs from that required under rule 482 could adversely affect 
broker-dealers' ability to provide valuable analysis. For example, a 
broker-dealer who wishes to center its analysis on a fund's risk-
adjusted returns would be limited in how such information could be 
presented in the report even though certain audiences for research 
reports could consider this information to be particularly relevant. 
Investors' access to potentially relevant and useful analysis could be 
limited by alternatives such as those discussed in this section.
    We believe that broker-dealers' direct compliance costs under these 
alternative provisions would generally be minimal. For example, if we 
were to incorporate rule 482's requirements on the presentation of 
performance data into proposed rule 139b, we expect that broker-dealers 
that publish research reports would have processes and systems that 
could produce charts and tables of the rule-specified performance 
measures using timely data.\375\
---------------------------------------------------------------------------

    \375\ We believe that most broker-dealers that would publish 
such reports are currently distributing advertisement under rule 
482, which are subject to similar requirements. See supra section 
II.D.1.
---------------------------------------------------------------------------

    In proposed rule 139b, we have chosen not to incorporate additional 
provisions relating to the presentation of performance data, as this 
approach promotes flexibility for broker-dealers to make different 
types of information and analysis available to investors. We are 
seeking commenters' views on these alternative provisions.
     Do commenters believe that the safe harbor under proposed 
rule 139b would be used to publish or distribute communications that 
have traditionally been considered registered investment company 
advertisements or sales materials subject to rule 482? To what extent? 
If not, why not? Would this practice to be more prevalent for certain 
types of broker-dealers or research reports about certain types of 
registered investment companies? Do commenters believe that imposing 
additional requirements on the presentation of performance information 
in research reports that are published or distributed in reliance on 
the proposed rule 139b safe harbor would result in additional costs and 
benefits that we have not considered? What is the magnitude of these 
costs and benefits? If we were to issue guidance relating to the 
presentation of performance in research reports about registered 
investment companies that are published or distributed in reliance on 
the proposed rule 139b safe harbor, would this result in additional 
costs and benefits that we have not considered? What is the magnitude 
of these costs and benefits?

IV. Paperwork Reduction Act

    We do not believe that the proposed rules would impose any new 
``collections of information'' as defined by the Paperwork Reduction 
Act of 1995 (``PRA''), 44 U.S.C. 3501 et seq.; nor would they create 
any new filing, reporting, recordkeeping, or disclosure reporting 
requirements.\376\ Accordingly, we are not submitting the proposed 
rules to the Office of Management and Budget for review under the 
PRA.\377\ We request comment on whether our conclusion that there are 
no collections of information is correct.
---------------------------------------------------------------------------

    \376\ As discussed above, certain communications that previously 
would have been treated as rule 482 advertising prospectuses or rule 
34b-1 supplemental sales literature could be considered covered 
investment fund research reports subject to the proposed rule 139b 
safe harbor, which could result in a reduction in the information 
collection burdens for rules 482 and 34b-1. In connection with an 
extension of a currently approved collection for rules 482 and 34b-
1, the Commission will adjust the burdens associated with these 
collections of information, as appropriate.
    \377\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------

V. Regulatory Flexibility Act Analysis

    This Initial Regulatory Flexibility Act Analysis has been prepared 
in accordance with section 3 of the Regulatory Flexibility Act 
(``RFA'').\378\ It relates to proposed rule 139b, proposed rule 24b-4, 
and proposed revisions to the rules under the Securities Act and the 
Exchange Act to implement the FAIR Act.
---------------------------------------------------------------------------

    \378\ See 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Reasons for, and Objectives of, the Proposed Action

    Proposed rule 139b provides that, if certain conditions are 
satisfied, a broker-dealer's publication or distribution of a covered 
investment fund research report would be deemed for purposes of 
sections 2(a)(10) and 5(c) of the Securities Act not to constitute an 
offer for sale or offer to sell a security that is the subject of an 
offering of the covered investment fund, even if the broker-dealer is 
participating or may participate in a registered offering of the 
covered investment fund's securities. Proposed rule 24b-4 provides that 
a covered investment fund research report about a registered investment 
company will not be subject to section 24(b) of the Investment Company 
Act (or the rules and regulations thereunder), except to the extent the 
research report is otherwise not subject to the content standards in 
SRO rules related to research reports, including those contained in the 
rules governing communications with the public regarding investment 
companies or substantially similar standards. The

[[Page 26827]]

proposed revision to paragraph (a) of rule 139 would clarify that rule 
139 does not affect the availability of any other exemption or 
exclusion from sections 2(a)(10) or 5(c) of the Securities Act that may 
be available to a broker-dealer (as provided, for example, by the 
provisions of rule 139a or proposed 139b). The proposed revision to 
rule 101 under Regulation M would be a conforming amendment intended to 
harmonize treatment of research under the Securities Act and Exchange 
Act rules by permitting distribution participants under Regulation M, 
such as brokers-dealers, to publish or disseminate any information, 
opinion, or recommendation relating to a covered security if the 
conditions of rule 138, rule 139, or proposed rule 139b under the 
Securities Act are met. The proposed rules and proposed rule revisions 
would implement the directives under the FAIR Act to extend the current 
safe harbor available under rule 139 to broker-dealers' publication or 
distribution of covered investment fund research reports. The reasons 
for, and objectives of, the proposed rules and proposed rule revisions 
are discussed in more detail in section II above.

B. Legal Basis

    We are proposing the rules contained in this document under the 
authority set forth in the Securities Act, particularly sections 6, 7, 
8, 10, 17(a), 19(a), and 28 thereof [15 U.S.C. 77a et seq.]; the 
Exchange Act, particularly, sections 2, 3, 9(a), 10, 11A(c), 12, 13, 
14, 15, 17(a), 23(a), 30, and 36 thereof [15 U.S.C. 78a et seq.]; the 
Investment Company Act, particularly, sections 6, 23, 24, 30, and 38 
thereof [15 U.S.C. 80a et seq.]; and the FAIR Act, particularly, 
section 2 thereof.

C. Small Entities Subject to the Proposed Rules

    The proposed rules would affect broker-dealers that publish or 
distribute covered investment fund research reports. As such, broker-
dealers that are small entities would be affected by the proposed 
rules. A broker-dealer is a small entity if it has total capital (net 
worth plus subordinated liabilities) of less than $500,000 on the date 
in the prior fiscal year as of which its audited financial statements 
were prepared pursuant to Sec.  240.17a-5(d),\379\ and it is not 
affiliated with any person (other than a natural person) that is not a 
small business or small organization.\380\ As of December 31, 2017, the 
Commission estimates that there were approximately 1,042 broker-dealers 
that would be considered small entities as defined above.\381\ To the 
extent a small broker-dealer would participate in the activity of 
publishing or distributing covered investment fund research reports and 
would seek to rely on the proposed rule 139b safe harbor, it may be 
affected by our proposal. Generally, we believe larger broker-dealers 
engage in these activities, but we request comment on whether and how 
the rules we are proposing today would affect small broker-dealers. We 
also request comment on the number of small entities that would be 
impacted by our proposal, including any available empirical data.
---------------------------------------------------------------------------

    \379\ See rule 0-10(c)(1) under the Exchange Act [17 CFR 240.0-
10(c)(1)]. Alternatively, if a broker-dealer is ``not required to 
file such statements, a broker or dealer that had total capital (net 
worth plus subordinated liabilities) of less than $500,000 on the 
last business day of the preceding fiscal year (or in the time that 
it has been in business, if shorter).'' See id.
    \380\ See rule 0-10(c)(2) under the Exchange Act [17 CFR 240.0-
10(c)(2)].
    \381\ This estimate is derived from an analysis of data for the 
period ending Dec. 31, 2017 obtained from FOCUS Reports (``Financial 
and Operational Combined Uniform Single'' Reports) that broker-
dealers generally are required to file with the Commission and/or 
SROs pursuant to rule 17a-5 under the Exchange Act [17 CFR 240.17a-
5].
---------------------------------------------------------------------------

D. Reporting, Recordkeeping and Other Compliance Requirements

    We believe that there are no reporting, recordkeeping and other 
compliance requirements with respect to proposed rule 139b and the 
proposed revision to Regulation M. As such, we believe that there are 
no attendant costs and administrative burdens for small entities 
associated with these activities, as they relate to proposed rule 139b 
and the proposed revision to Regulation M.
    Proposed rule 139b would extend the safe harbor under current rule 
139 to broker-dealers' publication or distribution of covered 
investment fund research reports. As discussed above, rule 139 
currently is not available for a broker-dealer's publication or 
distribution of research reports about registered investment companies 
and business development companies.\382\ Instead, we understand that a 
research report or other communication about a covered investment fund 
that is a registered investment company would ordinarily have to comply 
with the requirements of Securities Act rule 482.\383\ As a result of 
the FAIR Act, however, communications that historically have been 
treated as covered investment fund advertisements under rule 482 now 
could fall under the proposed rule 139b definition of ``research 
report.''
---------------------------------------------------------------------------

    \382\ See supra note 100 and accompanying text.
    \383\ See supra note 101 and accompanying text.
---------------------------------------------------------------------------

    As discussed above, section 24(b) of the Investment Company Act 
requires registered open-end investment companies to file sales 
literature addressed to or intended for distribution to prospective 
investors with the Commission.\384\ Section 2(b)(4) of the FAIR Act 
directs the Commission to provide that a covered investment fund 
research report shall not be subject to section 24(b) of the Investment 
Company Act or the rules and regulations thereunder, except that such 
report may still be subject to 24(b) and the rules and regulations 
thereunder if it is otherwise not subject to the content standards in 
the rules of any SRO related to research reports, including those 
contained in the rules governing communications with the public 
regarding investment companies or substantially similar standards.\385\ 
Today, registered investment company sales literature, including rule 
482 advertisements, are required to be filed with the Commission under 
section 24(b) of the Investment Company Act.\386\ These filings are 
typically done by broker-dealers' compliance staff. The Commission 
proposes to implement section 2(b)(4) of the FAIR Act via proposed rule 
24b-4, which provides that a covered investment fund research report 
about a registered investment company shall not be subject to section 
24(b) of the Investment Company Act (or the rules and regulations 
thereunder), unless the research report is not otherwise subject to the 
content standards in SRO rules related to research reports, including 
those contained in the rules governing communications with the public 
regarding investment companies or substantially similar standards.\387\ 
We interpret section 2(b)(4) of the FAIR Act as excluding covered 
investment fund research reports from section 24(b) of the Investment 
Company Act so long as they continue to be subject to the general 
content standards in FINRA rule 2210(d)(1), described above (or 
substantially similar SRO rules).\388\ Thus, covered investment fund 
research reports, by operation of proposed rule 24b-4, would no longer 
be subject to

[[Page 26828]]

filing requirements under section 24(b) because they would be subject 
to the general content standards of FINRA rule 2210(d)(1).\389\ 
Proposed rule 24b-4 would affect broker-dealers that, in lieu of a safe 
harbor such as that proposed to be provided by rule 139b, would have 
published or distributed communications styled as ``research reports'' 
in compliance with rule 482, which communications would be required to 
be filed with the Commission subject to section 24(b) of the Investment 
Company Act. As such, we believe that the administrative costs of 
broker-dealers that previously filed these communications pursuant to 
section 24(b) of the Investment Company Act would be reduced. However, 
large and small broker-dealers would not be affected differently by 
proposed rule 24b-4.
---------------------------------------------------------------------------

    \384\ See 15 U.S.C. 80a-24(b); 17 CFR 270.24b-3; supra section 
II.D.1.
    \385\ See supra note 167 and accompanying text.
    \386\ See supra note 29. Rule 24b-3 under the Investment Company 
Act deems these materials to have been filed with the Commission if 
filed with FINRA. See id.
    \387\ See proposed rule 24b-4; see also discussion accompanying 
supra notes 170-174.
    \388\ See supra paragraph accompanying notes 174-176.
    \389\ See supra section II.D.1.
---------------------------------------------------------------------------

    We encourage written comments regarding this analysis. We solicit 
comments as to whether the proposed regulation could have an effect 
that we have not considered. We request that commenters describe the 
nature of any impact on small entities and provide empirical data to 
support the extent of the impact.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    Although broker-dealers would be unable to rely on the rule 139 
safe harbor in publishing or distributing certain communications that 
could be considered covered investment fund research reports,\390\ the 
existing rule 139 safe harbor may be available for their publication or 
distribution of research reports for certain covered investment funds, 
such as commodity- or currency-based trusts or funds that have a class 
of securities registered under the Exchange Act.\391\ As discussed 
above, the FAIR Act directs us to propose and adopt rule amendments 
that would extend the current safe harbor available under rule 139 to 
``covered investment fund research reports.'' \392\ Proposed rule 139b, 
which is intended to implement the FAIR Act's directives, includes all 
of the entities in the definition of ``covered investment fund'' that 
are specified in the FAIR Act's parallel definition (including some 
types of entities where, if a broker-dealer were to publish or 
distribute a research report about that entity, the rule 139 safe 
harbor could already be available).\393\ As a result, in certain 
circumstances, a broker-dealer publishing or distributing a covered 
investment fund research report could rely either on rule 139 or 
proposed rule 139b. In light of this, we have clarified in proposed 
rule 139b that it provides a non-exclusive safe harbor, and we propose 
to amend rule 139 to include similar language regarding the non-
exclusivity of the safe harbor available under rule 139.\394\ Thus, a 
broker-dealer would be able to rely on proposed rule 139b to publish or 
distribute a covered investment fund research report, or could choose 
to rely instead on any other available exemption or exclusion from 
sections 2(a)(10) or 5(c) of the Securities Act, including those 
provided by rules 137, 138, and 139, so long as the applicable 
conditions are satisfied.
---------------------------------------------------------------------------

    \390\ See supra notes 11-15 and accompanying text.
    \391\ See supra section II.A.4.
    \392\ See supra section I.B.
    \393\ See supra section II.A.3.
    \394\ See supra section II.A.4.
---------------------------------------------------------------------------

F. Significant Alternatives

    The RFA directs us to consider significant alternatives that would 
accomplish the Commission's stated objectives, while minimizing any 
significant adverse impact on small entities. In connection with the 
proposals, we considered the following alternatives: (i) Establishing 
different compliance or reporting requirements that take into account 
the resources available to small entities; (ii) exempting broker-
dealers that are small entities from certain proposed conditions that 
must be satisfied in order for the proposed rule 139b safe harbor to be 
available (e.g., the extent to which the proposed regular-course-of-
business requirements would apply to small broker-dealers); (iii) 
clarifying, consolidating, or simplifying the conditions that must be 
satisfied for the proposed rule 139b safe harbor to be available for 
broker-dealers that are small entities; and (iv) using performance 
rather than design standards.
    We do not believe that establishing different compliance and 
reporting requirements or timetables for broker-dealers that are small 
entities, or exempting broker-dealers that are small entities from 
certain proposed conditions, would permit us to achieve our stated 
objectives. We have considered a variety of approaches to achieve our 
regulatory objectives and the directives of the FAIR Act. We do not 
believe that the proposed rules would impose any significant new 
compliance obligations, because the proposed rules generally reduce the 
restrictions regarding communications that would be considered covered 
investment fund research reports.
    As discussed above, the FAIR Act directs us to extend the current 
safe harbor available under rule 139 to broker-dealers' publication or 
distribution of covered investment fund research reports, and thus 
proposed rule 139b's framework, including its scope and conditions, is 
modeled after and generally tracks rule 139.\395\ Rule 139 does not 
incorporate conditions that would affect the availability of the rule's 
safe harbor differently for broker-dealers that are small (versus 
large) entities. We likewise do not believe it is necessary or 
appropriate that proposed rule 139b incorporate conditions that would 
affect the availability of the proposed rule's safe harbor differently 
based on whether a broker-dealer is a small entity. We have considered 
whether a different regular-course-of-business requirement would help 
mitigate investor confusion in the case of covered investment fund 
research reports about registered investment companies, as discussed in 
more detail above.\396\ This could have had the effect of limiting the 
availability of the proposed rule 139b safe harbor to certain broker-
dealers, which in turn could have direct or indirect effects on the 
availability of the safe harbor to smaller broker-dealers. However, for 
the reasons discussed above,\397\ we are not proposing a regular-
course-of-business requirement, in either the proposed rule 139b 
provisions on issuer-specific research reports or the proposed 
provisions on industry reports, other than a requirement that tracks 
the provisions of rule 139 (modified as directed by the FAIR Act).
---------------------------------------------------------------------------

    \395\ See supra paragraph accompanying notes 32-34.
    \396\ See supra section III.C.6.c.
    \397\ See id.
---------------------------------------------------------------------------

    Nor do we believe that clarifying, consolidating, or simplifying 
the proposed amendments for small entities would satisfy those 
objectives. Because proposed rule 139b's framework (including its scope 
and conditions) is modeled after and generally tracks rule 139, 
proposed rule 139b like rule 139 does not treat small broker-dealers 
differently than large broker-dealers, including by clarifying, 
consolidating, or simplifying any conditions. Our proposal includes 
specific requests for comment on whether clarifications to certain 
proposed rule provisions are necessary or appropriate, and the comments 
we receive in response could, in certain circumstances, indirectly 
affect our approach to small entities.\398\ For example, we request 
comment about whether the proposed regular-course-of-business 
requirement should be

[[Page 26829]]

modified to address newly-established broker-dealers (which are likely 
to be small entities).\399\ We also recognize that the guidance that we 
provide in this release--which is meant to clarify certain of the 
provisions of the proposed rule--could indirectly affect small 
entities, and we request comment on the effects of this guidance on 
small entities. For example, we request comment about whether smaller 
broker-dealers, or broker-dealers without significant research 
departments, be most impacted by our guidance on the proposed affiliate 
exclusion.\400\
---------------------------------------------------------------------------

    \398\ See generally supra section II.
    \399\ See supra section II.B.1.c; see also supra section 
II.B.2.b.
    \400\ See requests for comment at supra section III.C.2.a.
---------------------------------------------------------------------------

    Further, with respect to using performance rather than design 
standards, the proposed rule generally uses performance standards for 
all broker-dealers relying on the proposed rule, regardless of size. We 
believe that providing broker-dealers with the flexibility with respect 
to the design of covered investment fund research reports that they may 
publish or distribute in reliance on the proposed safe harbor is 
appropriate in light of the diversity of entities included in the 
universe of covered investment funds. We also believe that this 
approach is appropriate in light of the diverse methodologies that 
might be taken with respect to research about these entities 
(particularly because the term ``research report'' in the FAIR Act and 
the proposed rule is defined broadly, as discussed above \401\). 
However, we note that the proposed rule also uses design standards with 
respect to certain of its conditions (e.g., the conditions relating to 
reporting history and minimum public market value that apply to issuers 
that could appear in an issuer-specific research report). These are 
substantially similar to design standards used in rule 139, and they 
would apply with respect to the research reports published or 
distributed by all broker-dealers relying on the proposed rule, 
regardless of their size.\402\ For the reasons discussed above, we 
believe that this use of design standards is appropriate for the 
furtherance of investor protection, and to help ensure that the 
proposed rule is not used to circumvent the prospectus requirements of 
the Securities Act.\403\
---------------------------------------------------------------------------

    \401\ See supra note 11.
    \402\ See, e.g., supra sections II.B.1.a (Reporting History and 
Timeliness Requirements) and II.B.1.b (Minimum Public Market Value 
Requirement).
    \403\ See supra notes 57-58 and accompanying text.
---------------------------------------------------------------------------

    As we consider the comments we receive on our proposal, we will 
consider the available information to determine whether greater 
flexibility is warranted, consistent with investor protections.

G. General Request for Comment

    The Commission requests comments regarding this analysis. We 
request comment on the number of small entities that would be subject 
to the proposed rules and whether the proposed rules would have any 
effects that have not been discussed. We request that commenters 
describe the nature of any effects on small entities subject to the 
proposed rules and provide empirical data to support the nature and 
extent of such effects.

VI. Small Business Regulatory Enforcement Fairness Act

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996 (``SBREFA''),\404\ the Commission must advise OMB whether a 
proposed regulation constitutes a ``major'' rule. Under SBREFA, a rule 
is considered ``major'' where, if adopted, it results in or is likely 
to result in:
---------------------------------------------------------------------------

    \404\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996) (codified 
in various sections of 5 U.S.C., 15 U.S.C., and as a note to 5 
U.S.C. 601).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million or more;
     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effects on competition, investment, or 
innovation.
    We request comment on whether our proposal would be a ``major 
rule'' for purposes of SBREFA. We solicit comment and empirical data 
on:
     The potential effect on the U.S. economy on an annual 
basis;
     Any potential increase in costs or prices for consumers or 
individual industries; and
     Any potential effect on competition, investment, or 
innovation.
    Commenters are requested to provide empirical data and other 
factual support for their views to the extent possible.

VII. Statutory Authority

    We are proposing the rules contained in this document under the 
authority set forth in the Securities Act, particularly sections 6, 7, 
8, 10, 17(a), 19(a), and 28 thereof [15 U.S.C. 77a et seq.]; the 
Exchange Act, particularly, sections 2, 3, 9(a), 10, 11A(c), 12, 13, 
14, 15, 17(a), 23(a), 30, and 36 thereof [15 U.S.C. 78a et seq.]; the 
Investment Company Act, particularly, sections 6, 23, 24, 30, and 38 
thereof [15 U.S.C. 80a et seq.]; and the FAIR Act, particularly, 
section 2 thereof.

List of Subjects

17 CFR Part 230

    Advertising, Confidential business information, Investment 
companies, Reporting and recordkeeping requirements, Securities.

17 CFR Part 242

    Brokers, Fraud, Reporting and recordkeeping requirements, 
Securities.

17 CFR Part 270

    Confidential business information, Fraud, Investment companies, 
Life insurance, Reporting and recordkeeping requirements, Securities.

Text of Proposed Rules and Amendments

    For the reasons set out in the preamble, title 17, chapter II of 
the Code of the Federal Regulations is proposed to be amended as 
follows.

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

0
1. The authority citation for part 230 continues to read, in part, as 
follows:

    Authority:  15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h, 
77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o-
7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-
30, and 80a-37, and Pub. L. 112-106, sec. 201(a), sec. 401, 126 
Stat. 313 (2012), unless otherwise noted.
* * * * *
0
2. Amend Sec.  230.139 by revising the introductory text of paragraph 
(a) to read as follows:


Sec.  230.139   Publications or distributions of research reports by 
brokers or dealers distributing securities.

    (a) Registered offerings. Under the conditions of paragraph (a)(1) 
or (2) of this section, a broker's or dealer's publication or 
distribution of a research report about an issuer or any of its 
securities shall be deemed for purposes of sections 2(a)(10) and 5(c) 
of the Act not to constitute an offer for sale or offer to sell a 
security that is the subject of an offering pursuant to a registration 
statement that the issuer proposes to file, or has filed, or that is 
effective, even if the broker or dealer is participating or will 
participate in the registered offering of the issuer's securities. For 
purposes of the Fair Access to Investment Research Act of 2017 [Pub. L. 
115-66, 131 Stat. 1196 (2017)], a safe harbor has been established for 
covered investment fund research reports, and the specific terms of 
that safe harbor are set forth in Sec.  230.139b.
* * * * *

[[Page 26830]]

0
3. Add Sec.  230.139b to read as follows:


Sec.  230.139b   Publications or distributions of covered investment 
fund research reports by brokers or dealers distributing securities.

    (a) Registered offerings. Under the conditions of paragraph (a)(1) 
or (2) of this section, the publication or distribution of a covered 
investment fund research report by a broker or dealer that is not an 
investment adviser to the covered investment fund and is not an 
affiliated person of the investment adviser to the covered investment 
fund shall be deemed for purposes of sections 2(a)(10) and 5(c) of the 
Act not to constitute an offer for sale or offer to sell a security 
that is the subject of an offering pursuant to a registration statement 
of the covered investment fund that is effective, even if the broker or 
dealer is participating or may participate in the registered offering 
of the covered investment fund's securities. This section does not 
affect the availability of any other exemption or exclusion from 
sections 2(a)(10) or 5(c) of the Act available to the broker or dealer.
    (1) Issuer-specific research reports. (i) At the date of reliance 
on this section:
    (A) The covered investment fund:
    (1) Has been subject to the reporting requirements of section 30 of 
the Investment Company Act of 1940 (the ``Investment Company Act'') (15 
U.S.C. 80a-29) for a period of at least 12 calendar months and has 
filed in a timely manner all of the reports required, as applicable, to 
be filed for the immediately preceding 12 calendar months on Forms N-
CSR (Sec. Sec.  249.331 and 274.128 of this chapter), N-SAR (Sec. Sec.  
249.330 and 274.101 of this chapter), N-Q (Sec. Sec.  249.332 and 
274.130 of this chapter), N-PORT (Sec.  274.150 of this chapter), N-MFP 
(Sec.  274.201 of this chapter), and N-CEN (Sec. Sec.  249.330 and 
274.101 of this chapter) pursuant to section 30 of the Investment 
Company Act; or
    (2) If the covered investment fund is not a registered investment 
company under the Investment Company Act, has been subject to the 
reporting requirements of section 13 or section 15(d) of the Securities 
Exchange Act of 1934 (the ``Exchange Act'') (15 U.S.C. 78m or 78o(d)) 
for a period of at least 12 calendar months and has filed in a timely 
manner all of the reports required to be filed for the immediately 
preceding 12 calendar months on Forms 10-K (Sec.  249.310 of this 
chapter) and 10-Q (Sec.  249.308a of this chapter), or 20-F (Sec.  
249.220f of this chapter) pursuant to section 13 or section 15(d) of 
the Exchange Act; and
    (B) The aggregate market value of voting and non-voting common 
equity held by non-affiliates of the covered investment fund, or, in 
the case of a registered open-end investment company (other than an 
exchange-traded fund) its net asset value (subtracting the value of 
shares held by affiliates), equals or exceeds the aggregate market 
value specified in General Instruction I.B.1 of Form S-3; and
    (ii) The broker or dealer publishes or distributes research reports 
in the regular course of its business and, in the case of a research 
report regarding a covered investment fund that does not have a class 
of securities in substantially continuous distribution, such 
publication or distribution does not represent the initiation of 
publication of research reports about such covered investment fund or 
its securities or reinitiation of such publication following 
discontinuation of publication of such research reports.
    (2) Industry reports. (i) The covered investment fund is subject to 
the reporting requirements of section 30 of the Investment Company Act 
(15 U.S.C. 80a-29) or, if the covered investment fund is not a 
registered investment company under the Investment Company Act, is 
subject to the reporting requirements of section 13 or section 15(d) of 
the Exchange Act (15 U.S.C. 78m or 78o(d));
    (ii) The research report:
    (A) Includes similar information with respect to a substantial 
number of covered investment fund issuers of the issuer's type (e.g., 
money market fund, bond fund, balanced fund, etc.), or investment focus 
(e.g., primarily invested in the same industry or sub-industry, or the 
same country or geographic region); or
    (B) Contains a comprehensive list of covered investment fund 
securities currently recommended by the broker or dealer (other than 
securities of a covered investment fund that is an affiliate of the 
broker or dealer, or for which the broker or dealer serves as 
investment adviser (or for which the broker or dealer is an affiliated 
person of the investment adviser));
    (iii) The analysis regarding the covered investment fund issuer or 
its securities is given no materially greater space or prominence in 
the publication than that given to other covered investment fund 
issuers or securities; and
    (iv) The broker or dealer publishes or distributes research reports 
in the regular course of its business and, at the time of the 
publication or distribution of the research report (in the case of a 
research report regarding a covered investment fund that does not have 
a class of securities in substantially continuous distribution), is 
including similar information about the issuer or its securities in 
similar reports.
    (b) Self-regulatory organization rules. A self-regulatory 
organization shall not maintain or enforce any rule that would prohibit 
the ability of a member to publish or distribute a covered investment 
fund research report solely because the member is also participating in 
a registered offering or other distribution of any securities of such 
covered investment fund; or to participate in a registered offering or 
other distribution of securities of a covered investment fund solely 
because the member has published or distributed a covered investment 
fund research report about such covered investment fund or its 
securities. For purposes of section 19(b) of the Exchange Act (15 
U.S.C. 78s(b)), this paragraph (b) shall be deemed a rule under that 
Act.
    (c) Definitions. For purposes of this section:
    (1) ``Affiliated person'' has the meaning given the term in section 
2(a) of the Investment Company Act.
    (2) ``Covered investment fund'' means:
    (i) An investment company (or a series or class thereof) registered 
under, or that has filed an election to be treated as a business 
development company under, the Investment Company Act and that has 
filed a registration statement under the Act for the public offering of 
a class of its securities, which registration statement has been 
declared effective by the Commission; or
    (ii) A trust or other person:
    (A) Issuing securities in an offering registered under the Act and 
which class of securities is listed for trading on a national 
securities exchange;
    (B) The assets of which consist primarily of commodities, 
currencies, or derivative instruments that reference commodities or 
currencies, or interests in the foregoing; and
    (C) That provides in its registration statement under the Act that 
a class of its securities are purchased or redeemed, subject to 
conditions or limitations, for a ratable share of its assets.
    (3) ``Covered investment fund research report'' means a research 
report published or distributed by a broker or dealer about a covered 
investment fund or any securities issued by the covered investment 
fund, but does not include a research report to the extent that the 
research report is published or distributed by the covered investment

[[Page 26831]]

fund or any affiliate of the covered investment fund, or any research 
report published or distributed by any broker or dealer that is an 
investment adviser (or any affiliated person of an investment adviser) 
for the covered investment fund.
    (4) ``Exchange-traded fund'' has the meaning given the term in 
General Instruction A to Form N-1A (Sec. Sec.  239.15A and 274.11A of 
this chapter).
    (5) ``Investment adviser'' has the meaning given the term in 
section 2(a) of the Investment Company Act.
    (6) ``Research report'' means a written communication, as defined 
in Sec.  230.405 that includes information, opinions, or 
recommendations with respect to securities of an issuer or an analysis 
of a security or an issuer, whether or not it provides information 
reasonably sufficient upon which to base an investment decision.
0
4. Effective May 1, 2020, amend Sec.  230.139b by removing ``N-Q 
(Sec. Sec.  249.332 and 274.130 of this chapter),'' in paragraph 
(a)(1)(i)(A)(1).

PART 242--REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER 
MARGIN REQUIREMENTS FOR SECURITY FUTURES

0
5. The authority citation for part 242 continues to read as follows:

    Authority:  15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and 
80a-37.

0
6. Section 242.101 is amended by revising paragraph (b)(1) to read as 
follows:


Sec.  242.101.   Activities by distribution participants.

* * * * *
    (b) * * *
    (1) Research. The publication or dissemination of any information, 
opinion, or recommendation, if the conditions of Sec.  230.138, Sec.  
230.139, or Sec.  230.139b of this chapter are met; or
* * * * *

PART 270--RULE AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
7. The authority citation for part 270 continues to read, in part, as 
follows:

    Authority:  15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39, 
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless 
otherwise noted.
* * * * *
0
8. Add Sec.  270.24b-4 to read as follows:


Sec.  270.24b-4   Filing copies of covered investment fund research 
reports.

    A covered investment fund research report, as defined in paragraph 
(c)(3) of Sec.  230.139b of this chapter under the Securities Act of 
1933 (15 U.S.C. 77a et seq.), of a covered investment fund registered 
as an investment company under the Investment Company Act, shall not be 
subject to section 24(b) of the Act or the rules and regulations 
thereunder, except that such report shall be subject to such section 
and the rules and regulations thereunder to the extent that it is 
otherwise not subject to the content standards in the rules of any 
self-regulatory organization related to research reports, including 
those contained in the rules governing communications with the public 
regarding investment companies or substantially similar standards.

    By the Commission.

    Dated: May 23, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018-11497 Filed 6-7-18; 8:45 am]
 BILLING CODE 8011-01-P

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.