Covered Investment Fund Research Reports, 64180-64222 [2018-26613]

Download as PDF 64180 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 230, 242, 249, and 270 [Release Nos. 33–10580; 34–84710; IC– 33311; File No. S7–11–18] RIN 3235–AM24 Covered Investment Fund Research Reports Securities and Exchange Commission. ACTION: Final rules and technical amendment. AGENCY: The Commission is adopting a new rule under the Securities Act of 1933 to 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 in the rule are satisfied, the publication or distribution of a covered investment fund research report 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 adopting a new rule under the Investment Company Act of 1940 to exclude a covered investment fund research report from the coverage of section 24(b) of the Investment Company Act, except to the extent the research report is otherwise not subject to the content standards in selfregulatory organization rules related to research reports. We are also adopting a conforming amendment to rule 101 of Regulation M, and a technical amendment to Form 12b–25. DATES: This rule is effective January 14, 2019 except that amendatory instruction 4 amending § 230.139b(a)(1)(i)(A)(1) is effective May 1, 2020. Comments regarding the collection of information requirements within the meaning of the Paperwork Reduction Act of 1995 should be received on or before February 11, 2019. FOR FURTHER INFORMATION CONTACT: Asaf Barouk, Attorney-Adviser, John Lee, Senior Counsel; Amanda Hollander Wagner, Branch Chief; Thoreau Bartmann, Senior Special Counsel; 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 amozie on DSK3GDR082PROD with RULES2 SUMMARY: VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–8549. SUPPLEMENTARY INFORMATION: The Commission is adopting 17 CFR 230.139b (‘‘new rule 139b’’) under the Securities Act of 1933 [15 U.S.C. 77a et seq.]; 17 CFR 270.24b–4 (‘‘new rule 24b–4’’) under the Investment Company Act of 1940 [15 U.S.C. 80a–1 et seq.]; a conforming amendment to 17 CFR 242.101(a) (rule 101) of Regulation M [17 CFR 242.100–242.105]; and a technical amendment to Form 12b–25 under the Securities Exchange Act of 1934 [15 U.S.C. 78a et seq.]. Table of Contents I. Introduction II. Discussion A. Scope of 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 and Technical Amendments 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. Rule 139b 3. Rule 24b–4 4. Amendments to Rule 101 of Regulation M and Form 12b–25 5. Effects on Efficiency, Competition, and Capital Formation 6. Alternatives Considered IV. Paperwork Reduction Act V. Final Regulatory Flexibility Act Analysis A. Need for, and Objectives of, the Rules and Rule Amendments B. Significant Issues Raised by Public Comments C. Small Entities Subject to the Rules D. Reporting, Recordkeeping, and Other Compliance Requirements E. Agency Action To Minimize Effect on Small Entities VI. Statutory Authority I. Introduction As directed by the Fair Access to Investment Research Act of 2017,1 we 1 Fair Access to Investment Research Act of 2017, Public Law 115–66, 131 Stat. 1196 (2017) (the ‘‘FAIR Act’’). PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 are adopting new rule 139b 2 under the Securities Act of 1933 (the ‘‘Securities Act’’) to extend the current safe harbor available under rule 139 to a ‘‘covered investment fund research report.’’ 3 Rule 139 provides a safe harbor for the publication or distribution of research reports 4 concerning one or more issuers by a broker or dealer (a ‘‘broker-dealer’’) participating in a registered offering of one of the covered issuers’ securities.5 Rule 139’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 (‘‘BDCs’’).6 The 2 See Covered Investment Fund Research Reports, Securities Act Release No. 10498 (May 23, 2018) [83 FR 26788 (June 8, 2018)] (‘‘Proposing Release’’). 3 See section 2(a) of the FAIR Act; see also Proposing Release, supra note 2, at section I.B. The FAIR Act also includes an interim effectiveness provision that became effective as of July 3, 2018 and by its terms will terminate upon the adoption of new rule 139b. See section 2(d) of the FAIR Act. 4 See Proposing Release, supra note 2, at 26789 n.11 and accompanying text. See also infra notes 5–6. 5 Specifically, rule 139 provides that a brokerdealer’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.’’ Rule 139(a) under the Securities Act [17 CFR 230.139(a)]. A brokerdealer’s publication or distribution of a research report in reliance on rule 139 would therefore be deemed not to constitute an offer that otherwise could be a non-conforming prospectus in violation of section 5 of the Securities Act. 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). 6 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). In contrast, registered investment companies register their securities offerings on forms such as Forms N–1A, N–2, N–3, N–4, and N–6. To the extent that commodity- or currency-based trusts or funds (as defined in section II.A.3 below) register their securities offering under the Securities Act and meet the eligibility requirements of Forms S–3 or F–3, as well as the other conditions of rule 139, the rule 139 safe harbor is currently available for a broker-dealer’s publication or distribution of research reports pertaining to these issuers. Section 2(a)(3) of the Securities Act provides a safe harbor for broker-dealers with respect to research reports about ‘‘emerging growth E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 FAIR Act requires us to revise rule 139 to extend the safe harbor to brokerdealers’ publication or distribution of covered investment funds upon such terms, conditions, or requirements, as we may determine necessary or appropriate in the public interest, for the protection of investors, and for the promotion of capital formation.7 In May of 2018 we proposed new rules and rule amendments designed to meet the requirements of the FAIR Act. We received seven comment letters on the proposal.8 Commenters generally supported our proposed implementation of the FAIR Act. However, most commenters requested that we consider eliminating or modifying certain of the conditions in current rule 139, as applied to covered investment fund research reports (such as the minimum public float requirement and the requirement to publish research reports in the regular course of business).9 Other commenters raised concerns about the potential conflicts of interest that may arise in the context of a brokerdealer’s receipt of compensation from covered investment funds included in research reports, and commenters disagreed on the best ways of mitigating these conflicts.10 Finally, commenters expressed varying views on our request for input on whether research reports that include performance information should be required to present that performance information consistently with the way fund performance must be presented in fund advertisements pursuant to rule 482 and related requirements.11 companies,’’ as defined in section 2(a)(19) of the Securities Act. Broker-dealers may therefore currently rely on this safe harbor with respect to research reports about BDCs that are emerging growth companies. 7 See section 2(a) of the FAIR Act. 8 Comment Letter of Morningstar, Inc. (July 5, 2018) (‘‘Morningstar Comment Letter’’); Comment Letter of BlackRock, Inc. (July 9, 2018) (‘‘BlackRock Comment Letter’’); Comment Letter of Eversheds Sutherland (US) LLP (July 9, 2018) (‘‘Sutherland Comment Letter’’); Comment Letter of Fidelity Investments (July 9, 2018) (‘‘Fidelity Comment Letter’’); Comment Letter of the Investment Company Institute (July 9, 2018) (‘‘ICI Comment Letter’’); Comment Letter of the Securities Industry and Financial Markets Association (July 9, 2018) (‘‘SIFMA Comment Letter I’’); Comment Letter of the Securities Industry and Financial Markets Association (Sept. 14, 2018) (‘‘SIFMA Comment Letter II’’). 9 See, e.g., SIFMA Comment Letter I; ICI Comment Letter; see also BlackRock Comment Letter. 10 See, e.g., Morningstar Comment Letter; Fidelity Comment Letter. 11 See, e.g., SIFMA Comment Letter I; ICI Comment Letter; see also BlackRock Comment Letter. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 II. Discussion Rule 139b’s framework is modeled after and generally tracks rule 139. However, rule 139b differs from rule 139 in certain respects. Some of these differences are specifically directed or contemplated by the FAIR Act.12 Others, while not specifically directed by the FAIR Act, clarify and tailor the provisions of rule 139 more directly or specifically to the context of brokerdealers’ publication or distribution of covered investment fund research reports.13 For the reasons described below, we believe that the provisions of 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.14 We believe that maintaining a similar approach in rule 139b to rule 139 with modifications to the extent necessary or appropriate is consistent with the FAIR Act’s directive to revise rule 139 to extend the current safe harbor available under rule 139 to broker-dealer’s publication or distribution of covered investment fund research reports. We do not believe that the FAIR Act intended for us to make a new or disparate regulatory regime for research reports on covered investment funds that subjects these funds to different conditions where it is not necessary or appropriate for differentiation from research reports on other issuers published under rule 139. Therefore, we have sought to maintain similar treatment and conditions for funds under rule 139b and other issuers subject to rule 139 unless we believed that a deviation was necessary or appropriate for the particular operational or structural characteristics of a type of covered investment fund. In addition to rule 139b, we are also adopting rule 24b–4, a conforming amendment to rule 101 of Regulation M, and a technical amendment to Form 12b–25.15 A. Scope of Rule 139b Rule 139b establishes a safe harbor for the publication or distribution of ‘‘covered investment fund research 12 See, e.g., infra section II.A.1 (discussing the ‘‘affiliate exclusion’’ (defined below)). 13 See, e.g., infra section II.B.1.a (discussing reporting history and timeliness requirements for issuer-specific research reports). 14 See supra note 7 and accompanying text. 15 If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 64181 reports’’ by unaffiliated broker-dealers (as described below) participating in a securities offering of a ‘‘covered investment fund.’’ 16 We 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’’ We are adopting the definition of ‘‘covered investment fund research report’’ as proposed.17 The definition is consistent with the FAIR Act, which defined the term ‘‘covered investment fund research report’’ to mean a research report published or distributed by a broker-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 18 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 19 of an investment adviser) for the covered investment fund (the ‘‘affiliate exclusion’’).20 The affiliate exclusion prohibits two separate categories of research reports from being deemed to be ‘‘covered investment fund research reports’’ under rule 139b’s safe harbor. The first category covers research reports published or distributed by the covered investment fund or any affiliate of the covered investment fund. This exclusion prevents 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-dealer that is an investment adviser (or an affiliated 16 Under the safe harbor, such publication or distribution is 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 is available even if the broker-dealer is participating or may participate in a registered offering of the covered investment fund’s securities. 17 See rule 139b(c)(3). 18 ‘‘Affiliate’’ is defined in rule 405 under the Securities Act. See 17 CFR 230.405; Proposing Release, supra note 2, at 26790. 19 ‘‘Affiliated person’’ is defined in section 2(a) of the Investment Company Act of 1940 (the ‘‘Investment Company Act’’). See 15 U.S.C. 80a– 2(a); Proposing Release, supra note 2, at 26790; section 2(f)(1) of the FAIR Act and rule 139b(c)(1). 20 See section 2(f)(3) of the FAIR Act. E:\FR\FM\13DER2.SGM 13DER2 64182 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 person of an investment adviser) for the covered investment fund.21 As we noted in the Proposing Release, one factor to consider in evaluating whether a research report has been published or distributed by a person covered by the affiliate exclusion is the extent of such person’s involvement in the preparation of the research report.22 These 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 preparing the information or explicitly or implicitly endorsed or approved the information, also known as the entanglement theory and adoption theory, respectively.23 While we did not receive comments on the definition of ‘‘covered investment fund research report,’’ we received comments on the affiliate exclusion embedded in the definition.24 One commenter raised concerns about the incorporation of the adoption and entanglement theories, which could prohibit broker-dealers from engaging in certain activities designed to ensure the accuracy of research reports.25 Other commenters suggested that while the entanglement theory may have 21 Like the first category of exclusion, this second category of exclusion addresses the concern that a person covered by the affiliate exclusion may be able to circumvent the disclosure and prospectus delivery requirements of the Securities Act. For example, this second category helps to limit a person covered by the affiliate exclusion from 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. It also addresses the concern that a broker-dealer that is a covered investment 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 the 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 may benefit not only the fund but also the broker-dealer. 22 See Proposing Release, supra note 2, at 26791– 92. 23 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 prepublication 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)] (‘‘2000 Electronics Release’’) (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)] (‘‘Asset-Backed Securities Adopting Release’’) (adopting asset-backed securities regulations). 24 See Morningstar Comment Letter; Fidelity Comment Letter; ICI Comment Letter; SIFMA Comment Letter I; see also BlackRock Comment Letter. 25 See SIFMA Comment Letter I. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 relevance to research reports under proposed rule 139b, the adoption theory may not.26 Some commenters requested clarification on whether certain conduct—for example, a covered investment fund providing information or confirmation of certain factual matters such as performance data, holdings, or investment objectives or strategies—is prohibited by the affiliate exclusion.27 As we noted in the Proposing Release, the entanglement and adoption theories are helpful guideposts in establishing whether a research report about a covered investment fund was published or distributed by the fund.28 However, those theories of liability have been set forth by courts in interpreting the federal securities laws, and how a court would apply such theories with respect to covered investment fund research reports would be based on the facts and circumstances presented.29 Under rule 139b, we believe 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 rule.30 For example, if a broker-dealer distributes a research report including materials that a person covered by the affiliate exclusion authorized or approved for inclusion in the report, this could (depending on the facts and circumstances) inappropriately 26 See Fidelity Comment Letter; ICI Comment Letter; see also BlackRock Comment Letter. 27 See ICI Comment Letter; SIFMA Comment Letter I; see also BlackRock Comment Letter. 28 See Proposing Release, supra note 2, at 26792. 29 See 2000 Electronics Release, supra note 23 (with respect to entanglement theory cases, citing Elkind v. Liggett & Myers, Inc., 635 F.2d 156 (2d Cir. 1980); In the Matter of Syntex Corp. Sec. Litig., 855 F.Supp. 1086 (N.D. Cal. 1993); In the Matter of Caere Corp. Sec. Litig., 837 F. Supp. 1054 (N.D. Cal. 1993) and with respect to adoption theory cases, citing In the Matter of Cypress Semiconductor Sec. Litig., 891 F. Supp. 1369, 1377 (N.D. Cal. 1995), aff’d sub nom. Eisenstadt v. Allen, 113 F.3d 1240 (9th Cir. 1997); In the Matter of Presstek, Inc., Exchange Act Release No. 39472 (Dec. 22, 1997)). See also Asset-Back Securities Adopting Release, supra note 23. 30 See Proposing Release, supra note 2, at 26791. See also section 5(a), 5(b), and 5(c) of the Securities Act [15 U.S.C. 77e(a), (b), and (c)] (prohibiting both direct and indirect violations of the prospectus requirements); section 48(a) of the Investment Company Act [15 U.S.C. 80a–47(a)] (It shall be unlawful for any person, directly or indirectly, to cause to be done any act or thing through or by means of any other person which it would be unlawful for such person to do under the provisions of this subchapter or any rule, regulation, or order thereunder.); section 208(d) of the Investment Advisers Act of 1940 [15 U.S.C. 80b–8(d)] (It shall be unlawful for any person indirectly, or through or by any other person, to do any act or thing which it would be unlawful for such person to do directly under the provisions of this subchapter or any rule or regulation thereunder.). PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 circumvent the affiliate exclusion in rule 139b. Also in relation to the affiliate exclusion, one commenter suggested that the proposal did not adequately address conflicts of interest such as revenue sharing agreements.31 Other commenters disagreed stating that selfregulatory organization (‘‘SRO’’) rules and federal securities laws addressing conflicts of interest would apply to covered investment fund research reports.32 One commenter stated that additional restrictions are unnecessary because the proposed affiliate exclusion would be broad and effective.33 One commenter recommended that the final rule should not have any specific revenue sharing agreement requirements, but suggested that if the Commission believes it should address such potential conflicts in the final rule, the final rule should require a general disclosure similar to mutual fund prospectus disclosure alerting investors of potential revenue sharing agreements.34 While we appreciate the concerns noted with respect to potential conflicts of interest, and specifically those arising from revenue sharing agreements, we are not adding additional explicit conflicts-of-interest-related restrictions in the final rule. The antifraud provisions of the federal securities laws and certain existing Commission and SRO rules continue to apply to covered investment fund research reports, some of which, depending on the facts and circumstances, may require disclosure of such conflicts.35 For example, many covered investment fund research reports may be subject to FINRA’s research report rules, which require disclosure in a research report if the member or its affiliates have received compensation from the subject company other than for investment banking services in the previous year.36 31 Morningstar Comment Letter (stating that SRO rules would be inadequate in this respect and that the Commission should require elimination or mitigation of these conflicts). 32 See Fidelity Comment Letter; ICI Comment Letter; SIFMA Comment Letter I; see also BlackRock Comment Letter. 33 See ICI Comment Letter; see also BlackRock Comment Letter. 34 See Fidelity Comment Letter. 35 We note that the FAIR Act expressly stated that research reports published or distributed under its provisions would continue to be subject to the antifraud and anti-manipulation provisions of the federal securities laws, and rules adopted thereunder, including section 17 of the Securities Act, section 34(b) of the Investment Company Act, and sections 9 and 10 of the Exchange Act. See section 2(c)(1) of the FAIR Act. 36 See, e.g., FINRA rule 2241(c)(4)(D). See also, e.g., FINRA rule 2210(d)(1)(A) (requiring all member communications with the public to be E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations Depending on the facts and circumstances, covered investment fund research reports may also need to include information about the compensation received by the brokerdealer from covered investment funds included in the report if such compensation is of the type covered by section 17(b) of the Securities Act.37 We understand that disclosure about conflicts of interest created by the receipt of compensation by the brokerdealer from covered investment funds is consistent with current industry practices in communications that are Securities Act section 10(b) prospectuses and are currently styled as ‘‘research reports’’ subject to the requirements of rule 482.38 Considering current industry practice, and the protections offered by the other regulatory provisions discussed above, we do not believe that additional conflict-of-interest requirements are necessary in rule 139b. Accordingly, we are adopting the definition of covered investment fund research report as proposed. 2. Definition of ‘‘Research Report’’ amozie on DSK3GDR082PROD with RULES2 We are defining, as proposed,39 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 based on principles of fair dealing and good faith, be fair and balanced, and provide a sound basis for evaluating the facts in regards to any particular security; and barring members from omitting any material fact or qualification if the omission, in light of the context of the material presented, would cause the communication to be misleading). 37 See 15 U.S.C. 77q(b) (making it unlawful for any person, by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof). 38 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. 39 See Proposing Release, supra note 2, at 26792– 93. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 investment decision.40 This definition is identical to the corresponding definition of ‘‘research report’’ in rule 139.41 As discussed in the Proposing Release, while this definition is not identical to that in the FAIR Act, it is consistent with the FAIR Act because we interpret it to have the same meaning as the FAIR Act’s definition of ‘‘research report.’’ 42 We received one comment agreeing with this definition.43 3. Definition of ‘‘Covered Investment Fund’’ The FAIR Act defines the term ‘‘covered investment fund’’ to include registered investment companies, BDCs, and certain commodity- or currencybased trusts or funds.44 We are adopting 40 See 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. 41 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]. 42 See section 2(f)(6) of the FAIR Act; see also Proposing Release, supra note 2, at 26792–93 (explaining that the rule 139b definition tracks the FAIR Act definition except that it does not expressly reference ‘‘electronic communications’’ and that consistent with Commission rules on electronic communications, rule 139b definition’s reference to a ‘‘written communication,’’ as defined in rule 405, includes a ‘‘graphic communication,’’ which in turn includes electronic communications (other than telephone and other live communications)). 43 See SIFMA Comment Letter I (stating that it would reduce potential interpretive confusion for market participants who are familiar with the rule 139 definition). 44 See section 2(f)(2)(B) of the FAIR Act. 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’’). See section 2(f)(2)(B) of the FAIR Act. 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. PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 64183 a definition of the term ‘‘covered investment fund’’ in rule 139b that is substantially the same as the one used in the FAIR Act, with the addition that the definition specifies that the term ‘‘investment company’’ includes ‘‘a series or class thereof.’’ 45 We received no comments on this proposed definition. The final rule adopts the definition as proposed. 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 Securities Exchange Act of 1934 (the ‘‘Exchange Act’’), rather than relying on new rule 139b, instead may be able to rely on rule 139. Rule 139b does not preclude a broker-dealer from relying on existing rule 139 if applicable. In order to clarify that a broker-dealer may rely on existing research safe harbors, we proposed that rule 139b state that it 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.46 We received no comments on this aspect of the proposed rule and are adopting it as proposed.47 B. Conditions for the Safe Harbor As discussed in the Proposing Release, the Commission has previously acknowledged the value of research reports in providing the market and investors with information about reporting issuers.48 To mitigate the risk of research reports being used to circumvent the prospectus requirements of the Securities Act,49 the Commission 45 See 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)]. 46 See proposed rule 139b(a); see also 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)). 47 See rule 139b(a). 48 See Proposing Release, supra note 2, at 26794 (for example, the Commission has recognized that, for public operating entities 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 information about reporting entities into the marketplace). 49 See supra note 5 and accompanying text (noting that the rule 139 safe harbor permits a broker-dealer to publish or distribute a research E:\FR\FM\13DER2.SGM Continued 13DER2 64184 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations has placed conditions on a brokerdealer’s publication or distribution of research reports.50 Under Rule 139, these conditions include restrictions on the issuers to which the research may relate, as well as requirements that such reports be published in the regular course of business. These conditions vary depending on whether a research report covers a specific issuer (‘‘issuerspecific research reports’’) or a substantial number of issuers in an industry or sub-industry (‘‘industry research reports’’). Rule 139b carries over these conditions for covered investment fund research reports and incorporates certain modifications intended to adapt these conditions to covered investment funds that we discuss below. 1. Issuer-Specific Research Reports amozie on DSK3GDR082PROD with RULES2 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 rule 139b safe harbor, the fund must meet certain reporting history and timeliness requirements. We are adopting as proposed that any such covered investment fund must have been subject to the 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 rule 139b and that these reports have been filed in a timely manner.51 This requires 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 Securities Offering Reform Adopting Release, supra note 23 (discussing how 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); supra notes 35– 36 and accompanying text (discussing certain rules and regulations under the federal securities laws, as well as certain SRO rules, that help address certain conflicts of interest and abuses identified with analyst research). 50 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 notes 35–36. 51 Rule 139b(a)(1)(i)(A). We believe that this condition also gives effect to FAIR Act section 2(e), which makes the safe harbor contemplated by the FAIR Act unavailable with respect to brokerdealers’ publication or distribution of research reports about closed-end registered investment companies BDCs 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-dealer of a covered investment fund research report, the subject of which is a BDC or a registered closed-end VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 covered investment funds that are registered investment companies to have been subject to the reporting requirements of the Investment Company Act for a period of at least 12 calendar months prior to a brokerdealer’s reliance on the new rule and to have filed in a timely manner all required reports, as applicable, on Forms N–CSR,52 N–Q,53 N–PORT,54 N–MFP,55 and N–CEN 56 during the immediately preceding 12 calendar months.57 If the covered investment fund is not a registered investment company, it must have been subject to the reporting requirements under section 13 or section 15(d) of the Exchange Act for a period of at least 12 calendar months and have filed all required reports in a timely manner on Forms 10–K 58 and 10–Q 59 and 20–F 60 during the immediately preceding 12 calendar months.61 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 Commission under the federal securities laws.). 52 17 CFR 249.331 and 17 CFR 274.128. 53 17 CFR 249.332 and 17 CFR 274.130. 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 Investment Company Reporting Modernization, Investment Company Act Release No. 32314 (Oct. 13, 2016) [81 FR 81870 (Nov. 18, 2016)] (‘‘Reporting Modernization Release’’); 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 on Form N–Q, and filing these reports would not be required as a condition to rely on the rule 139b safe harbor. Accordingly, rule 139b, as adopted, will be amended effective May 1, 2020 by removing the reference to Form N–Q. See infra section VI (instruction 4 under Text of Proposed Rules and Amendments). 54 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 Reporting Modernization Release, supra note 53. Therefore, we would consider Form N–PORT to have been timely filed for purposes of the timeliness requirement if the public filing of Form N–PORT every third month is timely filed and publicly available. 55 17 CFR 274.201. 56 17 CFR 249.330 and 17 CFR 274.101. 57 Rule 139b(a)(1)(i)(A)(1). As discussed in the Proposing Release, Form N–SAR was rescinded on June 1, 2018, which is the compliance date for Form N–CEN. As such, reliance on new rule 139b is not conditioned on covered investment funds reporting on Form N–SAR and the reference to Form N–SAR, as proposed, is not included in paragraph (a)(1)(i)(A)(1) of rule 139b. See id.; see also Proposing Release, supra note 2, at 26794. 58 17 CFR 249.310. 59 17 CFR 249.308a. 60 17 CFR 249.220f. 61 Rule 139b(a)(1)(i)(A)(2). PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 Reporting History Several commenters requested we eliminate the reporting history requirement for issuer-specific research reports under rule 139b.62 One commenter suggested that the requirement is unnecessary because funds have ‘‘detailed and comprehensive regulatory filing and disclosure obligations’’ providing investors with ‘‘a wealth of information about funds.’’ 63 Another commenter argued that the reporting history requirement should be eliminated because ensuring compliance with the requirement would create ‘‘operational hurdles’’ for broker-dealers that provide investors with research on a large numbers of funds on a largely automated basis.64 Commenters also argued that the reporting history requirement unduly restricts research on newer funds.65 As discussed in the Proposing Release, rule 139b tracks the reporting history requirement of rule 139.66 We believe satisfying such a requirement indicates a likelihood that more current and timely information has been disseminated to and digested by the marketplace to inform investors of material information about the fund, including risks, and provides investors with SEC-filed information to compare against the contents of the research report.67 We also continue to believe that maintaining a reporting history requirement is consistent with the FAIR Act, which permits a reporting history requirement so long as it does not exceed the period required in rule 139.68 We do not believe that funds should be treated differently from other issuers subject to the reporting requirement of rule 139. The Commission included a reporting history requirement in rule 62 See Fidelity Comment Letter; ICI Comment Letter; SIFMA Comment Letter I; see also BlackRock Comment Letter. 63 See ICI Comment Letter; see also BlackRock Comment Letter. 64 See Fidelity Comment Letter. 65 See ICI Comment Letter; SIFMA Comment Letter I; see also BlackRock Comment Letter. 66 Rule 139 predicates issuer-specific research reports on an issuer’s eligibility to use Form S–3 or F–3, which are short form or shelf registration statements that are available to register an issuer’s securities offering only after it has been subject to and in compliance with the Exchange Act periodic reporting requirements for at least 12 months. 67 See Proposing Release, supra note 2, at 26795 nn.75–78 and accompanying text. The safe harbor would be unavailable to broker-dealers’ publication or distribution of research reports about closed-end registered investment companies or BDCs during these covered investment fund issuers’ first year of operation. See supra note 51. 68 See Proposing Release, supra note 2, at 26795 n.77 (explaining the reporting and timeliness requirements of rule 139). E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 139 because it helps to ensure that the market has information, beyond the research report, to allow investors to weigh how much value they will assign to the research report. The fund’s reporting history should be particularly important when the broker-dealer publishing the research report is participating or may participate in the fund’s offering, as is the case under rule 139b (similar to rule 139). As noted above, one commenter suggested that the reporting history requirement is unnecessary because funds’ ‘‘detailed and comprehensive regulatory filing and disclosure obligations’’ provide investors ‘‘a wealth of information about funds.’’ 69 Eliminating the reporting history requirement would reduce the information available to investors when evaluating research reports published or distributed by broker-dealers when those broker-dealers are also participating in the offering of the fund’s shares. The requirement also allows time for the market to absorb the previously released periodic reports and for investors to assess an issuer’s track record. Corporate issuers are subject to, under rule 139, filing and disclosure obligations similar to what is required of covered investment funds under rule 139b. Although funds differ from corporate issuers in many respects, investors would benefit similarly from having access to fund information to evaluate the research reports on which they may consider relying. Accordingly, for the same reasons the Commission determined to include this requirement in rule 139, we have determined to include this requirement in rule 139b. We also believe that broker-dealers will be able to comply with the reporting history requirement in a manner similar to how they comply with the parallel requirement in rule 139 and that the effect of the requirement on new funds would be similar to the effect on new issuers under rule 139.70 Other issuers also have ‘‘detailed and comprehensive 69 See ICI Comment Letter; see also BlackRock Comment Letter. 70 We believe that a broker-dealer would be relying on rule 139 or rule 139b because it would be involved in distributing securities of the issuer covered in the report, and would therefore have information about the issuer to confirm it has been subject to filing obligations for the preceding 12 calendar months. For example, this information is accessible through the Commission’s publicly available Electronic Data Gathering Analysis, and Retrieval (‘‘EDGAR’’) system. Moreover, we believe that broker-dealers that choose to automate publication of research reports may invest in technologies to implement this automation including by leveraging their existing technological infrastructures to verify the reporting history requirement for covered investment funds. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 regulatory and disclosure obligations’’ much like funds. In this regard, we are not persuaded that there is a material difference between covered investment funds and other issuers that would justify treating them in a disparate fashion. We continue to believe that the concerns underlying the reporting history requirement of rule 139 apply to research reports issued under rule 139b, and therefore are not persuaded that the reporting history requirement should be eliminated from rule 139b as suggested by some commenters. One commenter also requested the reporting history requirement be shortened from 12 months to 25 days after a fund initially starts offerings shares. The commenter argued that this would align with broker-dealers’ market practice of waiting 25 days after an initial public offering.71 Rule 139 is available only to brokerdealers that both publish or distribute a research report on an issuer and are participating or will participate in a registered offering of the issuer’s securities. The 25-day standard referenced by the commenter relates to the issuance of a research report after the prospectus delivery obligation in an initial public offering ends, not while the offering is ongoing and the brokerdealer is participating in it. Accordingly, the prospectus delivery obligation described by the commenter is distinct from the delivery obligation that applies to continuous offerings. Thus, the commenter’s suggested provision and rationale do not appropriately apply to a broker-dealer participating in a continuous offering. The 25-day standard referenced by the commenter is premised on statutory provisions addressing prospectus delivery, a different investor protection consideration from rules 139 and 139b. Accordingly, we believe the 25-day standard is inapposite to rule 139b, as rule 139b applies to broker dealers that are participating in the offering of the subject fund’s securities, not after the offering has ended. For these reasons, we are adopting the reporting history provision as proposed. 71 See SIFMA Comment Letter I; SIFMA Comment Letter II. Additionally, this commenter presented an example of a new ETF based on a new industry classification standard that has garnered interest from the market and satisfies the minimum public market value requirement, but would be unable to satisfy a 12-month reporting history requirement. See SIFMA Comment Letter II. This situation and result equally occurs in the operating company context, where a well-followed operating company that has an initial public offering might satisfy the minimum public market value requirement, but not the reporting history requirement, and thus could not be covered as a rule 139 issuer-specific research report until the 12-month reporting history requirement is also satisfied. PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 64185 Timeliness Two commenters opposed the proposed timeliness requirement for issuer-specific research reports.72 They argued that broker-dealers would face operational hurdles in confirming a covered investment fund’s timely filing of periodic reports.73 One commenter suggested that broker-dealer firms be allowed to accept compliance representations from covered investment funds for the reporting history and timeliness requirements.74 The other commenter requested that the timeliness requirement apply only when a broker-dealer initiates research coverage on a fund, rather than for each research report.75 Alternatively, the commenter also requested the Commission to permit broker-dealers to rely on the lack of any Form 12b–25 (indicating that a filing is late) filed by covered investment funds within the prior 12 months.76 Satisfaction of the timeliness requirement indicates a greater likelihood that a covered investment fund will make information available in a timely manner to inform investors of material information about the fund, including risks. We believe it is important for covered investment fund investors to have timely information from the fund when evaluating research reports, as it is for operating company investors. Rule 139 requires that an issuer satisfy the reporting history and timeliness requirements at the time the broker-dealer publishes or distributes a research report.77 Modifying rule 139b to allow confirming the timeliness of a fund’s reporting only upon initiation of coverage, or to accept the compliance representations of covered investment funds, would provide less protection to investors than the Commission determined to be appropriate in rule 139. We also do not believe providing disparate treatment between funds and other issuers with respect to reporting 72 See Fidelity Comment Letter; SIFMA Comment Letter I; SIFMA Comment Letter II. 73 See Fidelity Comment Letter; SIFMA Comment Letter I. In a subsequent letter, one commenter noted the difficulty broker-dealers would have in identifying reports filed by registered investment companies that are part of series companies, pointing to a lack of functionality in EDGAR’s mutual-fund specific search page. See SIFMA Comment Letter II. All registered investment company filings are available on EDGAR, however, and there are multiple ways to search the EDGAR system in addition to the mutual-fund specific page the commenter identified—including using a fund’s filing number, which can be found in a fund’s prospectus, or by using a Central Index Key (‘‘CIK’’) number. 74 See Fidelity Comment Letter. 75 See SIFMA Comment Letter I. 76 See SIFMA Comment Letter II. 77 See rule 139(a)(1)(i)(A)(1)–(2). E:\FR\FM\13DER2.SGM 13DER2 64186 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations history and timeliness conditions is necessitated by operational or structural differences between the issuer types. As with the 12-month reporting history requirement, we believe that confirming the timeliness of periodic filings for covered investment funds would be substantially similar to confirming the timeliness of periodic filings in the operating company context.78 We do, however, agree with the commenter that a fund filing a Form 12b–25 (or lack thereof) would serve as a useful indication of the fund’s timeliness. We believe that a broker-dealer may rely on the lack of a Form 12b–25 filing as confirmation that a fund’s filings are timely under the rule unless the brokerdealer is actually aware through other means that the issuer has not in fact made timely filings. Accordingly, we are adopting the timeliness requirement as proposed. b. Market Following Requirement amozie on DSK3GDR082PROD with RULES2 We are adopting a requirement that, in order for broker-dealers to use the rule 139b safe harbor to publish or distribute issuer-specific research reports, 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 new rule (the ‘‘float requirement’’). Specifically we are adopting a requirement that the aggregate market value of a covered investment fund, or the net asset value 79 in the case of a registered open-end investment company (other than an exchangetraded fund (‘‘ETF’’)) 80 i.e., a mutual fund, must equal or exceed the aggregate market value required by General 78 See Proposing Release, supra note 2, at 26794– 95. A broker-dealer has diligence and investigative obligations under section 11 of the Securities Act in order to be able to claim a due diligence defense available thereunder. See Securities Offering Reform Adopting Release, supra note 23; rule 176 of the Securities Act [17 CFR 230.176]. Like the reporting history requirement, broker-dealers could confirm the timeliness of a covered investment fund’s reports through a check of the Commission’s EDGAR system, which is free and readily available. This may allow the leveraging of operating efficiencies for broker-dealers already familiar with the requirement. 79 For mutual funds, 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 mutual funds, 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). 80 See rule 139b(a)(1)(i)(B); rule 139b(c)(4) (defining ‘‘exchange-traded fund’’ for purposes of the new rule to have the meaning given the term in General Instruction A to Form N–1A). VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 Instruction I.B.1 to Form S–3.81 This amount is currently $75 million.82 The FAIR Act permits us to set a float requirement for covered investment funds, as long as the minimum public float is not greater than what is required by rule 139.83 We are adopting the float requirement and level as proposed. However, as discussed below, the final rule includes two changes to the float calculation methodology for most covered investment funds. First, the final rule generally no longer requires that the fund issuer’s aggregate market value or net asset value be calculated net of its affiliates’ holdings.84 Second, the minimum float requirement must be satisfied at the initiation (or reinitiation) of research coverage and then once a quarter thereafter. The proposal, on the other hand, would have required that the minimum float requirement be satisfied each time a broker or dealer relied on the safe harbor to publish or distribute a research report on a covered investment fund. Float Level Several commenters argued that a float requirement should be eliminated or reduced in the context of covered investment funds because such a requirement would limit the extent of research that could be produced.85 Two commenters argued that for funds, NAV relates to the underlying value of the portfolio and therefore makes it an inapt proxy for market following.86 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.87 We continue to view as 81 The new rule refers to General Instruction I.B.1 to Form S–3. Under this instruction, aggregate market value is ‘‘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. 82 General Instruction I.B.1 to Form S–3. 83 See section 2(b)(2)(B) of the FAIR Act. 84 However, as discussed below, this change would not apply to the calculation of a commodityor currency-based trust or fund’s float. 85 See SIFMA Comment Letter; ICI Comment Letter; Fidelity Comment Letter. 86 See SIFMA Comment Letter; ICI Comment Letter. 87 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’’); see also Securities Offering Reform, Securities Act Release No. 8501 PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 significant the relationship between public float, information dissemination to the market, and following by investment institutions.88 While market following for funds that price at or near NAV may not have the same degree of impact on the price of the fund shares that it may have for other issuers, market following serves other purposes as well, including ensuring that a mix of information about the fund’s securities is available. We believe that providing a different calculation method for mutual funds is necessary to achieve the intent of the FAIR Act and is also consistent with the goals of the float requirement in rule 139. We also do not believe there is a reason to set the level of the minimum public float requirement based on a different set of considerations than for operating companies (i.e., the level of the security’s market following). As noted by commenters, we recognize that the minimum public float requirement may impact the amount of research on covered investment funds. However, we continue to believe that this requirement is consistent with rule 139’s framework and intent.89 As discussed previously, we believe that the intent of the FAIR Act was to extend the rule 139 framework to covered investment funds in a manner consistent with the treatment of other issuers subject to rule 139, except where necessary or appropriate. We do not believe it is necessary or appropriate to treat covered investment funds and other issuers differently here, except with respect to the calculation method for mutual funds as discussed below. We also believe that concern about coverage for smaller issuers—and balancing that concern with investor protection concerns when the brokerdealer distributing the report is participating in the issuer’s offering—is not unique to covered investment funds. As discussed in the Proposing Release, 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 limited segment of investors (which the float requirement could help to address).90 The float requirement is designed to protect investors by excluding research reports on covered (Nov. 3, 2004) [69 FR 67391 (Nov. 17, 2004)] (discussing public float of a certain level as a factor indicating that an issuer has a demonstrated market following). 88 See, e.g., S–3 Revisions Adopting Release, supra note 87. 89 See Proposing Release, supra note 2, at 26796. 90 See id. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 investment funds with a relatively small amount of total assets, which serves as a reasonable proxy for a limited market following.91 With respect to the level of the minimum public float, the float requirement is not intended to include or exclude a certain percentage of funds or other issuers from research coverage. The float requirement is intended to act as a proxy for market following. As we have previously analyzed in other contexts, analyst research coverage of an issuer is one indicia of market following. We have previously observed that analyst coverage drops off significantly with smaller issuers, and few if any issuers with less than $75 million in public float have significant analyst coverage.92 Moreover, while certain data aggregators provide analyst research report coverage for a number of funds, most funds are not followed by dedicated research analysts akin to the analyst coverage that we have previously identified as being one indicia of market interest and following for operating companies.93 As a consequence, we have observed that covered investment fund issuers with a public float of less than $75 million generally do not have a market following that would add to the mix of information in the marketplace. Some commenters suggested using a lower public float requirement for funds on the basis of seeking to equalize the percentage of funds that would be subject to coverage with the percentage 91 We believe that conditioning the availability of the safe harbor on the aforementioned reporting history and market valuation requirements will 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 limited trading or interest. See also infra discussion in the Economic Analysis at notes 350–354. 92 See Simplification of Registration Procedures for Primary Securities Offerings, Securities Act Release No. 6943 (July 16, 1992) [57 FR 32461 (July 22, 1992)] (stating that one indicia of market interest and following of a company is the number of research analysts covering the company and that approximately two-thirds of the newly eligible companies, based on the reduction of the float requirement to $75 million, are followed by at least three research analysts). See also Securities Offering Reform Adopting Release, supra note 23, at 44728 n.53 (stating that issuers with a market capitalization of between $75 million and $200 million, in most cases, have between zero to five analysts following them, with approximately 50% having zero to two analysts following them). 93 The Commission and the staff intend to monitor changes in analyst research coverage of funds and the impact of the minimum public market value requirement on the availability of research on covered investment funds and may in the future reduce, change, or eliminate the requirement to the extent that empirical evidence demonstrates that a lower threshold or different metric would be consistent with investor protection. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 64187 of issuers similarly subject to coverage in rule 139.94 Market following, however, appears to be a characteristic related to the size of a particular issuer, not to the statistical distribution of issuers in the market. In other words, there is no reason to believe that equalizing the percentage of issuers covered under rule 139 with the percentage of funds covered under rule 139b would result in a meaningful indication of market following because the result would depend on the distribution of issuers and funds by size. In addition, using a minimum public market value threshold that is the same as the parallel threshold in rule 139 may benefit market participants through regulatory consistency and reduce opportunities for investor confusion.95 While a broker-dealer publishing a research report about a fund that does not meet the minimum public float could not rely on rule 139b, other methods may be available to provide information about these funds by a broker-dealer participating in the offering, such as choosing to cover a smaller fund in a rule 482 communication.96 In addition, the public market value requirement is limited to issuer-specific research reports, and does not apply to industry research reports. noted that broker-dealers are unlikely to have information about beneficial owners of funds that are affiliates but hold the fund’s shares through another record owner. Commenters also stated that the proposed float requirement more generally creates operational challenges given the need to track and test fluctuating market values to comply with it, given that many funds are continuously offered.98 We appreciate these concerns and are therefore adopting two modifications to the final rule. First, the final rule does not require that the fund’s aggregate market value or net asset value be calculated net of affiliates’ holdings for most covered investment funds.99 However, the final rule, like the proposal, would require that a commodity- or currency-based trust or fund’s public float be calculated net of affiliate holdings, as under rule 139. Broker-dealers today can rely on rule 139 to publish research reports regarding these covered investment funds and we believe it appropriate to maintain consistency for issuers that can be covered under both rules, where consistent with the FAIR Act. Otherwise, exactly the same activity could be subject to different standards based on the rule that a broker-dealer chose to use. One commenter argued that determining affiliate ownership for Float Calculation such funds based on Forms 10–K and While we continue to believe that the S–1 may quickly become outdated.100 We believe that for purposes of float requirement serves a useful purpose, we recognize that the proposed calculating affiliate ownership when determining a covered investment float requirement could pose unique fund’s public float, broker-dealers may operational challenges for analysts rely on the covered investment fund’s covering certain covered investment funds. Accordingly, as discussed below, most recent ownership disclosures filed with the Commission for identifying the we are making certain changes to the beneficial owners, despite the potential timing and method of the float data limitations. As a consequence, we calculation that are designed to address believe that a broker-dealer need not these concerns for covered investment seek to identify unknown beneficial funds. One commenter stated that owners held through disclosed record calculating a covered investment fund’s owners, and also does not need to public float, and determining the generally exclude record owners from specific amount of affiliate holdings to the calculation of public float, except to be excluded in calculating the public the extent that they represent known float as proposed, is a practical beneficial owners. We believe this challenge for broker-dealers because it approach is reasonable and comparable was not clear to the commenter that to that used in the operating company third-party vendors or filings on EDGAR context. Unlike rule 139, rule 139b does not contain data regarding the value of permit affiliates of covered investment covered investment funds, net of value held by affiliates.97 This commenter also funds to rely on the safe harbor, 94 See Fidelity Comment Letter; SIFMA Comment Letter I. 95 See infra discussion following note 319. 96 See rule 482 [17 CFR 230.482]. Rule 482 sets forth certain filing and other investor protection requirements. Id. 97 See SIFMA Comment Letter II. This commenter stated that broker-dealers satisfy the parallel minimum public float requirement under rule 139 PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 by relying upon third-party data vendors, such as Bloomberg. We understand that third-party service providers do not currently calculate this number for covered investment funds, although they may do so in the future. 98 See Fidelity Comment Letter; SIFMA Comment Letter I. 99 See rule 139b(a)(1)(i)(B). 100 See SIFMA II Comment Letter. E:\FR\FM\13DER2.SGM 13DER2 64188 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 mitigating the risk that a fund with significant affiliate holdings would be the subject of market moving research by those same affiliates. We also appreciate that there is more limited information currently available regarding the holdings of affiliates of covered investment funds relative to operating companies, as noted by commenters.101 That many covered investment fund are continuously offered also adds operational challenges. A covered investment fund’s investor base, and thus potential affiliates, may change day to day, making it more difficult to identify affiliate holdings. In addition, covered investment funds are subject to unique legal provisions that generally restrict affiliate ownership and provide additional legal protections when affiliate ownership is permitted.102 Accordingly, not requiring a broker-dealer to identify and exclude affiliate holdings is designed to address these challenges and appropriately tailors this requirement for covered investment funds.103 Second, the final rule will permit a broker-dealer to satisfy the minimum float requirement when it initiates (or reinitiates) coverage and then once a quarter thereafter (so long as it continues issuing or distributing research on that fund), rather than each time the broker-dealer publishes or distributes a research report, as proposed.104 We recognize that in the operating company context where most issuers are not engaged in a continuous distribution, broker-dealers can rely on other research report rules that do not include a public float requirement. The requirement in proposed rule 139b that a covered investment fund have the requisite public float each time the broker-dealer publishes a research report could therefore have involved greater operational challenges than those associated with the corresponding requirement in rule 139. A broker-dealer would generally only need to comply with the requirement in rule 139 for a 101 See SIFMA Comment Letter II (noting that third party vendors do not currently provide float information net of affiliates for funds, and that for certain funds whose ownership is held in street name, affiliate ownership may be ‘‘unknowable’’). 102 See, e.g., Investment Company Act sections 12, 17, and 57 and rules thereunder. 103 The instructions to Form S–3 discuss methodologies for calculating float net of affiliates. When calculating float for purposes of rule 139b, those instructions related to the exclusion of affiliate ownership must be disregarded. 104 See rule 139b(a)(1)(i)(B). If a broker-dealer were to cease publication or distribution of a covered fund research report and then initiate coverage again, this provision would require the fund’s float to be above the minimum at the time that the broker or dealer begins relying on the safe harbor provided by rule 139b once more. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 discrete period of time while the issuer is in distribution, but would have been required to comply with the corresponding requirement in rule proposed 139b every time the brokerdealer published a research report about a covered investment fund that was in continuous distribution where the broker-dealer is participating in the offering. We believe that requiring a broker-dealer to determine the float upon initiation or reinitiation of coverage will ensure that the float requirement is met at the outset of research coverage. We are requiring a quarterly re-assessment of the float requirement to mitigate the risk that a covered investment fund’s float declines over time and no longer meets the float requirement. We believe a quarterly assessment is appropriate as it aligns with the quarterly reporting schedule of most funds, and balances the risks of only periodically verifying a fund’s float with the costs of more frequent or continuous assessments. We believe these adjustments appropriately tailor rule 139 to covered investment funds. For the reasons discussed below, we believe that the changes to the calculation and time of testing of the minimum public float requirement for covered investment funds under rule 139b are necessary or appropriate in the public interest, and for the protection of investors, and for the promotion of capital formation as they allow appropriately tailoring of rule 139 in applying it to covered investment funds while considering their unique structure and operational aspects. We proposed that the float threshold be calculated in terms of NAV rather than aggregate market value for mutual funds in order to reflect the market structure differences between mutual funds and all other covered investment funds.105 Absent this modification, the float requirement would categorically exclude broker-dealers from relying on rule 139b in their publication or distribution of mutual fund issuerspecific research reports, which would appear inconsistent with the FAIR Act’s directives. Mutual funds redeem their shares each day and therefore must compute their net asset value each day, providing a timely and reliable measure of the fund’s size, akin to other issuers’ public float; and investors’ ability to purchase and redeem fund shares at net asset value provides timely share prices akin to the price discovery that occurs in a public trading market. As discussed further below, for other types of covered investment funds, such as closed-end 105 Id. PO 00000 at 26796 n.86. Frm 00010 Fmt 4701 Sfmt 4700 funds and BDCs, which may or may not have public float, we believe it is appropriate, and consistent with the FAIR Act, to provide the same public float requirements—the manner of calculation and amount—as applies to issuer-specific research reports under rule 139. Accordingly, we are adopting this NAV calculation method as proposed. Non-Traded Funds Finally, one commenter suggested that we revise rule 139b to permit an issuer-specific research report to cover a non-traded closed-end fund or BDC that does not have a ‘‘public float,’’ and thus which, under proposed rule 139b, could not be included in an issuer-specific research report.106 This commenter noted that the proposed rule did not extend the NAV calculation method beyond open-end funds, but pointed to a footnote in the proposal that discussed the potential for non-traded BDCs or CEFs to be able to use a variant of the NAV approach, and asked that we amend the final rule to allow them to do so.107 Although under the proposed rule the NAV calculation method was only available to mutual funds, we acknowledge that the Proposing Release discussion was inconsistent with the proposed rule text in that the Proposing Release discussed the possibility of nontraded BDCs and CEFs calculating a NAV based on their last publicly disclosed share price for purposes of proposed rule 139b.108 We decline to amend the rule text to allow the NAV calculation method for non-traded BDCs and closed-end funds. We believe that it is inappropriate for non-traded BDCs and closed-end funds to satisfy the float requirement using a 106 See Sutherland Comment Letter. The commenter argued that all non-traded covered investment funds that have a net asset value (less the value of shares held by affiliates) that equals or exceeds the aggregate market value required in General Instruction I.B.1. to Form S–3 should be covered by new rule 139b. 108 Compare Proposing Release, supra note 2, at 26796 n.83 (‘‘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).’’) with proposed rule 139b(a)(1)(i)(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 (emphasis added) (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.’’ 107 Id. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations NAV calculation because doing so would undermine the purpose of the requirement. As discussed previously, historically, the Commission has used public float as a proxy for a security’s market following.109 We believe that the NAV method for mutual funds acts as an effective proxy for market following for mutual funds because mutual funds redeem their shares daily and therefore must compute their net asset value each day, providing a timely and reliable measure of the fund’s size, akin to other issuers’ public float; and investors’ ability to purchase and redeem fund shares at net asset value provides timely share prices akin to the price discovery that occurs in a public trading market. Non-traded BDCs and CEFs do not have an equivalent daily metric available, and often compute NAV on a significantly more infrequent basis, such as quarterly. In addition, we do not believe that providing a different calculation method for non-traded closed-end funds and non-traded BDCs is appropriate, because such funds do not have the same kind of structural differences that necessitate different treatment provided to openend funds. For example, unlike mutual funds, non-traded closed-end funds and BDCs could meet the float requirement if they chose to be listed and would not have to undertake any structural changes. By opting not to list, nontraded BDCs and closed-end funds are similar to non-listed operating company issuers that, by choosing not to list, cannot meet the public float requirement of rule 139. Finally, we do not believe that our approach is inconsistent with the statute or congressional intent. Specifically, we note that the FAIR Act includes an interim effectiveness provision, whereby if the Commission has not adopted a covered investment fund research report rule within 270 days of the Act’s enactment, broker-dealers could begin publishing or distributing covered investment fund research reports provided that certain rule 139 conditions are satisfied.110 One such specified condition is that an issuerspecific research report about a covered 109 See supra note 87 and accompanying text. supra note 3; section 2(d) of the FAIR Act. The FAIR Act’s interim effectiveness provision became effective as of July 3, 2018 and by its terms will terminate upon the adoption of a covered investment fund research report rule. Currently, at least one broker-dealer is issuing covered investment fund research reports in reliance on the interim effectiveness provision. See, e.g., Rachel Evans, In a Passive World, Bank of America’s New ETF Team Picks Stocks (Oct. 17, 2018), available at https://www.bloomberg.com/news/articles/2018-1017/in-a-passive-world-bank-of-america-s-new-etfteam-picks-stocks?srnd=etfs. amozie on DSK3GDR082PROD with RULES2 110 See VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 investment fund must satisfy the existing public float requirement of rule 139 during this interim effectiveness. As such, even during the interim effectiveness period provided under the FAIR Act and as a result of the conditions in rule 139, non-traded BDCs and CEFs would not be able to satisfy the public float requirement and thus by congressional design would not receive the benefit of the FAIR Act’s safe harbor. In light of the reasons discussed above, we have determined not to amend the proposed rule text as the commenter recommended to expressly include nontraded BDCs and CEFs within the safe harbor. c. Regular-Course-of-Business Requirement We are adopting as proposed a condition to rule 139b that a brokerdealer’s publication or distribution of research reports be ‘‘in the regular course of its business’’ 111 (the ‘‘regularcourse-of-business’’ requirement). Although the regular-course-of-business requirement is generally similar to the existing provisions of rule 139, it differs in one 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).112 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.’’ 113 Accordingly, rule 139b incorporates the ‘‘initiation or reinitiation’’ requirement from rule 139 and specifies that it applies only to research reports regarding a covered investment fund that does not have a class of securities in substantially continuous distribution.114 Determining whether a class of securities is in substantially continuous distribution would be based on an analysis of the relevant facts and circumstances. One commenter asked for clarification that the scope and meaning of ‘‘substantially continuous distribution’’ includes traded registered closed-end investment companies and BDCs 111 Rule 139b(a)(1)(ii). 139(a)(1)(iii) [17 CFR 230.139(a)(1)(iii)]. 113 Section 2(b)(1) of the FAIR Act. 114 See rule 139b(a)(1)(ii). 112 Rule PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 64189 engaged in at-the-market (‘‘ATM’’) offering programs over consecutive quarters pursuant to rule 415(a)(4) under the Securities Act.115 Determining whether a class of securities is in ‘‘substantially continuous distribution’’ is an analysis based on the relevant facts and circumstances. With respect to traded funds that offer ATM programs over consecutive quarters pursuant to rule 415(a)(4) under the Securities Act, we believe that a covered investment fund that engages in ongoing distributions of its shares on a frequency consistent with open-end investment companies is in substantially continuous distribution, but one that does so on a less frequent basis may not be. One commenter asked that we clarify whether broker-dealers that have published and distributed communications styled as ‘‘research reports’’ in compliance with rule 482 would meet the regular-course-ofbusiness requirement.116 This commenter also mentioned that some broker-dealers have published and distributed research reports on other issuers (such as non-covered investment funds, or on operating companies) in reliance on the rule 139 safe harbor. We believe that a broker-dealer can satisfy the regular-course-of-business requirement through either of the methods discussed by this commenter.117 A broker-dealer publishing or distributing an issuerspecific research report can satisfy the regular-course-of-business requirement if at the time of reliance on rule 139b it has distributed or published at least one research report about the issuer or its securities, or has distributed or published at least one such report following a period of discontinued coverage. In addition, the condition may be satisfied by publishing or distributing research reports on a covered investment fund when a broker-dealer is 115 See Sutherland Comment Letter. This commenter also asked for clarification regarding non-traded registered closed-end investment companies and non-traded BDCs offering shares on a continuous basis under Securities Act rule 415(a)(1)(ix). Although these funds would not be covered in issuer-specific research reports because they would not have the requisite public float, we believe that a ‘‘continuous’’ offering under rule 415(a)(1)(ix) would include a ‘‘substantially continuous offering’’ for purposes of rule 139b. See infra section II.B.2.b. 116 See Fidelity Comment Letter. 117 See also Securities Offering Reform Adopting Release, supra note 23, at 44763–64. There is no minimum time period for the broker or dealer to have distributed or published research reports, only that the particular broker or dealer has initiated or reinitiated coverage. Id. E:\FR\FM\13DER2.SGM 13DER2 64190 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 not participating in the offering of that fund.118 One commenter indicated that brokerdealers should not be required to have a traditional research department in order to rely on the rule.119 A traditional research department is not a requirement to meet the condition, but would be a factor in indicating compliance with the regular-course-ofbusiness requirement. We discussed a number of other factors that may evidence compliance with this condition in the Proposing Release.120 Several commenters expressed concerns that the regular-course-ofbusiness requirement was too restrictive.121 For example, one commenter stated that requiring brokerdealers to satisfy the regular-course-ofbusiness requirement by having a history of publishing or distributing research on the same types of securities as covered in the research report is inconsistent with the FAIR Act and congressional intent, and may preclude coverage by new broker-dealer entrants.122 We do not believe that the regular-course-of-business requirement is inconsistent with the FAIR Act, congressional intent, or would preclude new broker-dealer entrants from relying on the rule 139b safe harbor, as suggested by the commenter. We believe the FAIR Act and congressional intent are clear in their directive to extend the rule 139 safe harbor to covered investment fund research reports. Rule 139 includes a regular-course-ofbusiness requirement, and we believe it is appropriate for rule 139b to also include the same type of requirement. Commenters did not identify, and we are not aware of, any distinguishable differences in the operation of covered fund issuers that would necessitate 118 This would also include other types of research or rule 482 stylized ‘‘research reports,’’ discussed below. 119 See SIFMA Comment Letter I (also asking the Commission to clarify that the regular-course-ofbusiness requirement would definitively be satisfied where the research is produced by traditional research analysts within a traditional research department—regardless of whether it previously produced research on a particular type of security). 120 See Proposing Release, supra note 2, at 26796– 99 (These factors included whether the brokerdealer: Has a compliance structure in place with relevant policies and procedures governing their publication of research and their distribution of registered investment company advertisements; has a research department with research analysts covering particular issuers or industries; maintains policies and procedures governing its research protocols; and regularly publishes or distributes research on any other type of company or business other than covered investment funds.). 121 See SIFMA Comment Letter I; ICI Comment Letter; Fidelity Comment Letter; see also BlackRock Comment Letter. 122 See SIFMA Comment Letter I. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 different treatment from other issuers subject to rule 139 with respect to a regular-course-of-business requirement. Moreover, broker-dealers that wish to newly begin publishing or distributing research reports on funds could meet this condition through any of the methods discussed above.123 Once a broker-dealer has established a history of issuing such research reports pursuant to any of these (or potentially other) methods in the regular course of business, it could satisfy the condition and begin relying on rule 139b. Similarly, another commenter stated that in place of the regular-course-ofbusiness requirement, we should require broker-dealers’ policies and procedures to include rule 139b compliance.124 We are not incorporating this suggested change. Maintaining policies and procedures to comply with rule 139b is one of several factors we would assess in determining whether the broker-dealer has engaged in research report publication and distribution in the regular course of business, but such a factor alone does not establish that the regular-course-ofbusiness requirement has been met. 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.125 We continue to believe requiring that research reports be published or distributed in the regular course of a broker-dealer’s business under rule 139b, consistent with the requirements of rule 139, could reduce the potential that covered investment fund research reports could be used to circumvent the prospectus requirements of the Securities Act.126 For the reasons discussed in this section, we are adopting the regular-course-of-business requirement as proposed. 2. Industry Research Reports Rule 139b sets forth conditions for industry research reports that parallel the corresponding conditions under rule 139 and are intended to provide appropriate parameters to address the 123 See supra notes 116–118 and accompanying text. 124 See ICI Comment Letter; see also BlackRock Comment Letter. 125 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)]. 126 See Proposing Release, supra note 2, at 26797; see also Securities Offering Reform Adopting Release, supra note 23. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 risk of circumvention of the prospectus requirements of the Securities Act.127 a. Reporting Requirement Under the rule 139b 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 reporting requirement generally tracks an existing requirement for industry research reports under rule 139 but has been modified so that it would be applicable to industry research reports that include covered investment fund issuers.128 Like the parallel provision of rule 139, the reporting requirement under rule 139b helps ensure that there is publicly available information about the relevant issuers and that investors are able to use such information in making their investment decisions. Commenters did not present any concerns regarding the reporting requirement for purposes of industry research reports, and we are adopting it as proposed. b. Regular-Course-of-Business Requirement Under rule 139b, as proposed, a broker-dealer must publish or distribute research reports in the regular course of its business in order to rely on the new rule’s safe harbor.129 The regular-courseof-business requirement for industry research reports similarly applies to issuer-specific research reports,130 and it also tracks an existing requirement for industry research reports under rule 139.131 Like the parallel provision in rule 139, rule 139b’s regular-course-ofbusiness requirement for industry research reports includes the requirement that, at the time of publication or distribution of the 127 See supra notes 49–50 and accompanying text; see also supra paragraph accompanying notes 12– 15. 128 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.). 129 Rule 139b(a)(2)(iv) (the broker-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). 130 See supra section II.B.1.c. 131 See rule 139(a)(2)(v) [17 CFR 230.139(a)(2)(v)]. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 industry research report, the brokerdealer is including similar information about the issuer or its securities in similar reports.132 However, unlike rule 139, the ‘‘similar information’’ requirement under rule 139b applies 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.’’ 133 We believe that the ‘‘similar information’’ requirement is akin to the ‘‘initiation or reinitiation’’ requirement, in that both would have the effect of limiting a broker-dealer’s ability to rely on the rule 139b safe harbor to publish or distribute a research report about a particular covered investment fund if the brokerdealer had not previously published research on that issuer. Therefore, as in the ‘‘initiation or reinitiation’’ requirement, we are also excluding covered investment funds from the ‘‘similar information’’ requirement if they have a class of securities in substantially continuous distribution. We provided guidance in section II.B.1.c above on how a broker-dealer can meet the regular-course-of-business requirement in the context of issuerspecific research reports, and such guidance would be equally applicable in meeting the requirement in the context of industry research reports. We are adopting the requirement as proposed for the reasons discussed in this section and in the similar section for issuerspecific research reports. c. Content Requirements for Industry Research Reports Rule 139b’s safe harbor for publication or distribution of industry research reports is also conditioned on certain content requirements. We are adopting these requirements as proposed. Specifically, under rule 139b, 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’’),134 or alternatively contain a comprehensive 132 Rule 133 See 139b(a)(2)(iv). supra notes 113–114 and accompanying text. 134 Rule 139b(a)(2)(ii)(A). VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 list of covered investment fund securities currently recommended by the broker-dealer (the ‘‘comprehensive list requirement’’).135 These requirements are designed to result in industry research reports that cover a broad range of investment companies or securities.136 At the same time, the comprehensive list requirement would permit a different presentation of research about multiple covered investment funds than the industry representation requirement would permit.137 Because the affiliate exclusion applies to all covered investment fund research reports—i.e., both issuer-specific research reports and industry research reports—a brokerdealer seeking to rely on rule 139b by satisfying either the industry representation requirement or the comprehensive list requirement cannot include any covered investment fund issuer that is an affiliate of the brokerdealer, or for which the broker-dealer serves as an investment adviser (or is an affiliated person of the investment adviser) in a covered investment fund research report, including industry research reports.138 Several commenters argued that a broker-dealer should be able to include affiliated funds in industry research reports about covered investment funds.139 Another commenter argued that industry research reports with a substantial number of funds should satisfy the purposes of the affiliate exclusion if they contain similar information about each fund and no 135 Rule 139b(a)(2)(ii)(B). Research Reports, Securities Act Release No. 6492 (Oct. 6, 1983) [48 FR 46801 (Oct. 14, 1983)]. 137 Under 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. 138 See rule 139b(a)(2)(ii)(B) (excluding from the comprehensive list securities of a covered investment fund that is an affiliate of the brokerdealer, or for which the broker-dealer serves as investment adviser (or for which the broker-dealer is an affiliated person of the investment adviser)); see also supra section II.A.1. In the final rule, we also made a change to rule 139b(a)(2)(ii) to clarify that the industry research report provisions are with respect to covered investment fund research reports and the affiliate exclusion set forth therein. Thus, a broker-dealer cannot include a covered investment fund issuer in any industry specific report (i.e., industry representation requirement or the comprehensive list requirement) if the brokerdealer’s relationship to the issuer meets any of the affiliations designated in the affiliated exclusion. 139 See ICI Comment Letter; Fidelity Comment Letter; SIFMA Comment Letter I; see also BlackRock Comment Letter. 136 See PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 64191 particular fund is afforded materially greater space or prominence.140 Another commenter suggested that, in some instances, because affiliated funds may be as or more suitable than nonaffiliated funds, broker-dealers should be allowed to include affiliated funds in industry research reports.141 Several commenters also argued that we should permit broker-dealers to include both affiliated and non-affiliated funds in industry research reports, but only provide the rule 139b safe harbor for the non-affiliated funds included in the report. They suggested that any information about affiliated funds included in such a report not benefit from the safe harbor, and thus any discussions of those funds be subject to the requirements of rule 482.142 We believe extending the rule 139b safe harbor to affiliated funds in industry research reports (whether industry representation or comprehensive list reports) would not be consistent with the intent and plain language of section 2(f)(3) of the FAIR Act.143 We also believe that allowing for a mix of affiliated funds and nonaffiliated funds to appear together in a single research report, as suggested by commenters, in reliance on two separate and distinct characterizations of that communication (i.e., under rule 139b such a research report would be deemed not an offer under the Securities Act, and under rule 482 such a research report would be deemed to be a 10(b) omitting prospectus) would be an untenable regulatory framework. Not only would there be differing presentation, liability, and filing standards for the different portions of the report, but we believe that it could create challenges for regulators and others and confusion for investors because the information presented for each type of fund would likely differ.144 140 See SIFMA Comment Letter I. Fidelity Comment Letter. 142 See SIFMA Comment Letter I; Fidelity Comment Letter. 143 This section excludes from the definition of covered investment fund research report any 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-dealer that is an investment adviser (or an affiliated person of an investment adviser) for the covered investment fund. 144 For example, communications subject to rule 482 must be filed with the Commission pursuant to section 24(b) of the Investment Company Act. 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. 17 CFR 270.24b–3. Unless the entirety of the research report was filed, reviewing isolated and selective portions of a research report related to affiliated 141 See E:\FR\FM\13DER2.SGM Continued 13DER2 64192 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 Accordingly, we clarify that brokerdealers may not selectively apply the rule 139b safe harbor to certain aspects of a research report. The safe harbor must apply to the entirety of the report or it does not apply at all. Brokerdealers may, however, instead choose to issue a rule 482 communication that is styled as an industry research report about affiliated funds or about affiliated and non-affiliated funds; in either case, such a communication would be subject to the requirements of rule 482 and not gain the benefit of the rule 139b safe harbor. One commenter raised the concern that excluding affiliated funds from an industry research report subject to the comprehensive list requirement may create a false impression that an affiliated fund is excluded because it does not meet an investor’s criteria.145 We acknowledge this possibility. If a broker-dealer is concerned that a research report purporting to include a comprehensive list of funds may confuse investors, the broker-dealer could include an explanation of why affiliated funds are excluded from the research report. For example, a brokerdealer could include a statement in the report indicating that it does not include information about affiliated funds due to relevant securities regulations. One commenter argued that rule 139b should not include industry report content requirements because covered investment funds do not have the same market conditioning or ‘‘gun-jumping’’ concerns as securities covered in research reports published or distributed in reliance on rule 139.146 Since many covered investment funds continuously distribute their securities, conditioning the market concerns can remain throughout the offering for issuers covered under rule 139b. Market conditioning is a concern that information about a fund or its securities might supersede the information provided in their offering prospectus. With respect to research reports, this concern is heightened for issuer-specific research reports and therefore they are subject to more funds may not allow for effective review of such materials. 145 See Fidelity Comment Letter. 146 See ICI Comment Letter (citing an SEC staff report issued in 1969 noting that ‘‘gun-jumping’’ concerns primarily arise during the pre-filing stage of a securities offering and casting doubt on the doctrine’s applicability to non-participants in a securities offering). This commenter made the same argument regarding industry report presentation requirements. See infra note 152. See also BlackRock Comment Letter. Rule 139b is not limited to non-participants. Broker-dealers participating in the distribution of the covered investment fund’s securities may rely on the rule provided the applicable conditions are satisfied. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 stringent conditions than industry research reports. Market conditioning, however, remains a concern for industry research reports, as well. The content requirements for industry reports are designed to help ensure that industry reports become a part of the mix of information in the marketplace, rather than circumventing the prospectus requirements of the Securities Act or the issuer-specific conditions. The language from rule 139’s industry representation requirement is replicated 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 subindustry.’’ 147 As discussed in the Proposing Release, 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.148 Therefore, the 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).149 We believe that this requirement tracks rule 139 to the extent practicable and appropriate, and we did not receive comments on this aspect of the proposal. For the reasons discussed above, we are adopting the industry research report content requirements as proposed. d. Presentation Requirement for Industry Research Reports As proposed, the rule 139b safe harbor for industry research reports is conditioned on a presentation requirement. Under the new rule, analysis of any covered investment fund issuer or its securities included in an industry research report cannot be given materially greater space or prominence in the publication than that given to any other covered investment fund issuer or its securities.150 We believe that the concerns underlying the rule 139 presentation 147 Rule 139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)]. Proposing Release, supra note 2, at 26800. 149 Rule 139b(a)(2)(ii)(A). 150 Rule 139b(a)(2)(iii). 148 See PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 requirements apply equally in the context of covered investment fund research reports.151 The industry should already be familiar with this longestablished and well-understood condition, and therefore we believe implementing a similar presentation condition for industry research reports on covered investment funds would be straightforward. One commenter argued that rule 139b should not include industry report presentation requirements because covered investment funds do not have the same market conditioning or ‘‘gunjumping’’ concerns as those securities covered in research reports published or distributed in reliance of rule 139.152 As discussed above, market conditioning remains a concern for industry research reports.153 The presentation requirements for industry reports are designed to help ensure that industry reports become a part of the mix of information in the marketplace, rather than circumventing the prospectus requirements of the Securities Act or the issuer-specific conditions. For the same reasons discussed above, we disagree with this commenter.154 Accordingly, we are adopting this requirement as proposed. C. Presentation of Performance Information in Research Reports About Registered Investment Companies The proposed rule would not have required standardized performance presentation for covered investment fund research reports. However, the Commission requested comment on whether the final rule should require research reports about registered investment companies to be subject to standardized performance presentation requirements. The Commission expressed its concern that not including standardized performance measures in research reports could lead to investor confusion. The Commission also noted its longtime recognition that investors tend to consider investment performance to be a particularly significant factor in evaluating or comparing investment companies and had previously identified a number of circumstances in which performance could be disclosed in a misleading manner.155 151 See Proposing Release, supra note 2, at 26801. ICI Comment Letter; see also BlackRock Comment Letter. 153 See supra note 146 and accompanying paragraph. 154 See id. 155 See Proposing Release, supra note 2, at 26802. Additionally, the Commission noted its concern that rule 482 or rule 34b–1 could be circumvented by recasting registered investment company 152 See E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 In a change from the proposal, we are adopting a condition in rule 139b that if fund performance information is included in a research report, it must be presented in accordance with certain standardized presentation requirements dependent on the type of covered investment fund covered.156 For research reports that include registered open-end fund performance, we are requiring that fund performance be presented according to the presentment and timeliness requirements of rule 482.157 For research reports that include closed-end fund performance, one commenter argued for standardized presentation requirements for all covered investment funds and recommended that closed-end funds comply with the requirements of Form N–2 instead of rule 482, which does not offer any standardized performance requirements for closed-end funds.158 We agree with the commenter, and are therefore requiring that closed-end fund performance be presented in a manner that is in accordance with the instructions to item 4.1(g) of Form N–2, although other historical measures of performance may also be included if any other measurement is set out with no greater prominence. Specific statutory provisions and rules apply to advertising the performance of registered investment companies.159 An advertisement about a covered investment fund that is a advertisements or selling materials as research reports. Id. 156 Rule 139b(a)(3). 157 See id. (requiring that a research report discussing fund performance of a registered openend management investment company must present it in accordance with the performance requirements of paragraphs (d) and (e) of rule 482 [17 CFR 230.482] and must also comply with the timeliness requirement of performance data in paragraph (g) of rule 482). 158 See ICI Comment Letter; see also BlackRock Comment Letter. 159 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). VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 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 482.160 Therefore, 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.161 As discussed in the Proposing Release, given the breadth of the definition of ‘‘research report’’ under the FAIR Act (and the definition of ‘‘research report’’ 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 rule 139b safe harbor.162 Among other things, rule 482 requires standardized presentation of performance data included in registered open-end investment company advertisements.163 Alternatively, if other performance measures are presented, they must be accompanied by certain standardized performance data.164 Because a broker-dealer’s publication or distribution of a covered investment fund research report under rule 139b is 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 under rule 34b–1 under the Investment Company 160 See rule 482 under the Securities Act [17 CFR 230.482]. 161 See id. 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). 162 See Proposing Release, supra note 2, at 26801. 163 See rule 482(d)(1)–(4) under the Securities Act (for open-end investment companies other than money market funds) [17 CFR 230.482(d)(1)–(4)]; rule 482(e) under the Securities Act (for money market funds) [17 CFR 230.482(e)]. 164 See rule 482(d)(5) [17 CFR 230.482(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. See id. PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 64193 Act that must be accompanied or preceded by a statutory prospectus now could be considered covered investment fund research reports (which need not be preceded or accompanied by a statutory prospectus).165 Rule 34b–1 incorporates many of the rule 482 requirements relating to performance disclosure and makes these requirements applicable to supplemental sales literature.166 As discussed in the Proposing Release, 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,167 there could be circumstances where, under rule 139b, broker-dealers publish or distribute communications that historically have been viewed as registered investment company advertisements or selling materials. We received two comment letters addressing this issue.168 One commenter suggested that the presentation of performance information in research reports about registered investment companies should not be subject to the standardized performance requirements of rule 482.169 This commenter stated that because rule 482 is intended to apply to advertisements, such presentation requirements might undermine analysis or insights that a 165 See section 2(a)(10)(a) of the Securities Act; rule 139b(a). See also rule 34b–1 under the Investment Company Act [17 CFR 270.34b–1]. 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. 166 See rule 34b–1(b)(1)–(2) [17 CFR 270.34b– 1(b)(1)–(2)]. 167 See, e.g., supra sections II.A.1 (affiliate exclusion) and II.B.1.c and II.B.2.b (regular-courseof-business requirements). 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 infra section II.D.1. 168 See SIFMA Comment Letter I; ICI Comment Letter; see also BlackRock Comment Letter. 169 SIFMA Comment Letter I. E:\FR\FM\13DER2.SGM 13DER2 amozie on DSK3GDR082PROD with RULES2 64194 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations research analyst may seek to convey about one or more covered investment funds by highlighting a particular aspect of performance information. This commenter also stated that SRO rules would address the investor confusion concern raised by the Commission. We disagree that applying standardized performance presentation requirements would undermine a research analyst’s analysis or insights because rule 482 does not preclude non-standardized performance information. Rather, it requires standardized performance information to be presented if nonstandardized performance information is presented. We believe SRO rules may address some investor confusion concerns, but we believe requiring presentation performance requirements would more fully address these concerns. Another commenter stated that the Commission should require that fundspecific performance information in covered investment fund research reports be presented in accordance with the applicable standardization requirements.170 This commenter stated that investors tend to consider fund performance a significant factor in evaluating or comparing funds and that standardized fund performance reporting requirements have served investors well. Furthermore, this commenter noted that discrepancies in performance between a broker-dealer’s research report and what a fund may report or disclose in regulatory filings or advertisements would risk confusing investors. We agree with both of the commenter’s points. This commenter also noted that if the final rule does not require standardized presentation requirements for fund performance information, the Commission should require a clear and prominent disclosure whenever fund-specific performance is not in accordance with these standards. The final rule thus requires that a research report that includes open-end fund performance information must present this information in accordance with rule 482 presentment and timeliness requirements. A research report must present closed-end fund performance information in accordance with the instructions to item 4.1(g) set forth in Form N–2 (although other historical measures of performance may also be included if the other measurement is set out with no greater prominence than the measurement that 170 ICI Comment Letter. This commenter also suggested the disclosure of Form N–2 performance data for closed-end funds. See also BlackRock Comment Letter. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 is in accordance with the instructions to item 4.1(g) of Form N–2). Rule 139b(a)(3) requirements would not preclude research report analysts from presenting performance information in their preferred manner; rather, it requires that standardized performance information also be included if non-standardized performance information is presented. To satisfy this requirement, analysts may choose to present non-standardized performance information in a way they believe highlights a particular insight or analysis, so long as it is presented alongside the standardized performance information consistent with rule 482 requirements or Form N–2, if applicable.171 As noted in the proposal, covered investment fund research reports relying on the rule 139b safe harbor are subject to the antifraud provisions of the federal securities laws.172 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.173 This guidance provided factors to be weighed when determining whether fund performance in sales literature is adequately disclosed. The guidance factors in rule 156 174 are informative in evaluating whether any presentations of registered investment company performance in these research reports could be misleading because they reflect principles that would help guide this analysis (such as providing information to investors that is informative and that does not create unrealistic investor expectations 175). We believe that 171 See rule 139b(a)(3). section 2(c)(1) of the FAIR Act (stating that nothing in the FAIR Act shall be construed as in any way limiting the applicability of the antifraud or anti-manipulation provisions of the federal securities laws and rules adopted thereunder to a covered investment fund research report, including section 17 of the Securities Act, section 34(b) of the Investment Company Act, and sections 9 and 10 of the Exchange Act). 173 See Amendments to Investment Company Advertising Rules, Securities Act Release No. 8294 (Sept. 29, 2003) [68 FR 57759 (Oct. 6, 2003)]; see also rule 156 under the Securities Act [17 CFR 230.156]. 174 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. 175 See Amendments to Investment Company Advertising Rules, Securities Act Release No. 8101 (May 17, 2002) [67 FR 36712 (May 24, 2002)]. 172 See PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 incorporating these rule 482 and Form N–2 presentation standards in rule 139b reduces the potential for confusion between (i) registered open-end management investment company advertisements and selling materials covered by rule 482 and registered closed-end investment company selling materials covered by Form N–2 and (ii) rule 139b research reports. Moreover, we believe it would reduce the potential for investor confusion resulting from divergent standards in the presentation of performance data. 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.176 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.177 As discussed in more detail below, we are adopting rule 24b– 4 to implement this provision of the FAIR Act. New 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 176 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 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 research reports on covered investment funds that are investment companies subject to section 24(b) of the Investment Company Act. For example, registered closed-end investment companies, BDCs, 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 research report that is not subject to section 24(b) of the Investment Company Act would not be subject to filing requirements 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. 177 See id. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations 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.178 Currently, the SRO content standards relevant to communications that would be considered covered investment fund research reports under rule 139b include the applicable content standards of FINRA rules 2210, 2241, and 2242.179 FINRA’s rule governing communications with the public (FINRA rule 2210) contains general content standards that apply broadly to member communications,180 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.’’ 181 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.’’ 182 In order to provide clarity and facilitate consistent and predictable application of rule 24b–4, we interpret section 2(b)(4) of the FAIR Act as excluding covered investment fund research reports from section 24(b) of the Investment Company Act so long as they continue to be subject to the general content standards in FINRA rule 2210(d)(1) (or substantially similar SRO rules). Accordingly, by operation of rule 24b–4, covered investment fund research reports under rule 139b that 178 See rule 24b–4. infra note 183 (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 rule 139b). 180 See FINRA rule 2210(d)(1). 181 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). 182 Section 2(b)(4) of the FAIR Act. amozie on DSK3GDR082PROD with RULES2 179 See VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 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).183 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 Investment Company Act or rule 497 under the Securities Act,184 and therefore would no longer be subject to 183 A subset of communications that would fall within the definition of ‘‘covered investment fund research report’’ under 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 new 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). 184 See infra notes 187–189 and accompanying text. PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 64195 routine review.185 We received no comments on SRO content standards specifically, but some commenters suggested that FINRA rules (particularly with respect to definitions and filing requirements thereunder) be modified or harmonized with rule 139b, which we discuss below.186 Filing Requirements for Covered Investment Fund Research Reports Rule 24b–4, as adopted, modifies the filing requirements that currently apply to certain broker-dealer communications regarding registered investment companies. 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 187 and rule 497 under the Securities Act.188 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.189 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.190 Such communications styled 185 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.’’). 186 See, e.g., Fidelity Comment Letter; SIFMA Comment Letter I. 187 See supra note 144. 188 See rule 497 of the Securities Act [17 CFR 230.497]. Rule 497, which 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. 189 See supra note 144; see also 17 CFR 230.497(i). 190 See infra section III.C.3. E:\FR\FM\13DER2.SGM 13DER2 64196 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations as ‘‘research reports’’ that previously had been subject to the filing requirements of section 24(b) of the Investment Company Act no longer would be subject to these requirements by operation of rule 24b–4, as adopted, because they would be subject to the general content standards of FINRA rule 2210(d)(1).191 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.192 However, FINRA provides a number of exclusions from the filing requirements.193 For example, with respect to research reports (as that term is defined in FINRA rule 2241), 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.194 Because covered investment fund research reports are not required to be filed with the Commission pursuant to section 24(b), as directed by the FAIR Act, 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. However, 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.’’ 195 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 amozie on DSK3GDR082PROD with RULES2 191 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 165–167. 192 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 187–189 and accompanying text. 193 See generally FINRA rule 2210(c)(7). 194 See FINRA rule 2210(c)(7)(O). 195 See section 2(c)(2) of the FAIR Act. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 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.196 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.197 Two commenters requested that FINRA’s filing requirements be modified in light of the FAIR Act.198 One commenter recommended that the Commission work with FINRA to harmonize FINRA’s research rules with rule 139b and that broker-dealers relying on rule 139b be exempted from FINRA’s filing requirements with respect to covered investment fund research reports.199 Another commenter suggested that the relevant statutory language of the FAIR Act 200 should be interpreted to be limited to covered investment fund research reports made in reliance of the 139b safe harbor that only provide ‘‘information’’ that a user would not be able to use for research and analysis.201 This commenter asserted that only covered investment fund research reports that solely provide information would fall within the scope of what an SRO could require to be filed under its authority. Moreover, one commenter argued that because the definition of ‘‘research report’’ under the FAIR Act was broader than FINRA’s definition of research report, that this may cause confusion and conflicting interpretive views on what communications are deemed research for purposes of the safe harbor and filing exclusion.202 As we discussed above, section 2(c)(2) of the FAIR Act states that nothing in 196 Id. See also 15 U.S.C. 80a–24(b); FINRA rule 2210. 197 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). 198 See SIFMA Comment Letter I; Fidelity Comment Letter. 199 See Fidelity Comment Letter. 200 The FAIR Act provides that the Act does not limit the authority of any self-regulatory organization 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. 201 SIFMA Comment Letter I. 202 See Fidelity Comment Letter. PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 the FAIR Act shall be construed as in any way limiting the authority of an SRO, which includes FINRA, to require the filing of communications with the public, including covered investment fund research reports, the purpose of which is not to provide research and analysis of covered investment funds. To the extent FINRA would seek to amend its rules, any such proposed rule changes would be filed with the Commission pursuant to section 19(b)(1) of the Exchange Act and rule 19b–4 thereunder. 2. SRO Limitations The FAIR Act also 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.203 Proposed rule 139b incorporated this provision of the FAIR Act, and we received no comments on this aspect of the proposal. We note that 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 rule 139b. To provide additional context for the 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 rule 139b as proposed.204 E. Conforming and Technical Amendments Rule 101 of Regulation M under the Exchange Act 205 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. We proposed, in connection with our adoption of Securities Act rule 139b, a conforming 203 Section 2(b)(3) of the FAIR Act. rule 139b(b). 205 17 CFR 242.101(a). 204 See E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 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 rule 139b are satisfied. The conforming amendment is intended to align the treatment of research under 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 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. The conforming amendment is intended to harmonize treatment of research under the Securities Act and Exchange Act rules. We received no comments on this aspect of the proposal. We are adopting the conforming amendment as proposed. In October 2016, the Commission adopted new rules and forms and amended other rules and forms under the Investment Company Act to modernize the reporting and disclosure of information by registered investment companies.206 The Commission, among other things, adopted Form N–CEN, a new form for registered investment companies to report census-type information to the Commission, and rescinded Form N–SAR, a form on which the Commission had previously collected census-type information on management investment companies and unit investment trusts. To implement these changes, the Commission revised references to rules and forms to remove references to Form N–SAR and replace them with references to Form N–CEN, but inadvertently did not revise Form 12b–25. We are making a technical amendment to Form 12b–25 to replace references to Form N–SAR with references to Form N–CEN and to 206 See Reporting Modernization Release, supra note 53. 207 Transition reports on Form N–SAR were covered by rule 30b1–3 under the Investment Company Act, which was rescinded by the Reporting Modernization Adopting Release. See Reporting Modernization Adopting Release, supra note 53, at 81929 n.781 and accompanying and following text. 208 15 U.S.C. 77b(b); 15 U.S.C. 78c(f); 15 U.S.C. 80a–2(c); 15 U.S.C. 80b–2(c). 209 15 U.S.C. 78w(a)(2). 210 See Proposing Release, supra note 2. 211 See id. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 remove the checkbox and accompanying text related to transition reports on Form N–SAR.207 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.208 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.209 The economic analysis proceeds as follows. We begin with a discussion of the baseline used in the analysis. We then discuss the costs and benefits of the rules we are adopting, as well as the effects of these rules on efficiency, competition, and capital formation compared to the baseline. Where possible, we attempt to quantify the economic effects we discuss, although in many cases we are unable to do so and instead rely on qualitative characterizations. In the Proposing Release, we requested comment on our analysis of these effects.210 We did not receive comments that provided any additional quantification of these effects, nor did commenters provide data that could facilitate a more quantitative analysis. We therefore 212 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. 213 The rules we are adopting, through their effects on capital formation, may also affect securities issuers more broadly. See infra section III.C.5. 214 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 rule 139b(c)(2)(ii). PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 64197 continue to be unable to produce reasonable quantitative estimates for most of the economic effects, and—as in the Proposing Release—rely on qualitative economic assessments instead.211 B. Baseline The Commission’s economic analysis evaluates the costs and benefits of the rules being adopted relative to a baseline that represents the best assessment of relevant markets and market participants in the absence of these rules. In this section, we begin by characterizing the relevant market structure and participants.212 We then proceed to describe the relevant regulatory structure. 1. Market Structure and Market Participants The rules we are adopting directly affect broker-dealers, but their indirect effects extend to covered investment funds, other producers of research on covered investment funds, and consumers of information about covered investment funds.213 a. Covered Investment Funds The ‘‘covered investment fund’’ definition in the FAIR Act and rule 139b has the effect of capturing five common types of investment vehicles: Mutual funds, ETFs, certain currency and commodity exchanged traded products (‘‘ETPs’’), 214 closed-end funds, and BDCs.215 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.216 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.217 BILLING CODE 8011–01–P 215 See supra section II.A.3. fund, ETF, and ETP statistics are based on data from CRSP mutual fund database (2017Q4). Closed-end fund statistics are based on data from CRSP monthly stock file (Dec. 2017). BDC statistics are based on the Commission’s listing of registered BDCs. Securities and Exchange Commission, Business Development Company Report: January 2012–July 2018 (Sept. 28, 2018), available at https://www.sec.gov/open/datasets-bdc.html. 217 See supra note 216. Market value of BDC shares are based on information obtained from CRSP, Compustat, and Audit Analytics. 216 Mutual E:\FR\FM\13DER2.SGM 13DER2 64198 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations Public Market Value of Covered Investment Funds Market value of publicly-traded securities issued by covered invesbnent funds, by type and year. 15 j = ·,g FUnd'JYpe e ;= ] ~ 10 Closed-End Fund ] ETFIETP ~ Mutual Fund i 5 2009 2010 2011 2012 2013 2014 2015 2016 2017 Year VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 PO 00000 Frm 00020 Fmt 4701 Sfmt 4725 E:\FR\FM\13DER2.SGM 13DER2 ER13DE18.000</GPH> amozie on DSK3GDR082PROD with RULES2 Figure 1: Numbers of publicly traded covered investment funds, by type and year. Counts based on CRSP mutual fund database, CRSP monthly stock file, and Commission's listing ofBDC registrants; see supra note 216. BDC data begins in 2013. Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations 218 See Investment Company Institute, 2017 Investment Company Fact Book (2017), available at https://www.icifactbook.org/ (‘‘ICI Fact Book’’). 219 See supra note 217. 220 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 17:51 Dec 12, 2018 Jkt 247001 retail investors, or households).221 Consequently, at least 75% of the public market value of all covered investment funds is held through retail accounts. By analyzing institutional holdings from year-end 2017 Form 13F filings we estimate that across ETF and ETPs, the mean institutional holding 222 was 45%.223 For BDCs, we estimate the 221 Percentage by value. See ICI Fact Book, supra note 218, 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. 222 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). 223 Year-end 2017 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:// PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 mean institutional holding was 30%, while for closed-end funds, we estimate the mean institutional holding was 21%. Based on these figures, we further estimate that shares representing 86% of the public market value of all covered investment funds are held through retail accounts.224 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 (Sept. 27, 2010), available at https://www.sec.gov/files/ 480.pdf. 224 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 221 and accompanying text. E:\FR\FM\13DER2.SGM 13DER2 ER13DE18.001</GPH> amozie on DSK3GDR082PROD with RULES2 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.218 Mutual funds comprise the bulk (84%) of covered investment funds.219 Nearly half of U.S. households hold mutual fund shares 220 and the vast majority (89%) of mutual fund shares are held through retail accounts (i.e., accounts of 64199 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations As depicted in Figure 3, the covered investment fund market is dynamic. In 2017, 638 covered investment funds were created, while 853 were closed or merged into other covered investment funds.225 b. Broker-Dealers 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 affected by the rules we are adopting.227 As discussed above, registered investment companies represent the vast majority of covered investment funds.228 Broker-dealers report revenues from the distribution of investment company shares in regulatory filings,229 and we use this to estimate brokerdealers’ 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 brokerdealers’ revenues. Of these 3,882 brokerdealers, 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.230 As shown in The broker-dealers directly affected by the rules we are adopting 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 226 225 See supra note 216. rely here primarily on broker-dealers’ quarterly FOCUS reports. 226 We VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 227 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 rule 139b. 228 See supra section III.B.1.a. PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 229 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’’). 230 We describe these dealers as ‘‘affected,’’ but the degree to which they are affected will vary E:\FR\FM\13DER2.SGM 13DER2 ER13DE18.002</GPH> amozie on DSK3GDR082PROD with RULES2 64200 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations Figure 4, among the affected brokerdealers, the importance of revenues from the distribution of covered investment funds varies widely.231 However, in aggregate, these revenues accounted for 13% of affected brokerdealers’ total revenues.232 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. BILLING CODE 8011–01–C broker-dealers’ in-house research departments (if they have such departments) are currently capable of providing research on a large percentage of covered investment funds. Most covered investment funds are not followed by dedicated research analysts akin to the analyst coverage that the Commission has previously identified as being one indicator of market interest and following for operating companies. Existing Commission and SRO rules do not delineate a category of ‘‘research reports’’ pertaining to covered investment funds. Consequently, it is not possible to identify with precision broker-dealer communications under the baseline that would be considered ‘‘research reports’’ as defined in 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.235 FINRA member firms—the vast majority 236 of broker-dealers—file these communications with FINRA.237 The number of communications filed with FINRA help to provide an estimate of the number of communications currently published or distributed by broker-dealers that could potentially be considered ‘‘research reports’’ under rule 139b. FINRA staff has 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 The Commission does not have comprehensive data on broker-dealers that publish or distribute research reports on entities that are included within the definition of ‘‘covered investment fund’’ under rule 139b.233 The Commission estimates that in 2017, there were 1,417 broker-dealers that reported revenues from the distribution of covered investment funds.234 We assume that these broker-dealers will 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 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. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 231 This suggests that the degree to which the ‘‘affected’’ broker-dealers are affected by the rule will also vary widely. 232 Estimates are based on staff analysis of FOCUS filings. 233 See supra section III.B.1.b. 234 See id. PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 235 See supra note 162 and accompanying text. on staff analysis of FOCUS filings, we estimate that as of year-end 2017, there were 3,882 registered broker-dealers, 3,755 of which were members of FINRA. 237 See supra note 189 and accompanying text. 236 Based E:\FR\FM\13DER2.SGM 13DER2 ER13DE18.003</GPH> c. Research on Covered Investment Funds amozie on DSK3GDR082PROD with RULES2 64201 64202 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 rule 34b–1, for a total of 56,235 communications.238 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 rule 139b. First, these data do not reflect the affiliate exclusion incorporated in the rule 139b definition of ‘‘covered investment fund research report,’’ which has the effect of excluding from the safe harbor research reports that are published or distributed by persons covered by the affiliate exclusion.239 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 broker-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 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 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 rule 139b. Under FINRA rule 2241, the term ‘‘research report’’ includes any written 238 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 note 165. 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. 239 See supra notes 18–21 and accompanying text. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 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.240 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.241 As discussed above, the FAIR Act and the rule 139b definition of ‘‘research report’’ do not require a communication to provide information reasonably sufficient upon which to base an investment decision.242 Also, unlike the definition of ‘‘research report’’ in FINRA rule 2241, the FAIR Act and the rule 139b definitions of ‘‘research report’’ 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 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). Data aggregators provide various forms of information and analysis about covered investment funds, ranging from automated fund rankings, to analyst research reports.243 240 See FINRA rule 2241(a)(11). FINRA rule 2242(a)(3). 242 See supra note 40 and accompanying text. 243 While various firms provide automated fund rankings for much of the covered investment fund universe, true ‘‘analyst coverage’’ is considerably more limited. Morningstar provides ‘‘analyst ratings’’ for certain open-end funds, closed-end funds, and ETFs. Based on queries of the Morningstar database, as of October 2018, only 241 See PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 Because data and analysis provided by these firms play an important role in investors’ information environment under the baseline, these firms will be affected by changes to the competitive environment resulting from the rules we are adopting.244 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.245 2. Regulatory Structure The objective of this analysis is to consider the effects of regulations being adopted pursuant to the FAIR Act’s statutory mandate. Thus, for the purposes of the baseline, we take into account the regulatory structure in place immediately prior to the enactment of the FAIR Act. We also note that on July 3, 2018, the interim effectiveness provision of the FAIR Act came into effect.246 This provision allows brokerdealers to rely on the rule 139 safe harbor when publishing or distributing covered investment fund research reports. In addition, under this provision, covered investment funds are deemed to be securities that are listed on a national securities exchange and are not subject to section 24(b) of the Investment Company Act. While the effectiveness of this provision is now part of the regulatory framework, in light of its recent effectiveness and the 1,562 open-end funds, no closed-end funds, and 200 ETFs had a Morningstar analyst rating. We calculated that in total, as of December 2017, there were 9,564 mutual funds, 596 closed-end funds, and 1,629 ETFs and ETPs. See supra note 216. 244 See infra section III.C.5. 245 See, 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/ Landing/Morningstars-Two-Ratings-For-AssessingA-Fund. 246 See section 2(d) of the FAIR Act. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations limited time duration until it will be replaced by rule 139b, as a practical matter, it is unclear to what extent broker-dealers will rely on the interim provision to publish or distribute research reports about covered investment funds. a. Legal and Regulatory Framework Applicable to Statements Included in Covered Investment Fund Research Reports A broker-dealer’s publication or distribution of a covered investment fund research report could 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.247 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.248 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) of the Securities Act.249 In addition, rule 482 advertisements regarding open-end investment companies, trust accounts, and money markets funds are subject to requirements on the standardized presentation of performance information.250 Additionally, certain SRO rules governing content standards may apply to advertisements styled as ‘‘research reports’’ under rule 482 or to communications that would be covered investment fund research reports under rule. These include FINRA rule 2210, which contains general content standards that apply broadly to member 247 See supra note 5 and accompanying text. 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 167 and accompanying text. 249 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]. 250 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 166, 248. amozie on DSK3GDR082PROD with RULES2 248 Research VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 communications.251 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.252 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.253 b. Filing Requirements Under the baseline, 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 482 254 and registered investment company sales material, including rule 482 ‘‘omitting prospectus’’ advertisements as well as supplemental sales literature,255 are required to be filed with the Commission under section 24(b) of the Investment Company Act.256 Brokerdealers that are FINRA members are also subject to certain additional filing requirements under current FINRA rule 2210.257 251 See FINRA rule 2210(d)(1). supra note 183 (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 rule 139b). 253 In the Proposing Release, we asked commenters to supply data that could aid us in quantifying these costs. No such data was provided in the comment letters received. See Proposing Release, supra note 2, at 26812. 254 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 161. 255 See supra note 248. 256 Rule 24b–3 under the Investment Company Act deems these materials to have been filed with the Commission if filed with FINRA. See supra notes 144, 189 and accompanying text. 257 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 176–178, and accompanying text. 252 See PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 64203 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 provisions of the rules we are adopting 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 new rules. We conclude with a discussion of alternatives considered. 1. FAIR Act Statutory Mandate a. Benefits We believe that the expansion of the rule 139 safe harbor (as mandated by the FAIR Act) will generally reduce brokerdealers’ costs of publishing and distributing research reports about covered investment funds. These cost reductions are expected because under the new rules a broker-dealer could publish or distribute covered investment fund research reports without reliance on rule 482 or rule 34b–1 and without being required to file these reports under section 24(b) of the Investment Company Act and the rules and regulations thereunder.258 Brokerdealers publishing or distributing covered investment fund research reports in reliance on the expanded safe harbor will not be subject to the liability provisions of section 12(a)(2) of the Securities Act,259 rule 34b–1, or the filing requirements of section 24(b) of the Investment Company Act.260 Thus, they will 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).261 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’’ will 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 258 See supra section II.D.1. supra note 249. 260 See supra section II.D.1. 261 However, 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. 259 See E:\FR\FM\13DER2.SGM 13DER2 64204 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 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. 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,262 and—perhaps more importantly—that broker-dealers may enjoy a comparative advantage in its production.263 However, other studies have questioned the investment value of such research to investors 264 or its continued relevance.265 262 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). 263 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). 264 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, 40.1 Journal of Accounting and Economics 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). 265 See Oya Alt(nk(l(c ¸, Robert S. Hansen & Liyu Ye, Can analysts pick stocks for the long-run?, 119 VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 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’’).266 Although individual securities within a covered investment fund’s portfolio may be 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’’ 267 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.268 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 a valuable source of information for investors evaluating relative fund performance.269 We believe that the quantity of information available to potential investors of covered investment funds will increase as a result of brokerdealers’ increased publication and distribution of covered investment fund research reports. The rules we are adopting will also allow for greater flexibility in the type of information that 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). 266 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. 267 We mean this in the sense of providing a signal about future investment performance. 268 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). 269 See, e.g., W. J. Armstrong, Egemen Genc & Marno Verbeek, Going for Gold: An Analysis of Morningstar Analyst Ratings, Management Science (Aug. 2017). PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 broker-dealers may communicate to customers.270 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.271 b. Costs Prior experience and academic research suggests that, unchecked, broker-dealers’ conflicts of interest can lead to bias in research reports,272 and that such bias has the potential to adversely affect investor welfare.273 270 Currently such communications would be subject to rule 482 requirements, including standards on the presentation of performance information. See supra section II.C. 271 See Matthew Gentzkow & Jesse M. Shapiro, Media Bias and Reputation, 114 Journal of Political Economy 2, 280–316 (Apr. 1, 2006). 272 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). 273 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 Global Research Analyst Settlement, Litigation Release No. 18438 (Oct. 31, 2003) (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 2010 Modifications to Global Research Analyst E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 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 rule 139b safe harbor could increase opportunities for broker-dealers to promote funds from which they derive the most financial benefits.274 If such conflicts are unrecognized by or unknown to investors, they could negatively affect investor welfare. Although market mechanisms 275 as well as existing regulation 276 may limit the extent of such actions, there is the potential that they could nonetheless impose costs on investors—particularly retail investors.277 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,278 and also rule 139b,279 will 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 brokerdealer is an affiliated person of the investment adviser), we believe that there will be limited potential for the greatest conflicts of interest to impose costs on investors. Other conflicts of interest may nevertheless arise from incentives in fund distribution arrangements.280 Distributing broker-dealers may receive compensation from sales loads, 12b–1 fees,281 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 Settlement, Litigation Release No. 21457 (Mar. 19, 2010). 274 Such concerns were also noted by one commenter. See Morningstar Comment Letter. 275 See infra section III.C.1.b(2). 276 See infra section III.C.1.b(1). 277 See infra section III.C.1.b(2). 278 See section 2(f)(3) of the FAIR Act. 279 See rule 139b(a). 280 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). 281 See rule 12b–1 under the Investment Company Act [17 CFR 270.12b–1]. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 particular funds or share classes.282 Associated persons of broker-dealers (i.e., analysts) may face similar conflicts of interests arising from incentives in their compensation agreements.283 Finally, broker-dealers may have fewer direct or non-pecuniary incentives.284 However, in all of these cases, the risk that such conflicts of interest could result in actions that negatively impact information communicated to investors is mitigated by the fact that a brokerdealer will bear the costs of such actions, but generally may be unable to fully appropriate the benefits.285 It is difficult for us to quantify the aforementioned costs in the context of this rulemaking. We are not aware of any studies directly examining the role that conflicts of interest play in broker282 See infra note 298 (noting that the Commission has historically found broker-dealers to have violated sections 17(a)(2) and (3) of the Securities Act by making recommendations of more expensive mutual fund share classes while omitting material facts). 283 Such conflicts of interest arising from incentives in compensation agreements involving research analysts 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. 284 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 183. 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)]. 285 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. PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 64205 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.286 Although one commenter registered similar concerns,287 no commenters provided any data that would facilitate such a quantitative analysis.288 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 adopting,289 and certain market mechanisms will reduce these costs. (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.290 As discussed in detail above,291 the definition of ‘‘research report’’ for purposes of Regulation AC and FINRA rules 2241 and 2242 is narrower than the definition of ‘‘research report’’ for purposes of the FAIR Act and rule 139b. However, to the extent a research report meets both the definition of a research report under rule 139b and the definition of research report as defined in Regulation AC, Regulation AC will be applicable to that research report (and, if it meets the definition of ‘‘research report’’ in FINRA rule 2241, FINRA rule 2241 also will apply if the research report otherwise were within the scope of rule 2241 292). These rules may help promote objective and reliable research.293 286 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, 60 Journal of Banking & Finance 1, 284–295 (2015). 287 See Morningstar Comment Letter. 288 In the Proposing Release, we requested comment on our characterization of these costs. See Proposing Release, supra note 2, at 26816. 289 See infra section III.C.2. 290 See supra note 35; see also Proposing Release, supra note 2, at 26791 n.37. 291 See supra note 183. 292 See id. 293 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)]. Several studies have analyzed bias in E:\FR\FM\13DER2.SGM Continued 13DER2 64206 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 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.’’ 294 If a broker-dealer recommends 295 a covered investment fund to its customers, additional obligations under the federal securities laws and FINRA rules will apply. As a general matter, broker-dealers must deal with their customers fairly 296—and, as part of that obligation, have a reasonable basis for any recommendation.297 Furthermore, 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 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). 294 See supra section II.D.1. 295 See, e.g., Additional Guidance on FINRA’s New Suitability Rule, FINRA Regulatory Notice 12– 25 (May 2012), at Q.2, (regarding the scope of ‘‘recommendation’’), n.25. 296 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.’’). 297 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).’’). VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 conflicts of interest, including any economic self-interest.298 (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,299 which we believe can mitigate the effects of conflicts of interest on research reports.300 With respect to brokerdealers’ research on operating companies, analysts’ career concerns 301 have also been found to have similar effects, and, in principle, broker-dealers’ reputations could as well.302 However, 298 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.’’). 299 See infra section III.C.5. 300 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). 301 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, 60 The Journal of Finance 2, 673–717 (Apr. 1, 2005) see also Lily Fang & Ayako Yasuda, The Effectiveness of Reputation as a Disciplinary Mechanism in SellSide Research, 22 The Review of Financial Studies 9, 3735–3777 (Sept. 1, 2009) (‘‘Fang and Yasuda Article’’) 302 For a discussion of the role of reputation in financial intermediation, see Thomas J. Chemmanur & Paolo Fulghieri, Investment Bank Reputation, Information Production, and Financial PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 we believe it is unlikely that analyst career concerns or broker-dealer reputation will play as significant a role in the context of covered investment fund research reports which we expect to be aimed primarily at retail investors. Research reports about operating companies have traditionally been provided to institutional customers as part of a bundle of services provided by full-service brokerages.303 In this setting, broker-dealers benefit from institutional investors’ willingness to pay for broker-dealers’ additional bundled services (e.g., research).304 Such institutional customers are generally capable of producing similar reports, and so can evaluate the quality of broker-dealers’ research.305 Thus, they 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.306 With retail investors, information asymmetries are greater: Retail investors do not generally possess the capabilities to replicate an analyst report or evaluate its quality.307 Moreover, the problem of evaluating the performance of analysts is harder in the context of covered Intermediation, 49 The Journal of Finance 1, 57–79 (1994) (‘‘Chemmanur and Fulghieri Article’’). See also Fang and Yasuda Article, supra note 301 (analyst reputation mitigates bias, but institutional reputation does not). 303 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’’). We note however, that this model has been disrupted by the European MiFID II regulations that took effect in 2018. See e.g. CFA Institute, MiFID II: A New Paradigm for Investment Research, available at https://www.cfainstitute.org/ -/media/documents/support/advocacy/mifid_ii_ new-paradigm-for-research-report.ashx 304 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 may 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). 305 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 analysts’ recommendations while retail investors do not). 306 See supra section III.B.1.c. 307 See Mehran and Stulz Article, supra note 303. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 investment funds.308 Because institutional investors are not major investors in covered investment funds,309 we believe they are unlikely to provide market discipline in this context.310 We also acknowledge that biases resulting from conflicts of interest need not adversely impact investors if investors disregard,311 discount,312 or de-bias 313 the recommendations of conflicted analysts.314 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,315 may fail to de-bias or otherwise condition their trades based on the credibility of the recommendation,316 and could thus be led to invest in underperforming securities.317 308 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). 309 See supra section III.B.1.a. 310 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). 311 See Dugar and Nathan Article, supra note 272. 312 See Michaely and Womack Article, supra note 273. 313 See Lin and McNichols Article, supra note 272. 314 Institutional market participants generally attribute bias in sell-side analysts’ research reports to conflicts of interest. See Michaely and Womack Article, supra note 273. 315 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). 316 See id.; Malmendier and Shanthikumar Article, supra note 305. 317 See Mikhail Walther and Willis Article, supra note 315. See also Malmendier and Shanthikumar Article, supra note 305. 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 VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 2. Rule 139b As discussed above, rule 139b conditions eligibility for the safe harbor on satisfaction of several conditions.318 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).319 We believe that modeling rule 139b on rule 139 will benefit market participants through regulatory consistency. We address these conditions in turn in the sections that follow. a. Affiliate Exclusion Under the affiliate exclusion of rule 139b,320 a broker-dealer who is an affiliate of a covered investment fund (or is an investment adviser or an affiliated person of the investment adviser to a covered investment fund), would not be eligible for the safe harbor of 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.321 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 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). 318 See supra section II.B. 319 See supra paragraph accompanying notes 12– 15. 320 See section 2(f)(3) of the FAIR Act. See supra section II.A.1. 321 See supra section III.C.1.b. PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 64207 research reports to their customers on funds that they (or their affiliated persons) advise.322 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 new 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. The affiliate exclusion and associated guidance 323 will reduce the potential for retail investors to receive research reports containing materials from persons whose financial incentives create the greatest conflicts of interest.324 The affiliate exclusion is also likely to limit the benefits of the 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. We believe that under the affiliate exclusion, it would be inappropriate for such broker-dealers to publish or distribute research report provided by a covered investment fund or the fund’s affiliates.325 Thus, the affiliate exclusion could have the effect of limiting brokerdealers’ 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. 322 See supra notes 18–21 and accompanying text. supra section II.A.1. 324 Persons covered by the affiliate exclusion may have strong financial interests to increase sales of associated covered investment funds. See supra paragraph accompanying note 278. 325 Among other things, we believe 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 rule. See supra paragraph accompanying note 30. 323 See E:\FR\FM\13DER2.SGM 13DER2 64208 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 b. Regular-Course-of-Business Requirement Under rule 139b, research reports (both issuer-specific research reports and industry research reports) 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.326 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.327 The regular-course-ofbusiness requirement of 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.328 Given the breadth of the definition of ‘‘research report’’ under the FAIR Act (and the definition of ‘‘research report’’ that we are adopting under rule 139b), certain communications that are currently treated as covered investment fund advertisements under Securities Act rule 482 could fall under the rule 139b definition of ‘‘research report.’’ 329 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 BDCs. This may result in investors not being able to readily discern what constitutes a research report and what constitutes an advertisement about these issuers. We continue to 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.330 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 326 See 327 See supra sections II.B.1.c and II.B.2.b. supra notes 112–114 and accompanying text. 328 See section 2(b)(1) of the FAIR Act; see also supra note 101 and accompanying text. 329 See supra note 162 and accompanying text. 330 See Proposing Release, supra note 2, at 26797. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 business’’ could, in practice, prove uniquely challenging in the covered investment funds context.331 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.332 Institutional customers are generally capable of producing similar reports, and so can more readily evaluate the quality of broker-dealers’ research.333 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 investors.334 Thus, we believe that cultivating a reputation for high-quality research is less likely to serve as the primary business rationale for brokerdealers’ 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 will not be as clear. Second, 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 331 See Proposing Release, supra note 2, at 26797– 98 (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 requirement should be modified to address broker-dealers that have not previously published or distributed covered investment fund research reports)). 332 See Mehran and Stulz Article, supra note 303. 333 See id; see also Malmendier and Shanthikumar Article, supra note 305. 334 See supra section III.B.1.c. PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 fund.335 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.336 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. We noted in the Proposing Release that due to the aforementioned distinctions in the information environment and business rationale, we believed that the regular-course-ofbusiness requirement in the context of rule 139b may be more challenging to apply in practice than the regularcourse-of-business requirement in the context of rule 139 and that the potential benefits of this requirement in rule 139b may be more limited. We also noted that the effects of the regularcourse-of-business requirement would be clearer in cases where, in the case of issuer-specific research reports, the 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 would condition the availability of the safe harbor on the research report not representing the initiation or reinitiation of coverage by the broker-dealer publishing or distributing said research report. However, because the universe of covered investment funds is dominated 335 The regular-course-of-business requirement generically requires ‘‘research reports’’ to be published or distributed in the regular course of a broker-dealer’s business and is not limited to covered investment fund research reports. See Proposing Release, supra note 2, at 26797. 336 See supra notes 267–268 and accompanying text. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations by funds with a class of securities that could be considered to be in substantially continuous distribution,337 the bright-line test of the regular-courseof-business requirement would impact only a small subset of funds. Related concerns were voiced by several commenters who questioned the feasibility of satisfying the regularcourse-of-business requirement under the proposed rules.338 As discussed above, we have included additional guidance to mitigate concerns about the interpretation of the regular-course-ofbusiness requirement.339 While we believe that this guidance should address commenters’ concerns about the feasibility of satisfying the regularcourse-of-business requirement, we acknowledge that—due to the reasons discussed above—broker-dealers evaluating whether their research activities satisfy the regular-course-ofbusiness requirement are likely to face more uncertainty when those activities relate to covered investment funds than when those activities relate to operating companies. However, we believe that broker-dealers would only issue covered investment fund research reports if the benefits are likely to outweigh the costs, including uncertainty. c. Reporting History and Minimum Market Value Requirements for Issuers Appearing in Issuer-Specific Research Reports Under rule 139b, a broker-dealer’s publication or distribution of issuerspecific research reports does 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.340 Issuers are also 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 section 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 rule as well as 337 See supra section III.B.1.a. supra sections II.B.1.c, II.B.2.b. 339 See supra paragraph accompanying note 118. 340 See rule 139b(a)(1)(i)(B). amozie on DSK3GDR082PROD with RULES2 338 See VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 to have timely filed all required reports during the preceding 12 calendar months.341 The covered investment funds market is dynamic.342 In 2017, more than six hundred covered investment funds entered the market, while more than eight 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.343 Thus, for covered investment funds, the universe of young—and potentially lessfollowed—issuers is large.344 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.345 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.346 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 341 Including Forms N–CSR, 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 rule 139b(a)(1)(i)(A). 342 See supra section III.B.1.a. 343 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. 344 For example, Morningstar notes that funds with short track records are unlikely to be provided coverage. See Morningstar, Morningstar Manager Research Coverage Decision-Making (June 2018), available at https://morningstardirect .morningstar.com/clientcomm/Morningstar_ Manager_Research_Coverage_Decision_Making.pdf. 345 See supra section III.B.1.a. 346 See supra note 310 and accompanying text. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 64209 have a disproportionate effect on retail investors’ beliefs about the fund and— in the case of a biased research report— 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 limited trading or interest.347 As noted by several commenters, because young and small covered investment funds are relatively common, the costs associated with these conditions on the availability of a safe harbor could be significant.348 In particular, as shown in Table 1, the $75 million minimum public market valuation condition will 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.349 Research reports about nearly half of extant ETFs, ETPs will not qualify for the safe harbor.350 Availability of the safe harbor would be least impacted for research reports about BDCs and closed-end funds.351 Although small funds represent a very small fraction of covered investment fund assets, they are relatively large in number.352 Because nearly one-third of covered investment funds will not satisfy the eligibility criteria for the safe harbor, we believe that those funds will be less likely to receive coverage by broker-dealers insofar as the inability to rely on the safe harbor reduces brokerdealers’ willingness to publish and distribute research reports. 347 For example, while Morningstar provides analyst ratings for 200 ETFs and 1,562 open-end funds, among ETFs and open-end funds falling below the $75 million minimum public market value threshold, only 27 received an analyst rating. See supra notes 243 and 344. 348 See SIFMA Comment Letter I; ICI Comment Letter; Fidelity Comment Letter; see also BlackRock Comment Letter. 349 30% of all covered investment funds have public market valuations less than $75 million. See Table 1. 350 41% of ETF and ETPs have public market valuations less than $75 million. See Table 1. 351 12% of closed-end funds and 7% of BDCs have public market valuations less than $75 million. See Table 1. 352 See Table 1. E:\FR\FM\13DER2.SGM 13DER2 64210 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations 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 are based on data from CRSP mutual fund database (2017Q3). Close-end fund statistics are based on data from CRSP monthly stock file (Dec. 2017). BDC statistics are based on Commission’s listing of registered BDCs, and regulatory filings (2017) compiled by Compustat and Audit Analytics] Funds with public market value <$75 million Covered investment fund type Number of funds (%) Open-end ......................................................................................................................................................... Closed-end ....................................................................................................................................................... ETF/ETP .......................................................................................................................................................... BDC ................................................................................................................................................................. 30 12 41 7 <1 <1 <1 <1 Total .......................................................................................................................................................... 30 <1 Several commenters raised concerns that—in addition to the aforementioned costs—compliance with the reporting history and minimum market value requirements as proposed could be operationally challenging for brokerdealers.353 In general, we do not believe that verifying covered investment funds’ reporting history and public market valuation represents a significant additional burden for broker-dealers in this position.354 Another commenter noted that some broker-dealers provide investors research about large numbers of funds on a largely automated basis, and that ensuring compliance with the reporting history and minimum public market value requirements would create ‘‘operational hurdles’’ for these brokerdealers.355 We believe that brokerdealers that choose to automate publication of research reports will make significant investments in technology to implement this automation, and that broker-dealers with infrastructure capable of automating publication of research reports should have little difficulty implementing the procedures required for similarly automating the verification of these requirements.356 However, in a change from the proposal, final rule amozie on DSK3GDR082PROD with RULES2 Fund assets (%) 353 See SIFMA Comment Letter I; see also Fidelity Comment Letter. 354 For example, much of this information is currently accessible through the publicly available EDGAR system and/or third-party data providers. 355 See Fidelity Comment Letter; see also paragraphs accompanying supra notes 64, 73. 356 We note that a software system capable of automatically generating non-trivial research reports about a given covered investment funds would contain data access modules providing programmatic access to the covered investment fund’s historical filings and pricing data. Conditional on the existence of such modules, implementation of tests for the reporting history and minimum market value requirements would represent a de minimis cost. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 139b will not require the minimum public market valuation condition to be verified at the time of reliance.357 Rather, the final rule requires that this condition be satisfied at the time of the broker’s or dealer’s first publication or distribution of a research report on the covered investment fund, and at least quarterly thereafter.358 We believe this change should simplify compliance without materially affecting the provisions’ effectiveness.359 Finally, one commenter raised concerns that because of shortcomings in the data currently available about affiliates’ holdings, it may not be possible for broker-dealers to establish the public market value of a covered investment fund if affiliate holdings are to be excluded from the calculation.360 Although we believe that that the information required to make this calculation may be available to brokerdealers, we understand that it may not currently be generally available in a structured form amenable to automation. This could present operational difficulties for brokerdealers developing processes for automated report publication. In a change from the proposal, final rule 139b eliminates the requirement that the public market valuation calculation be calculated net of affiliates’ holdings for most covered investment funds. We believe that this change is unlikely to materially affect the effectiveness of the minimum public market value 357 See supra section II.B.1.b. rule 139b(a)(1)(i)(B). 359 We believe that implementing periodic assessments would be simpler and less costly than implementing an assessment at the time of reliance. At the same time, we do not believe that there would be a material difference in the set of covered investment funds captured by the minimum public valuation threshold under these two approaches. See supra paragraph accompanying note 104. 360 See SIFMA Comment Letter II. 358 See PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 requirement 361 while eliminating a plausible obstacle to its automated verification in the vast majority of cases. We acknowledge, however, that retaining the requirement to adjust for affiliate holdings in the public market valuation calculation for commodityand currency-based trusts could reduce the amount of automated coverage provided to such trusts by brokerdealers.362 d. Reporting Requirement for Issuers Appearing in Industry Reports Under 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).363 As discussed above, these 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 361 Covered investment funds are subject to unique legal provisions that generally restrict affiliate ownership and provide additional legal protections when affiliate ownership is permitted. See, e.g., Investment Company Act sections 12, 17, and 57 and rules thereunder. In addition, unlike rule 139, rule 139b does not permit affiliates of covered investment funds to rely on the safe harbor, mitigating the risk that a fund with significant affiliate holdings would be the subject of market moving research by those same affiliates. 362 See supra note 99. 363 See 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 calendar months. See supra section II.B.1.a. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations beyond marginally improving economic efficiency by more closely aligning regulations with their intended context. e. Content and Presentation Requirements for Industry Research Reports Under rule 139b, the content and presentation standards for industry research reports of rule 139 are tailored to the context of covered investment funds. Under rule 139b (and rule 139), issuers appearing in industry research reports are subject to fewer conditions than issuers that are subjects of issuerspecific research reports.364 We believe that in the absence of content and presentation requirements such as these, 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 content and presentation standards we are adopting have benefits similar to those of the parallel content and presentation requirements in rule 139, and provide meaningful limits for industry research reports.365 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. f. Presentation of Performance Information Given the definition of ‘‘research report’’ under the FAIR Act (and the definition of ‘‘research report’’ being adopted 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 rule 139b safe harbor.366 In the Proposing Release, we raised concerns that not including provisions similar to rule 482 in proposed rule 139b 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.367 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. As discussed above, unlike in the Proposing Release, final rule 139b incorporates provisions on the presentation of performance information in research reports about registered investment companies that mirror those of rule 482 and—with respect to closedend funds—Form N–2.368 Incorporating these presentation standards in rule 139b reduces the potential for confusion between (i) registered open-end management investment company advertisements and selling materials covered by rule 482 and registered closed-end investment company selling materials covered by Form N–2 and (ii) rule 139b research reports.369 Additionally, incorporating some of these provisions into rule 139b would reduce the potential for investor confusion resulting from divergent standards in the presentation of performance data. Because fees can represent a significant drag on investment returns,370 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,371 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 367 See amozie on DSK3GDR082PROD with RULES2 364 See supra sections II.B.1, II.B.2. 365 See supra sections II.B.2.c, II.B.2.d. 366 See supra note 162 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 rule 139b. See supra note 165 and accompanying text. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 Proposing Release, supra note 2, at 26825. 482 does not set forth requirements on the presentation of performance information in research reports about registered closed-end investment companies. See supra section II.C. 369 See supra paragraph accompanying notes 165– 167. 370 See, e.g., Mark M. Carhart, On Persistence in Mutual Fund Performance, 52 The Journal of Finance 1, 57–82 (Mar. 1997). 371 See Erik R. Sirri & Peter Tufano, Costly Search and Mutual Fund Flows, 53 The Journal of Finance 5, 1589–1622 (Oct. 1, 1998). 368 Rule PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 64211 promote a covered investment fund, or to promote certain funds over others.372 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 unsophisticated investors. We believe that these additional requirements on the presentation of performance information will limit opportunities for selective performance disclosure and will curtail opportunities to circumvent the performance reporting requirements of rule 482 and Form N– 2. By limiting opportunities for selective performance disclosure, we believe that final rule 139b will also reduce the potential for investor confusion. Under the final rule, there will 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 reports issued by different brokerdealers. These results would benefit investors. As discussed in the Proposing Release, the extent of the benefits resulting from requirements on the presentation of performance information depends on their 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 in the Proposing Release, we believe 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. We believe that rule 482 standards on the presentation of performance information have been effective at limiting selective disclosure in applicable registered investment company advertisements, and that they will be similarly effective for research reports falling under rule 139b. Moreover, as noted above, we believe that retail investors will be the primary consumers of such research reports, and that such investors would be most likely 372 See E:\FR\FM\13DER2.SGM supra section III.C.1.b. 13DER2 64212 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations to benefit from these additional provisions. As discussed in the Proposing Release, we believe that the most significant costs associated with additional requirements on the manner in which performance information may be presented would result from their potential to limit the manner in which the content of broker-dealers’ research reports is presented. Although we are not preventing alternative performance measures from being included in research reports, by limiting the prominence afforded to such performance measures we 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. We believe that broker-dealers’ direct compliance costs under these additional provisions would be minimal. Because we believe that broker-dealers that will publish research reports are likely currently distributing advertisements under rule 482, these broker-dealers likely already have processes and systems to produce charts and tables of performance measures using timely data under the presentation standards required by the final rules. However, we acknowledge that the final rules’ will impose costs on broker-dealers that did not previously distribute advertisements under rule 482 and they would need to develop processes and systems to implement these presentation standards. We estimate the one-time implementation costs attributable to the new presentation standards for each broker-dealer publishing research reports to be approximately 5 hours or $1,310.373 Further, we expect the systems necessary to satisfy the requirement for timely data under rule 482(g) would generally be available to broker-dealers publishing research reports. amozie on DSK3GDR082PROD with RULES2 3. Rule 24b–4 Rule 24b–4 excludes 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 373 Calculated as 5 hours × Senior Business Analyst at $262 per hour = $1.310. The hourly wage rate is from SIFMA’s Management & Professional Earnings in the Securities Industry 2013, modified to account for an 1,800-hour work year; multiplied by 5.35 to account for bonuses, firm size, employee benefits and overheard; and adjusted to account for the effects of inflation. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 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 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).374 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 rule.375 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), 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).376 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 new 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 were subject to FINRA’s filing requirements would no longer be subject to routine review.377 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 rule 24b–4, may be to reduce the monitoring by FINRA and the Commission of brokerdealers’ communications with 374 See supra note 183 and accompanying text. id. 376 See id. 377 See supra section II.D.1. 375 See PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 customers for compliance with the applicable rules and regulations.378 4. Amendments to Rule 101 of Regulation M and Form 12b–25 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.379 However, rule 101 provides an exception for research activities that satisfy the conditions of Securities Act rule 138 or rule 139. The conforming amendment expands this exception to include research activities that satisfy the conditions of rule 139b. We believe that broker-dealers would generally be unable to make use of the rule 139b safe harbor absent this conforming amendment. Consequently, we do not consider its effects separately. As discussed above, we are making a technical amendment to Form 12b–25 to replace references to Form N–SAR with references to Form N–CEN and to remove the checkbox and accompanying text related to transition reports on Form N–SAR.380 The amendments to Form 12b–25 that the Commission is adopting are ministerial actions that correct outdated references and therefore will have no separate economic effect, including no effect on competition. 5. Effects on Efficiency, Competition, and Capital Formation The primary effects on economic efficiency and capital formation resulting from 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 brokerdealers’ production of research reports about covered investment funds—that we expect to occur as a result of the FAIR Act’s statutory mandates 381—is valuable to investors, we expect it to increase allocative efficiency, with 378 But see supra note 195 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. 379 See supra section II.E. 380 See id. 381 See supra section III.C.1.a. E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations 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.382 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 383 on the availability of the safe harbor in rule 139b 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 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.384 In addition, we believe that the Commission’s various tailoring of the new 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 supra section III.C.1.b. 383 See supra section III.C.2. 384 See supra section III.C.2.a. amozie on DSK3GDR082PROD with RULES2 382 See VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 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.385 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,386 we believe that most broker-dealers will continue to rely on content licensed from independent firms.387 We also believe that there are competitive implications stemming from the guidance we have given to address possible circumvention of the affiliate exclusion.388 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. 6. Alternatives Considered We considered several alternative approaches to implementing the FAIR Act mandates that could satisfy the 385 See supra section III.B.1.c. supra section III.B.1.a. 387 We expect that broker-dealers that choose to publish research on covered investment funds will generally not license it to their competitors. 388 See supra section III.C.2.a. 64213 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 $75 million minimum public market value requirement will promote investor protection by limiting research reports to issuers that have a demonstrated market following.389 However, we acknowledge that it will mean that research reports about significant numbers of smaller covered investment funds would not qualify for inclusion in research reports under the safe harbor.390 We believe that this will reduce the effect of the new rules on the availability of research reports about smaller covered investment funds.391 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 undermining investor protection (because it would not materially increase the number of qualifying funds without a demonstrated market following). 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 386 See PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 389 See supra section II.B.1.b. SIFMA Comment Letter I; see also ICI Comment Letter; BlackRock Comment Letter. 391 See supra section III.C.2.c. 390 See E:\FR\FM\13DER2.SGM 13DER2 64214 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations 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. Figure 5 shows that although the safe harbor would not be available to significant numbers of covered investment funds under the $75 million threshold, material increasing its availability would only be 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. 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.392 At the same time, we believe that imposing the threshold would only restrict the availability of research for covered investment funds that have small economic significance. As shown in Figure 7, covered investment funds falling below the $75 million threshold account for less than 1% of the dollars invested in each of the four covered investment fund types. 392 One commenter suggested lowering the threshold to no more than $20 million; see SIFMA Comment Letter I. Another commenter noted that 41% of all ETFs and exchange-traded products would be excluded by the $75 million threshold; see Fidelity Comment Letter. Although these commenters argued that lowering the threshold could benefit investors by increasing the number of funds for which covered investment fund research reports were available, they did not address the question of the potential cost to investors resulting from a lower threshold. See supra section III.C.2.c. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 E:\FR\FM\13DER2.SGM 13DER2 ER13DE18.004</GPH> amozie on DSK3GDR082PROD with RULES2 value requirement that is greater than what is required under rule 139). Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations 64215 Covered Investment Funds' Public Market Values, 2017 Truncated histogram of covered investment funds' public market values ($0-$150 million). Fund Type 400 ~ mmx Closed-End Fund ETFIETP Mutual Fund 200 50 0 100 ISO Public Market Value($ millions) Figure 6: Truncated histogram of covered investment funds' public market values ($0--$150 million), 2017. Altcmativc Minimum Public Market Value l'lm:sholds Percemage of covered investmellt fimd c1o1lars invested in fimds with pubic market v.Wes (2017) below a given t1Jres1Jho1d. 1S SO 100 Pubic Market Value (S m5ms) what is required under rule 139.393 This effectively prevents us from conditioning the availability of the safe 393 See VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 PO 00000 harbor for research reports on the subject covered investment fund having a public float of more than $75 million. Consequently, we do not consider supra note 83 and accompanying text. Frm 00037 Fmt 4701 Sfmt 4700 E:\FR\FM\13DER2.SGM 13DER2 ER13DE18.006</GPH> The FAIR Act prevents us from conditioning the availability of the safe harbor on a minimum public market value requirement that is greater than ER13DE18.005</GPH> amozie on DSK3GDR082PROD with RULES2 Figure 7: Percentage of covered investment fund dollars invested in funds with a public market value (2017) below a given threshold. 64216 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations higher minimum public market value thresholds. b. Conditions on Issuers Appearing in Industry Research Reports amozie on DSK3GDR082PROD with RULES2 (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 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 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. 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 VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 businesses).394 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 research 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 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 482.395 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.396 Moreover, permitting affiliated funds to be included in such comprehensive lists could result in confusion: Brokerdealers 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. c. Approach to Regular-Course-ofBusiness Requirement As discussed in section III.C.2.b, in principle we expect a regular-course-ofbusiness 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 394 See supra section II.B.2.c. id. 396 See supra section III.C.1.b. 395 See PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 course of business’’ could present more challenges than in the rule 139 context of research reports about the securities of operating companies.397 Thus, we requested comment on and have considered various alternative approaches to the regular-course-ofbusiness requirements.398 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.399 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.400 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).401 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’s having operated for some amount of time, could lead to the publication of reports that are more likely to be recognized as research.402 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.403 In rule 139b, we have chosen not to incorporate these more specific alternative approaches to the regular397 See supra section II.B.2.b. Proposing Release, supra note 2, at 26797– 98. We did not receive comments specifically addressing the economic effects of alternative approaches to the regular-course-of-business requirement. 399 See id. 400 See id. 401 See id. 402 See id. 403 See Chemmanur and Fulghieri Article, supra note 302; 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 301 (where sell-side research analysts’ reputation mitigates manifestation of conflicts of interest from underwriting relationships, while institutional reputation does not). 398 See E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations course-of-business requirement. While we note the potential benefits of such approaches in enhancing the value that covered investment fund research reports may provide investors, we also understand that these more specific alternatives may restrict the flow of relevant information to investors. amozie on DSK3GDR082PROD with RULES2 d. Presentation of Performance Information As discussed above, we have chosen to incorporate rule 482 and Form N–2 requirements on the presentation of performance information in final rule 139b.404 We also considered the alternatives of including rule 156 guidance factors (or a subset thereof), requirements relating to disclosure of nonrecurring fees, and requirements on the timeliness of performance data.405 We also considered a requirement in rule 139b to incorporate general narrative disclosure into a research report about a registered investment company, aimed at reducing potential investor confusion.406 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).407 In general, imposing additional requirements on the presentation of performance information would further reduce opportunities for research reports to present fund performance information in a manner inconsistent with similar information presented in advertisements and supplemental sales literature. We believe that these additional requirements would therefore reduce investor confusion and opportunities for the safe harbor to be used to present misleading information to investors.408 However, imposing these additional requirements would increase compliance costs for brokerdealers. In particular, imposing rule 156 (or similar) guidance factors would make determinations of compliance with the provisions of rule 139b less certain. This could make broker-dealers reluctant to rely on the rule 139b safe 404 See 405 See supra sections II.C and III.C.2.f. Proposing Release, supra note 2, at 26825– 26. 406 See id. id. 408 See id. 407 See VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 harbor and impede the publication and distribution of broker-dealer research on covered investment funds. The alternatives of including various forms of disclosures to the effect that a ‘‘research report’’ is not subject to the Commission’s regulations applicable to sales and advertising would impose the lowest costs on broker-dealers. However, we believe that requiring disclosure to this effect is unlikely to have significant beneficial effects in the retail context. IV. Paperwork Reduction Act New rule 139b contains ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’).409 Specifically, rule 139b(a)(3) requires that brokerdealers that provide performance information in their covered investment fund research reports about (i) open-end funds must be in accordance with specified rule 482 presentation requirements or (ii) closed-end funds must be in accordance with a specified instruction set forth in Form N–2. The title for this collection of information is: ‘‘Rule 139b Disclosure of Standardized Performance,’’ a new collection of information. We are requesting comment on this collection of information requirement in this Release, and intend to submit these requirements to the Office of Management and Budget (‘‘OMB’’) for review under the PRA.410 If approved, responses to the new collection of information requirement would not be mandatory for brokerdealers seeking to rely upon rule 139b but would be necessary for those brokerdealers that would like to provide performance information in their covered investment fund research reports. Responses to the information 409 44 U.S.C. 3501–3521. the Proposing Release, we did not submit a PRA analysis because—although there was a set of requests for comment on the subject—the proposal did not include a standardized performance disclosure requirement, and we believed our proposal did not contain a ‘‘collection of information’’ requirement within the meaning of the PRA. See Proposing Release, supra note 2, at 26826. As discussed in the Proposing Release, supra note 2, at 26826, and 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 rule 139b safe harbor. This could result in a reduction in the information collection burdens for rules 482 and 34b–1 if fewer materials are filed. In connection with the extension of a currently approved collection for rules 482 and 34b–1, the Commission will adjust the burdens associated with these collections of information to reflect these changes, as appropriate. At this time, we do not have any comments regarding overall burden estimates for the final rule. This Release is requesting such comments. 410 In PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 64217 collections will not be kept confidential. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. In the Proposing Release, we solicited comment on whether rule 139b should include a standardized performance disclosure requirement.411 In response to comments received, we have decided to adopt such a requirement.412 We believe that standardized performance presentation is an appropriate requirement because investors tend to consider fund performance a significant factor in evaluating or comparing investment companies, and the requirement addresses potential investor confusion if a communication were not easily recognizable as research as opposed to an advertising prospectus or supplemental sales literature. Rule 139b requires that research reports about open-end funds that include performance information must present it in accordance with paragraphs (d), (e), and (g) of rule 482. Rule 139b also requires that research reports about closed-end funds that include performance information must present it in accordance with instructions to item 4.1(g) of Form N–2. It is difficult to provide estimates of the burdens and costs for those brokerdealers that will include performance information in a rule 139b research report. As discussed above, this is difficult to estimate because current data collected does not reflect the affiliate exclusion, does not include the entire universe of covered investment funds, and it is uncertain what percentage of communications currently filed as rule 482 advertising prospectuses (or rule 34b–1 supplemental sales materials) will instead be published in reliance on rule 139b, as covered investment fund research reports.413 For purposes of the PRA, we estimate that 10% of the rule 482 and rule 34b–1 communications currently filed by broker-dealers with FINRA (approximately 65,000) could be considered as rule 139b covered investment fund research reports. We estimate that broker-dealers will publish annually 6,500 (10% of 65,000) covered investment fund research reports. Moreover, we assume for purposes of the PRA that all estimated rule 139b research reports will include fund performance information. We further 411 See Proposing Release, supra note 2, at 26803– 04. 412 See supra section II.C. supra note 239 and accompanying paragraph. 413 See E:\FR\FM\13DER2.SGM 13DER2 64218 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations estimate that 1,417 broker-dealers would likely be respondents to the collection of information with a frequency of 4.6 responses per year.414 We further estimate that 50% of these broker-dealers will have experience in complying with standardized performance requirements under rule 482. For the 50% of this subset of broker-dealers that do not have experience with complying with rule 482, we estimate that there will be a one-time implementation cost for each broker-dealer of 5 internal burden hours. Additionally, we estimate that each research report will require 3 hours of ongoing internal burden hours by a broker-dealers’ personnel to comply with the rule 139b collection of information requirements, which for each broker-dealer is estimated to be 13.8 internal burden hours.415 Accordingly, we estimate that the standardized performance presentation requirements will result in an average annual hour burden of about 16.3 hours per broker-dealer 416 in the first year of compliance and about 13.8 hours per broker-dealer for each of the next two years. Amortized over three years, the average annual hour burden will be about 14.63 hours per broker-dealer.417 In sum, we estimate that rule 139b’s requirements will impose a total annual internal hour burden of 20,731 hours on broker-dealers.418 We do not think there is an external cost burden associated with this collection of information. Request for Comment We request comment on our approach and the accuracy of the current estimates. Pursuant to 44 U.S.C. 3506(c)(2)(A), the Commission solicits comments to: (1) Evaluate whether the collections of information are necessary for the proper performance of the functions of the agency, including whether the information will have practical utility; (2) evaluate the accuracy of the Commission’s estimate of the burden of the collections of information; (3) determine whether there are ways to enhance the quality, utility, and clarity of the information to amozie on DSK3GDR082PROD with RULES2 414 See supra note 230 and accompanying text. 6,500 covered investment fund research reports/ 1,417 broker-dealers = 4.6 annual responses per broker-dealer. 415 4.6 annual responses per broker-dealer × 3 internal burden hours = 13.8 annual internal burden hours per broker-dealer. 416 (50% of * 13.8 hours ongoing compliance) + (50% * (13.8 hours ongoing compliance + 5 hours of initial compliance hours)). 417 ((16.3 internal burden hours in year 1) + (13.8 internal burden hours in year 2) + (13.8 internal burden hours in year 3))/3. 418 14.63 annualized burden hours * 1,417 brokerdealers. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 be collected; and (4) evaluate whether there are ways to minimize the burden of the collections of information on those who are required to respond, including through the use of automated collection techniques or other forms of information technology. The agency has submitted the proposed collections of information to OMB for approval. Persons wishing to submit comments on the collection of information requirements of the proposed amendments should direct them to the Office of Management and Budget, Attention Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, Washington, DC 20503, and should send a copy to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549, with reference to File No. S7–11–18. As OMB is required to make a decision concerning the collections of information between 30 and 60 days after publication of the proposal, a comment to OMB is best assured of having its full effect if OMB receives it within 30 days of publication. Requests for materials submitted to OMB by the Commission with regard to these collections of information should be in writing, refer to File No. S7–11–18, and be submitted to the Securities and Exchange Commission, Office of FOIA Services, 100 F Street NE, Washington, DC 20549. V. Final Regulatory Flexibility Act Analysis This Final Regulatory Flexibility Act Analysis has been prepared in accordance with section 4(a) of the Regulatory Flexibility Act (‘‘RFA’’).419 It relates to new rule 139b, new rule 24b– 4, and revisions to the rules under the Securities Act and the Exchange Act to implement the FAIR Act. An Initial Regulatory Flexibility Analysis (‘‘IRFA’’) was prepared in accordance with the RFA and included in the Proposing Release.420 The Proposing Release included, and solicited comment on, the IRFA. A. Need for, and Objectives of, the Rules and Rule Amendments Rule 139b provides that, if certain conditions are satisfied, a brokerdealer’s publication or distribution of a covered investment fund research report is 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 419 See 420 See 5 U.S.C. 604(a). Proposing Release, supra note 2, at 26826– 29. PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 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. 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 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 new rule 139b). The revision to rule 101 under Regulation M is 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 rule 139b under the Securities Act are met. The new rules and rule revisions 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 new rules and rule revisions are discussed in more detail in section II above. B. Significant Issues Raised by Public Comments In the Proposing Release, we requested comment on each aspect of the IRFA, including the number of small entities that would be affected by the proposed rules and amendments, the existence or nature of the potential impact of the proposals on small entities discussed in the analysis and how to quantify the impact of the proposed rules. We did not receive comments specifically addressing the impact of the rules and amendments on small entities subject to the rule. C. Small Entities Subject to the Rules The new rules affect broker-dealers that publish or distribute covered investment fund research reports. As such, broker-dealers that are small E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations entities are affected by the adopted 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),421 and it is not affiliated with any person (other than a natural person) that is not a small business or small organization.422 As of December 31, 2017, the Commission estimates that there were approximately 1,043 brokerdealers that would be considered small entities as defined above.423 To the extent a small broker-dealer publishes or distributes covered investment fund research reports and seeks to rely on the rule 139b safe harbor—and is without a significant research department or wants to rely on pre-publication materials distributed by a covered investment fund, its adviser, or affiliated persons—it may be significantly affected by the final rules. Generally, we believe larger brokerdealers engage in these activities, and we did not receive comments on whether and how the rules we are adopting today affect small brokerdealers. We also did not receive comment on the number of small entities that would be affected by our adoption, including any available empirical data. amozie on DSK3GDR082PROD with RULES2 D. Reporting, Recordkeeping, and Other Compliance Requirements We believe that there are no reporting, recordkeeping, and other compliance requirements with respect to rule 139b and the 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 rule 139b and the revision to Regulation M. Rule 139b extends the safe harbor under rule 139 to broker-dealers’ publication or distribution of covered investment fund research reports. As a result of the FAIR Act communications that historically have been treated as 421 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 (or in the time that it has been in business, if shorter).’’ See id. 422 See rule 0–10(c)(2) under the Exchange Act [17 CFR 240.0–10(c)(2)]. 423 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]. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 covered investment fund advertisements under rule 482 now could fall under the new 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.424 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.425 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.426 These filings are typically done by broker-dealers’ compliance staff. The Commission implemented section 2(b)(4) of the FAIR Act via new 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.427 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).428 Thus, covered investment fund research reports, by operation of rule 24b–4, 424 See 15 U.S.C. 80a–24(b); 17 CFR 270.24b–3; supra section II.D.1. 425 See supra section II.D.1. 426 See supra notes 187–189 and accompanying text. Rule 24b–3 under the Investment Company Act deems these materials to have been filed with the Commission if filed with FINRA. See id. 427 See rule 24b–4; see also discussion accompanying supra notes 179–183. 428 See supra paragraph accompanying notes 183– 185. PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 64219 would no longer be subject to filing requirements under section 24(b) because they would be subject to the general content standards of FINRA rule 2210(d)(1).429 Rule 24b–4 would affect broker-dealers that, in lieu of a safe harbor such as that 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. The Commission estimates that there were approximately 1,043 broker-dealers, as of December 31, 2017, that would be considered small entities as defined above.430 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 will be reduced. However, large and small broker-dealers will not be affected differently by rule 24b–4. The amendments are discussed in detail in Section II above. We discuss the economic impact, including the estimated compliance costs and burdens, of the amendments in Section III above. E. Agency Action To Minimize Effect on Small Entities 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 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 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 conditions, would 429 See 430 See E:\FR\FM\13DER2.SGM supra section II.D.1. supra note 423. 13DER2 amozie on DSK3GDR082PROD with RULES2 64220 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations 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 new rules impose any significant new compliance obligations, because the new 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 rule 139b’s framework, including its scope and conditions, is modeled after and generally tracks rule 139.431 Rule 139 does not incorporate conditions that 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 rule 139b incorporate conditions that would affect the availability of the new rule’s safe harbor differently based on whether a brokerdealer is a small entity. We have considered whether a different regularcourse-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.432 This could have had the effect of limiting the availability of the 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,433 we are not adopting a regular-course-of-business requirement, in either the new rule 139b provisions on issuer-specific research reports or the 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 amendments for small entities would satisfy those objectives. Because rule 139b’s framework (including its scope and conditions) is modeled after and generally tracks rule 139, rule 139b, like rule 139, does not treat small brokerdealers differently than large brokerdealers, including by clarifying, consolidating, or simplifying any conditions. Further, with respect to using performance rather than design standards, the rule generally uses performance standards for all brokerdealers relying on the rule, regardless of size. We believe that providing brokerdealers with the flexibility with respect to the design of covered investment fund research reports that they may publish or distribute in reliance on the 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 rule is defined broadly, as discussed above 434). However, we note that the 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 new rule, regardless of their size.435 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 rule is not used to circumvent the prospectus requirements of the Securities Act.436 VI. Statutory Authority We are adopting 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. 434 See 431 See supra paragraph accompanying notes 12– 15. 432 See 433 See supra section III.C.6.c. id. VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 supra section II.A.2. e.g., supra sections II.B.1.a (Reporting History and Timeliness Requirements) and II.B.1.b (Market Following Requirement). 436 See supra notes 49–50 and accompanying text. 435 See, PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 17 CFR Part 242 Brokers, Fraud, Reporting and recordkeeping requirements, Securities. 17 CFR Part 249 Reporting and recordkeeping requirements, Securities. 17 CFR Part 270 Confidential business information, Fraud, Investment companies, Life insurance, Reporting and recordkeeping requirements, Securities. Text of Rules and Amendments For the reasons set out in the preamble, title 17, chapter II of the Code of the Federal Regulations is 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. * * * * * ■ 3. Add § 230.139b to read as follows: E:\FR\FM\13DER2.SGM 13DER2 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 § 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–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 (B) At the time of the broker’s or dealer’s initial publication or distribution of a research report on the covered investment fund (or reinitation VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 thereof), and at least quarterly thereafter; (1) If the covered investment fund is of the type defined in paragraph (c)(2)(i) of this section, the aggregate market value of voting and non-voting common equity held by affiliates and nonaffiliates equals or exceeds the aggregate market value specified in General Instruction I.B.1 of Form S–3 (§ 239.13 of this chapter); (2) If the covered investment fund is of the type defined in paragraph (c)(2)(ii) of this section, the aggregate market value of voting and non-voting common equity held by non-affiliates equals or exceeds the aggregate market value specified in General Instruction I.B.1 of Form S–3 (§ 239.13 of this chapter); or (3) If the covered investment fund is a registered open-end investment company (other than an exchangetraded fund) its net asset value (inclusive of shares held by affiliates and non-affiliates) equals or exceeds the aggregate market value specified in General Instruction I.B.1 of Form S–3 (§ 239.13 of this chapter); 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 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; (ii) The covered investment fund 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 PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 64221 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. (3) Disclosure of standardized performance. In the case of a research report about a covered investment fund that is a registered open-end management investment company or a trust account (or series or class thereof), any quotation of the issuer’s performance must be presented in accordance with the conditions of paragraphs (d), (e), and (g) of § 230.482. In the case of a research report about a covered investment fund that is a registered closed-end investment company, any quotation of the issuer’s performance must be presented in a manner that is in accordance with instructions to item 4.1(g) of Form N–2 (§§ 239.14 and 274.11a–1 of this chapter), provided, however, that other historical measures of performance may also be included if any other measurement is set out with no greater prominence than the measurement that is in accordance with the instructions to item 4.1(g) of Form N–2. (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. E:\FR\FM\13DER2.SGM 13DER2 64222 Federal Register / Vol. 83, No. 239 / Thursday, December 13, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 (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 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 VerDate Sep<11>2014 17:51 Dec 12, 2018 Jkt 247001 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 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. 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 249—FORMS, SECURITIES EXCHANGE ACT OF 1934 7. The authority citation for part 249 continues to read, in part, as follows: ■ Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C. 5461 et seq.; and 18 U.S.C. 1350; Sec. 953(b), Pub. L. 111–203, 124 Stat. 1904; Sec. 102(a)(3), Pub. L. 112–106, 126 Stat. 309 (2012); Sec. 107, Pub. L. 112–106, 126 Stat. 313 (2012), and Sec. 72001, Pub. L. 114–94, 129 Stat. 1312 (2015), unless otherwise noted. * * * * * 8. Amend Form 12b–25 (referenced in § 249.322) as follows: ■ a. On the cover page accompanying the checkboxes, removing the phrase ‘‘Form N–SAR’’ and adding in its place ‘‘Form N–CEN’’; ■ PO 00000 Frm 00044 Fmt 4701 Sfmt 9990 b. On the cover page below the checkboxes, removing the checkbox and accompanying phrase ‘‘Transition Report on Form N–SAR’’; ■ c. In Part II, removing the phrase ‘‘Form N–SAR’’ and adding in its place ‘‘Form N–CEN’’; and ■ d. In Part III, removing the phrase ‘‘Form N–SAR’’ and adding in its place ‘‘Form N–CEN’’. ■ Note: the text of Form 12b–25 does not, and this amendment will not, appear in the Code of Federal Regulations. PART 270—RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940 9. 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. * * * * * ■ 10. Add § 270.24b–4 to read as follows: § 270.24b–4 Filing copies of covered investment fund research reports. 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 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 selfregulatory 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: November 30, 2018. Brent J. Fields, Secretary. [FR Doc. 2018–26613 Filed 12–12–18; 8:45 am] BILLING CODE 8011–01–P E:\FR\FM\13DER2.SGM 13DER2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 83, Number 239 (Thursday, December 13, 2018)]
[Rules and Regulations]
[Pages 64180-64222]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-26613]



[[Page 64179]]

Vol. 83

Thursday,

No. 239

December 13, 2018

Part II





Securities and Exchange Commission





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17 CFR Parts 230, 242, 249, et al.





Covered Investment Fund Research Reports; Final Rule

Federal Register / Vol. 83 , No. 239 / Thursday, December 13, 2018 / 
Rules and Regulations

[[Page 64180]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 242, 249, and 270

[Release Nos. 33-10580; 34-84710; IC-33311; File No. S7-11-18]
RIN 3235-AM24


Covered Investment Fund Research Reports

AGENCY: Securities and Exchange Commission.

ACTION: Final rules and technical amendment.

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SUMMARY: The Commission is adopting a new rule under the Securities Act 
of 1933 to 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 in the rule are satisfied, the publication or distribution 
of a covered investment fund research report 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 adopting a new rule under the 
Investment Company Act of 1940 to exclude a covered investment fund 
research report from the coverage of section 24(b) of the Investment 
Company Act, except to the extent the research report is otherwise not 
subject to the content standards in self-regulatory organization rules 
related to research reports. We are also adopting a conforming 
amendment to rule 101 of Regulation M, and a technical amendment to 
Form 12b-25.

DATES: This rule is effective January 14, 2019 except that amendatory 
instruction 4 amending Sec.  230.139b(a)(1)(i)(A)(1) is effective May 
1, 2020. Comments regarding the collection of information requirements 
within the meaning of the Paperwork Reduction Act of 1995 should be 
received on or before February 11, 2019.

FOR FURTHER INFORMATION CONTACT: Asaf Barouk, Attorney-Adviser, John 
Lee, Senior Counsel; Amanda Hollander Wagner, Branch Chief; Thoreau 
Bartmann, Senior Special Counsel; 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 adopting 17 CFR 230.139b 
(``new rule 139b'') under the Securities Act of 1933 [15 U.S.C. 77a et 
seq.]; 17 CFR 270.24b-4 (``new rule 24b-4'') under the Investment 
Company Act of 1940 [15 U.S.C. 80a-1 et seq.]; a conforming amendment 
to 17 CFR 242.101(a) (rule 101) of Regulation M [17 CFR 242.100-
242.105]; and a technical amendment to Form 12b-25 under the Securities 
Exchange Act of 1934 [15 U.S.C. 78a et seq.].

Table of Contents

I. Introduction
II. Discussion
    A. Scope of 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 and Technical Amendments
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. Rule 139b
    3. Rule 24b-4
    4. Amendments to Rule 101 of Regulation M and Form 12b-25
    5. Effects on Efficiency, Competition, and Capital Formation
    6. Alternatives Considered
IV. Paperwork Reduction Act
V. Final Regulatory Flexibility Act Analysis
    A. Need for, and Objectives of, the Rules and Rule Amendments
    B. Significant Issues Raised by Public Comments
    C. Small Entities Subject to the Rules
    D. Reporting, Recordkeeping, and Other Compliance Requirements
    E. Agency Action To Minimize Effect on Small Entities
VI. Statutory Authority

I. Introduction

    As directed by the Fair Access to Investment Research Act of 
2017,\1\ we are adopting new rule 139b \2\ under the Securities Act of 
1933 (the ``Securities Act'') to extend the current safe harbor 
available under rule 139 to a ``covered investment fund research 
report.'' \3\ Rule 139 provides a safe harbor for the publication or 
distribution of research reports \4\ concerning one or more issuers by 
a broker or dealer (a ``broker-dealer'') participating in a registered 
offering of one of the covered issuers' securities.\5\ Rule 139'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 (``BDCs'').\6\ 
The

[[Page 64181]]

FAIR Act requires us to revise rule 139 to extend the safe harbor to 
broker-dealers' publication or distribution of covered investment funds 
upon such terms, conditions, or requirements, as we may determine 
necessary or appropriate in the public interest, for the protection of 
investors, and for the promotion of capital formation.\7\
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    \1\ Fair Access to Investment Research Act of 2017, Public Law 
115-66, 131 Stat. 1196 (2017) (the ``FAIR Act'').
    \2\ See Covered Investment Fund Research Reports, Securities Act 
Release No. 10498 (May 23, 2018) [83 FR 26788 (June 8, 2018)] 
(``Proposing Release'').
    \3\ See section 2(a) of the FAIR Act; see also Proposing 
Release, supra note 2, at section I.B. The FAIR Act also includes an 
interim effectiveness provision that became effective as of July 3, 
2018 and by its terms will terminate upon the adoption of new rule 
139b. See section 2(d) of the FAIR Act.
    \4\ See Proposing Release, supra note 2, at 26789 n.11 and 
accompanying text. See also infra notes 5-6.
    \5\ 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.'' Rule 139(a) under the Securities Act [17 CFR 230.139(a)]. A 
broker-dealer's publication or distribution of a research report in 
reliance on rule 139 would therefore be deemed not to constitute an 
offer that otherwise could be a non-conforming prospectus in 
violation of section 5 of the Securities Act. 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).
    \6\ 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). In contrast, registered investment companies 
register their securities offerings on forms such as Forms N-1A, N-
2, N-3, N-4, and N-6. To the extent that commodity- or currency-
based trusts or funds (as defined in section II.A.3 below) register 
their securities offering under the Securities Act and meet the 
eligibility requirements of Forms S-3 or F-3, as well as the other 
conditions of rule 139, the rule 139 safe harbor is currently 
available for a broker-dealer's publication or distribution of 
research reports pertaining to these issuers.
     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 this safe harbor 
with respect to research reports about BDCs that are emerging growth 
companies.
    \7\ See section 2(a) of the FAIR Act.
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    In May of 2018 we proposed new rules and rule amendments designed 
to meet the requirements of the FAIR Act. We received seven comment 
letters on the proposal.\8\ Commenters generally supported our proposed 
implementation of the FAIR Act. However, most commenters requested that 
we consider eliminating or modifying certain of the conditions in 
current rule 139, as applied to covered investment fund research 
reports (such as the minimum public float requirement and the 
requirement to publish research reports in the regular course of 
business).\9\ Other commenters raised concerns about the potential 
conflicts of interest that may arise in the context of a broker-
dealer's receipt of compensation from covered investment funds included 
in research reports, and commenters disagreed on the best ways of 
mitigating these conflicts.\10\ Finally, commenters expressed varying 
views on our request for input on whether research reports that include 
performance information should be required to present that performance 
information consistently with the way fund performance must be 
presented in fund advertisements pursuant to rule 482 and related 
requirements.\11\
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    \8\ Comment Letter of Morningstar, Inc. (July 5, 2018) 
(``Morningstar Comment Letter''); Comment Letter of BlackRock, Inc. 
(July 9, 2018) (``BlackRock Comment Letter''); Comment Letter of 
Eversheds Sutherland (US) LLP (July 9, 2018) (``Sutherland Comment 
Letter''); Comment Letter of Fidelity Investments (July 9, 2018) 
(``Fidelity Comment Letter''); Comment Letter of the Investment 
Company Institute (July 9, 2018) (``ICI Comment Letter''); Comment 
Letter of the Securities Industry and Financial Markets Association 
(July 9, 2018) (``SIFMA Comment Letter I''); Comment Letter of the 
Securities Industry and Financial Markets Association (Sept. 14, 
2018) (``SIFMA Comment Letter II'').
    \9\ See, e.g., SIFMA Comment Letter I; ICI Comment Letter; see 
also BlackRock Comment Letter.
    \10\ See, e.g., Morningstar Comment Letter; Fidelity Comment 
Letter.
    \11\ See, e.g., SIFMA Comment Letter I; ICI Comment Letter; see 
also BlackRock Comment Letter.
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II. Discussion

    Rule 139b's framework is modeled after and generally tracks rule 
139. However, rule 139b differs from rule 139 in certain respects. Some 
of these differences are specifically directed or contemplated by the 
FAIR Act.\12\ Others, 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.\13\ For the 
reasons described below, we believe that the provisions of 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.\14\ We believe that maintaining a 
similar approach in rule 139b to rule 139 with modifications to the 
extent necessary or appropriate is consistent with the FAIR Act's 
directive to revise rule 139 to extend the current safe harbor 
available under rule 139 to broker-dealer's publication or distribution 
of covered investment fund research reports. We do not believe that the 
FAIR Act intended for us to make a new or disparate regulatory regime 
for research reports on covered investment funds that subjects these 
funds to different conditions where it is not necessary or appropriate 
for differentiation from research reports on other issuers published 
under rule 139. Therefore, we have sought to maintain similar treatment 
and conditions for funds under rule 139b and other issuers subject to 
rule 139 unless we believed that a deviation was necessary or 
appropriate for the particular operational or structural 
characteristics of a type of covered investment fund. In addition to 
rule 139b, we are also adopting rule 24b-4, a conforming amendment to 
rule 101 of Regulation M, and a technical amendment to Form 12b-25.\15\
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    \12\ See, e.g., infra section II.A.1 (discussing the ``affiliate 
exclusion'' (defined below)).
    \13\ See, e.g., infra section II.B.1.a (discussing reporting 
history and timeliness requirements for issuer-specific research 
reports).
    \14\ See supra note 7 and accompanying text.
    \15\ If any of the provisions of these rules, or the application 
thereof to any person or circumstance, is held to be invalid, such 
invalidity shall not affect other provisions or application of such 
provisions to other persons or circumstances that can be given 
effect without the invalid provision or application.
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A. Scope of Rule 139b

    Rule 139b establishes 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.'' \16\ We define 
the term ``covered investment fund research report,'' as well as the 
``covered investment fund'' and ``research report'' components of this 
definition.
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    \16\ Under the safe harbor, such publication or distribution is 
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 is 
available even if the broker-dealer is participating or may 
participate in a registered offering of the covered investment 
fund's securities.
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1. Definition of ``Covered Investment Fund Research Report''
    We are adopting the definition of ``covered investment fund 
research report'' as proposed.\17\ The definition is consistent with 
the FAIR Act, which defined the term ``covered investment fund research 
report'' to mean a research report published or distributed by a 
broker-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 \18\ 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 
\19\ of an investment adviser) for the covered investment fund (the 
``affiliate exclusion'').\20\
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    \17\ See rule 139b(c)(3).
    \18\ ``Affiliate'' is defined in rule 405 under the Securities 
Act. See 17 CFR 230.405; Proposing Release, supra note 2, at 26790.
    \19\ ``Affiliated person'' is defined in section 2(a) of the 
Investment Company Act of 1940 (the ``Investment Company Act''). See 
15 U.S.C. 80a-2(a); Proposing Release, supra note 2, at 26790; 
section 2(f)(1) of the FAIR Act and rule 139b(c)(1).
    \20\ See section 2(f)(3) of the FAIR Act.
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    The affiliate exclusion prohibits two separate categories of 
research reports from being deemed to be ``covered investment fund 
research reports'' under rule 139b's safe harbor. The first category 
covers research reports published or distributed by the covered 
investment fund or any affiliate of the covered investment fund. This 
exclusion prevents 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-dealer that is an investment adviser (or an 
affiliated

[[Page 64182]]

person of an investment adviser) for the covered investment fund.\21\
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    \21\ Like the first category of exclusion, this second category 
of exclusion addresses the concern that a person covered by the 
affiliate exclusion may be able to circumvent the disclosure and 
prospectus delivery requirements of the Securities Act. For example, 
this second category helps to limit a person covered by the 
affiliate exclusion from 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. It also addresses 
the concern that a broker-dealer that is a covered investment 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 the 
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 may benefit not 
only the fund but also the broker-dealer.
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    As we noted in the Proposing Release, one factor to consider in 
evaluating whether a research report has been published or distributed 
by a person covered by the affiliate exclusion is the extent of such 
person's involvement in the preparation of the research report.\22\ 
These 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 preparing the information or 
explicitly or implicitly endorsed or approved the information, also 
known as the entanglement theory and adoption theory, respectively.\23\
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    \22\ See Proposing Release, supra note 2, at 26791-92.
    \23\ 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)] (``2000 Electronics Release'') 
(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)] (``Asset-Backed Securities Adopting Release'') 
(adopting asset-backed securities regulations).
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    While we did not receive comments on the definition of ``covered 
investment fund research report,'' we received comments on the 
affiliate exclusion embedded in the definition.\24\ One commenter 
raised concerns about the incorporation of the adoption and 
entanglement theories, which could prohibit broker-dealers from 
engaging in certain activities designed to ensure the accuracy of 
research reports.\25\ Other commenters suggested that while the 
entanglement theory may have relevance to research reports under 
proposed rule 139b, the adoption theory may not.\26\ Some commenters 
requested clarification on whether certain conduct--for example, a 
covered investment fund providing information or confirmation of 
certain factual matters such as performance data, holdings, or 
investment objectives or strategies--is prohibited by the affiliate 
exclusion.\27\
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    \24\ See Morningstar Comment Letter; Fidelity Comment Letter; 
ICI Comment Letter; SIFMA Comment Letter I; see also BlackRock 
Comment Letter.
    \25\ See SIFMA Comment Letter I.
    \26\ See Fidelity Comment Letter; ICI Comment Letter; see also 
BlackRock Comment Letter.
    \27\ See ICI Comment Letter; SIFMA Comment Letter I; see also 
BlackRock Comment Letter.
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    As we noted in the Proposing Release, the entanglement and adoption 
theories are helpful guideposts in establishing whether a research 
report about a covered investment fund was published or distributed by 
the fund.\28\ However, those theories of liability have been set forth 
by courts in interpreting the federal securities laws, and how a court 
would apply such theories with respect to covered investment fund 
research reports would be based on the facts and circumstances 
presented.\29\
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    \28\ See Proposing Release, supra note 2, at 26792.
    \29\ See 2000 Electronics Release, supra note 23 (with respect 
to entanglement theory cases, citing Elkind v. Liggett & Myers, 
Inc., 635 F.2d 156 (2d Cir. 1980); In the Matter of Syntex Corp. 
Sec. Litig., 855 F.Supp. 1086 (N.D. Cal. 1993); In the Matter of 
Caere Corp. Sec. Litig., 837 F. Supp. 1054 (N.D. Cal. 1993) and with 
respect to adoption theory cases, citing In the Matter of Cypress 
Semiconductor Sec. Litig., 891 F. Supp. 1369, 1377 (N.D. Cal. 1995), 
aff'd sub nom. Eisenstadt v. Allen, 113 F.3d 1240 (9th Cir. 1997); 
In the Matter of Presstek, Inc., Exchange Act Release No. 39472 
(Dec. 22, 1997)). See also Asset-Back Securities Adopting Release, 
supra note 23.
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    Under rule 139b, we believe 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 rule.\30\ 
For example, if a broker-dealer distributes a research report including 
materials that a person covered by the affiliate exclusion authorized 
or approved for inclusion in the report, this could (depending on the 
facts and circumstances) inappropriately circumvent the affiliate 
exclusion in rule 139b.
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    \30\ See Proposing Release, supra note 2, at 26791. See also 
section 5(a), 5(b), and 5(c) of the Securities Act [15 U.S.C. 
77e(a), (b), and (c)] (prohibiting both direct and indirect 
violations of the prospectus requirements); section 48(a) of the 
Investment Company Act [15 U.S.C. 80a-47(a)] (It shall be unlawful 
for any person, directly or indirectly, to cause to be done any act 
or thing through or by means of any other person which it would be 
unlawful for such person to do under the provisions of this 
subchapter or any rule, regulation, or order thereunder.); section 
208(d) of the Investment Advisers Act of 1940 [15 U.S.C. 80b-8(d)] 
(It shall be unlawful for any person indirectly, or through or by 
any other person, to do any act or thing which it would be unlawful 
for such person to do directly under the provisions of this 
subchapter or any rule or regulation thereunder.).
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    Also in relation to the affiliate exclusion, one commenter 
suggested that the proposal did not adequately address conflicts of 
interest such as revenue sharing agreements.\31\ Other commenters 
disagreed stating that self-regulatory organization (``SRO'') rules and 
federal securities laws addressing conflicts of interest would apply to 
covered investment fund research reports.\32\ One commenter stated that 
additional restrictions are unnecessary because the proposed affiliate 
exclusion would be broad and effective.\33\ One commenter recommended 
that the final rule should not have any specific revenue sharing 
agreement requirements, but suggested that if the Commission believes 
it should address such potential conflicts in the final rule, the final 
rule should require a general disclosure similar to mutual fund 
prospectus disclosure alerting investors of potential revenue sharing 
agreements.\34\
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    \31\ Morningstar Comment Letter (stating that SRO rules would be 
inadequate in this respect and that the Commission should require 
elimination or mitigation of these conflicts).
    \32\ See Fidelity Comment Letter; ICI Comment Letter; SIFMA 
Comment Letter I; see also BlackRock Comment Letter.
    \33\ See ICI Comment Letter; see also BlackRock Comment Letter.
    \34\ See Fidelity Comment Letter.
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    While we appreciate the concerns noted with respect to potential 
conflicts of interest, and specifically those arising from revenue 
sharing agreements, we are not adding additional explicit conflicts-of-
interest-related restrictions in the final rule. The antifraud 
provisions of the federal securities laws and certain existing 
Commission and SRO rules continue to apply to covered investment fund 
research reports, some of which, depending on the facts and 
circumstances, may require disclosure of such conflicts.\35\ For 
example, many covered investment fund research reports may be subject 
to FINRA's research report rules, which require disclosure in a 
research report if the member or its affiliates have received 
compensation from the subject company other than for investment banking 
services in the previous year.\36\

[[Page 64183]]

Depending on the facts and circumstances, covered investment fund 
research reports may also need to include information about the 
compensation received by the broker-dealer from covered investment 
funds included in the report if such compensation is of the type 
covered by section 17(b) of the Securities Act.\37\
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    \35\ We note that the FAIR Act expressly stated that research 
reports published or distributed under its provisions would continue 
to be subject to the antifraud and anti-manipulation provisions of 
the federal securities laws, and rules adopted thereunder, including 
section 17 of the Securities Act, section 34(b) of the Investment 
Company Act, and sections 9 and 10 of the Exchange Act. See section 
2(c)(1) of the FAIR Act.
    \36\ See, e.g., FINRA rule 2241(c)(4)(D). See also, e.g., FINRA 
rule 2210(d)(1)(A) (requiring all member communications with the 
public to be based on principles of fair dealing and good faith, be 
fair and balanced, and provide a sound basis for evaluating the 
facts in regards to any particular security; and barring members 
from omitting any material fact or qualification if the omission, in 
light of the context of the material presented, would cause the 
communication to be misleading).
    \37\ See 15 U.S.C. 77q(b) (making it unlawful for any person, by 
the use of any means or instruments of transportation or 
communication in interstate commerce or by the use of the mails to 
publish, give publicity to, or circulate any notice, circular, 
advertisement, newspaper, article, letter, investment service, or 
communication which, though not purporting to offer a security for 
sale, describes such security for a consideration received or to be 
received, directly or indirectly, from an issuer, underwriter, or 
dealer, without fully disclosing the receipt, whether past or 
prospective, of such consideration and the amount thereof).
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    We understand that disclosure about conflicts of interest created 
by the receipt of compensation by the broker-dealer from covered 
investment funds is consistent with current industry practices in 
communications that are Securities Act section 10(b) prospectuses and 
are currently styled as ``research reports'' subject to the 
requirements of rule 482.\38\ Considering current industry practice, 
and the protections offered by the other regulatory provisions 
discussed above, we do not believe that additional conflict-of-interest 
requirements are necessary in rule 139b. Accordingly, we are adopting 
the definition of covered investment fund research report as proposed.
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    \38\ 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.
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2. Definition of ``Research Report''
    We are defining, as proposed,\39\ 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.\40\ This definition is 
identical to the corresponding definition of ``research report'' in 
rule 139.\41\ As discussed in the Proposing Release, while this 
definition is not identical to that in the FAIR Act, it is consistent 
with the FAIR Act because we interpret it to have the same meaning as 
the FAIR Act's definition of ``research report.'' \42\ We received one 
comment agreeing with this definition.\43\
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    \39\ See Proposing Release, supra note 2, at 26792-93.
    \40\ See 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.
    \41\ 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].
    \42\ See section 2(f)(6) of the FAIR Act; see also Proposing 
Release, supra note 2, at 26792-93 (explaining that the rule 139b 
definition tracks the FAIR Act definition except that it does not 
expressly reference ``electronic communications'' and that 
consistent with Commission rules on electronic communications, rule 
139b definition's reference to a ``written communication,'' as 
defined in rule 405, includes a ``graphic communication,'' which in 
turn includes electronic communications (other than telephone and 
other live communications)).
    \43\ See SIFMA Comment Letter I (stating that it would reduce 
potential interpretive confusion for market participants who are 
familiar with the rule 139 definition).
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3. Definition of ``Covered Investment Fund''
    The FAIR Act defines the term ``covered investment fund'' to 
include registered investment companies, BDCs, and certain commodity- 
or currency-based trusts or funds.\44\ We are adopting a definition of 
the term ``covered investment fund'' in rule 139b that is substantially 
the same as the one used in the FAIR Act, with the addition that the 
definition specifies that the term ``investment company'' includes ``a 
series or class thereof.'' \45\ We received no comments on this 
proposed definition. The final rule adopts the definition as proposed.
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    \44\ See section 2(f)(2)(B) of the FAIR Act. 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''). 
See section 2(f)(2)(B) of the FAIR Act. 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.
    \45\ See 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)].
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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 
Securities Exchange Act of 1934 (the ``Exchange Act''), rather than 
relying on new rule 139b, instead may be able to rely on rule 139. Rule 
139b does not preclude a broker-dealer from relying on existing rule 
139 if applicable. In order to clarify that a broker-dealer may rely on 
existing research safe harbors, we proposed that rule 139b state that 
it 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.\46\ We received no comments on this 
aspect of the proposed rule and are adopting it as proposed.\47\
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    \46\ See proposed rule 139b(a); see also 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)).
    \47\ See rule 139b(a).
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B. Conditions for the Safe Harbor

    As discussed in the Proposing Release, the Commission has 
previously acknowledged the value of research reports in providing the 
market and investors with information about reporting issuers.\48\ To 
mitigate the risk of research reports being used to circumvent the 
prospectus requirements of the Securities Act,\49\ the Commission

[[Page 64184]]

has placed conditions on a broker-dealer's publication or distribution 
of research reports.\50\ Under Rule 139, these conditions include 
restrictions on the issuers to which the research may relate, as well 
as requirements that such reports be published in the regular course of 
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''). Rule 139b carries over these 
conditions for covered investment fund research reports and 
incorporates certain modifications intended to adapt these conditions 
to covered investment funds that we discuss below.
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    \48\ See Proposing Release, supra note 2, at 26794 (for example, 
the Commission has recognized that, for public operating entities 
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 
information about reporting entities into the marketplace).
    \49\ See supra note 5 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 Securities Offering Reform Adopting 
Release, supra note 23 (discussing how 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); supra notes 35-36 
and accompanying text (discussing certain rules and regulations 
under the federal securities laws, as well as certain SRO rules, 
that help address certain conflicts of interest and abuses 
identified with analyst research).
    \50\ 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 notes 35-36.
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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 rule 
139b safe harbor, the fund must meet certain reporting history and 
timeliness requirements. We are adopting as proposed that any such 
covered investment fund must have been subject to the 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 rule 139b and that these reports have 
been filed in a timely manner.\51\ This requires covered investment 
funds that are registered investment companies to have been subject to 
the reporting requirements of the Investment Company Act for a period 
of at least 12 calendar months prior to a broker-dealer's reliance on 
the new rule and to have filed in a timely manner all required reports, 
as applicable, on Forms N-CSR,\52\ N-Q,\53\ N-PORT,\54\ N-MFP,\55\ and 
N-CEN \56\ during the immediately preceding 12 calendar months.\57\ If 
the covered investment fund is not a registered investment company, it 
must have been subject to the reporting requirements under section 13 
or section 15(d) of the Exchange Act for a period of at least 12 
calendar months and have filed all required reports in a timely manner 
on Forms 10-K \58\ and 10-Q \59\ and 20-F \60\ during the immediately 
preceding 12 calendar months.\61\
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    \51\ Rule 139b(a)(1)(i)(A). We believe that this 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 BDCs 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-
dealer of a covered investment fund research report, the subject of 
which is a BDC 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 
Commission under the federal securities laws.).
    \52\ 17 CFR 249.331 and 17 CFR 274.128.
    \53\ 17 CFR 249.332 and 17 CFR 274.130. 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 Investment Company Reporting Modernization, 
Investment Company Act Release No. 32314 (Oct. 13, 2016) [81 FR 
81870 (Nov. 18, 2016)] (``Reporting Modernization Release''); 
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 on Form N-Q, and filing these 
reports would not be required as a condition to rely on the rule 
139b safe harbor. Accordingly, rule 139b, as adopted, will be 
amended effective May 1, 2020 by removing the reference to Form N-Q. 
See infra section VI (instruction 4 under Text of Proposed Rules and 
Amendments).
    \54\ 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 Reporting Modernization Release, supra note 53. 
Therefore, we would consider Form N-PORT to have been timely filed 
for purposes of the timeliness requirement if the public filing of 
Form N-PORT every third month is timely filed and publicly 
available.
    \55\ 17 CFR 274.201.
    \56\ 17 CFR 249.330 and 17 CFR 274.101.
    \57\ Rule 139b(a)(1)(i)(A)(1). As discussed in the Proposing 
Release, Form N-SAR was rescinded on June 1, 2018, which is the 
compliance date for Form N-CEN. As such, reliance on new rule 139b 
is not conditioned on covered investment funds reporting on Form N-
SAR and the reference to Form N-SAR, as proposed, is not included in 
paragraph (a)(1)(i)(A)(1) of rule 139b. See id.; see also Proposing 
Release, supra note 2, at 26794.
    \58\ 17 CFR 249.310.
    \59\ 17 CFR 249.308a.
    \60\ 17 CFR 249.220f.
    \61\ Rule 139b(a)(1)(i)(A)(2).
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Reporting History
    Several commenters requested we eliminate the reporting history 
requirement for issuer-specific research reports under rule 139b.\62\ 
One commenter suggested that the requirement is unnecessary because 
funds have ``detailed and comprehensive regulatory filing and 
disclosure obligations'' providing investors with ``a wealth of 
information about funds.'' \63\ Another commenter argued that the 
reporting history requirement should be eliminated because ensuring 
compliance with the requirement would create ``operational hurdles'' 
for broker-dealers that provide investors with research on a large 
numbers of funds on a largely automated basis.\64\ Commenters also 
argued that the reporting history requirement unduly restricts research 
on newer funds.\65\
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    \62\ See Fidelity Comment Letter; ICI Comment Letter; SIFMA 
Comment Letter I; see also BlackRock Comment Letter.
    \63\ See ICI Comment Letter; see also BlackRock Comment Letter.
    \64\ See Fidelity Comment Letter.
    \65\ See ICI Comment Letter; SIFMA Comment Letter I; see also 
BlackRock Comment Letter.
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    As discussed in the Proposing Release, rule 139b tracks the 
reporting history requirement of rule 139.\66\ We believe satisfying 
such a requirement indicates a likelihood that more current and timely 
information has been disseminated to and digested by the marketplace to 
inform investors of material information about the fund, including 
risks, and provides investors with SEC-filed information to compare 
against the contents of the research report.\67\ We also continue to 
believe that maintaining a reporting history requirement is consistent 
with the FAIR Act, which permits a reporting history requirement so 
long as it does not exceed the period required in rule 139.\68\
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    \66\ Rule 139 predicates issuer-specific research reports on an 
issuer's eligibility to use Form S-3 or F-3, which are short form or 
shelf registration statements that are available to register an 
issuer's securities offering only after it has been subject to and 
in compliance with the Exchange Act periodic reporting requirements 
for at least 12 months.
    \67\ See Proposing Release, supra note 2, at 26795 nn.75-78 and 
accompanying text. The safe harbor would be unavailable to broker-
dealers' publication or distribution of research reports about 
closed-end registered investment companies or BDCs during these 
covered investment fund issuers' first year of operation. See supra 
note 51.
    \68\ See Proposing Release, supra note 2, at 26795 n.77 
(explaining the reporting and timeliness requirements of rule 139).
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    We do not believe that funds should be treated differently from 
other issuers subject to the reporting requirement of rule 139. The 
Commission included a reporting history requirement in rule

[[Page 64185]]

139 because it helps to ensure that the market has information, beyond 
the research report, to allow investors to weigh how much value they 
will assign to the research report. The fund's reporting history should 
be particularly important when the broker-dealer publishing the 
research report is participating or may participate in the fund's 
offering, as is the case under rule 139b (similar to rule 139). As 
noted above, one commenter suggested that the reporting history 
requirement is unnecessary because funds' ``detailed and comprehensive 
regulatory filing and disclosure obligations'' provide investors ``a 
wealth of information about funds.'' \69\ Eliminating the reporting 
history requirement would reduce the information available to investors 
when evaluating research reports published or distributed by broker-
dealers when those broker-dealers are also participating in the 
offering of the fund's shares. The requirement also allows time for the 
market to absorb the previously released periodic reports and for 
investors to assess an issuer's track record.
---------------------------------------------------------------------------

    \69\ See ICI Comment Letter; see also BlackRock Comment Letter.
---------------------------------------------------------------------------

    Corporate issuers are subject to, under rule 139, filing and 
disclosure obligations similar to what is required of covered 
investment funds under rule 139b. Although funds differ from corporate 
issuers in many respects, investors would benefit similarly from having 
access to fund information to evaluate the research reports on which 
they may consider relying. Accordingly, for the same reasons the 
Commission determined to include this requirement in rule 139, we have 
determined to include this requirement in rule 139b.
    We also believe that broker-dealers will be able to comply with the 
reporting history requirement in a manner similar to how they comply 
with the parallel requirement in rule 139 and that the effect of the 
requirement on new funds would be similar to the effect on new issuers 
under rule 139.\70\ Other issuers also have ``detailed and 
comprehensive regulatory and disclosure obligations'' much like funds. 
In this regard, we are not persuaded that there is a material 
difference between covered investment funds and other issuers that 
would justify treating them in a disparate fashion. We continue to 
believe that the concerns underlying the reporting history requirement 
of rule 139 apply to research reports issued under rule 139b, and 
therefore are not persuaded that the reporting history requirement 
should be eliminated from rule 139b as suggested by some commenters.
---------------------------------------------------------------------------

    \70\ We believe that a broker-dealer would be relying on rule 
139 or rule 139b because it would be involved in distributing 
securities of the issuer covered in the report, and would therefore 
have information about the issuer to confirm it has been subject to 
filing obligations for the preceding 12 calendar months. For 
example, this information is accessible through the Commission's 
publicly available Electronic Data Gathering Analysis, and Retrieval 
(``EDGAR'') system. Moreover, we believe that broker-dealers that 
choose to automate publication of research reports may invest in 
technologies to implement this automation including by leveraging 
their existing technological infrastructures to verify the reporting 
history requirement for covered investment funds.
---------------------------------------------------------------------------

    One commenter also requested the reporting history requirement be 
shortened from 12 months to 25 days after a fund initially starts 
offerings shares. The commenter argued that this would align with 
broker-dealers' market practice of waiting 25 days after an initial 
public offering.\71\
---------------------------------------------------------------------------

    \71\ See SIFMA Comment Letter I; SIFMA Comment Letter II. 
Additionally, this commenter presented an example of a new ETF based 
on a new industry classification standard that has garnered interest 
from the market and satisfies the minimum public market value 
requirement, but would be unable to satisfy a 12-month reporting 
history requirement. See SIFMA Comment Letter II. This situation and 
result equally occurs in the operating company context, where a 
well-followed operating company that has an initial public offering 
might satisfy the minimum public market value requirement, but not 
the reporting history requirement, and thus could not be covered as 
a rule 139 issuer-specific research report until the 12-month 
reporting history requirement is also satisfied.
---------------------------------------------------------------------------

    Rule 139 is available only to broker-dealers that both publish or 
distribute a research report on an issuer and are participating or will 
participate in a registered offering of the issuer's securities. The 
25-day standard referenced by the commenter relates to the issuance of 
a research report after the prospectus delivery obligation in an 
initial public offering ends, not while the offering is ongoing and the 
broker-dealer is participating in it. Accordingly, the prospectus 
delivery obligation described by the commenter is distinct from the 
delivery obligation that applies to continuous offerings. Thus, the 
commenter's suggested provision and rationale do not appropriately 
apply to a broker-dealer participating in a continuous offering. The 
25-day standard referenced by the commenter is premised on statutory 
provisions addressing prospectus delivery, a different investor 
protection consideration from rules 139 and 139b. Accordingly, we 
believe the 25-day standard is inapposite to rule 139b, as rule 139b 
applies to broker dealers that are participating in the offering of the 
subject fund's securities, not after the offering has ended. For these 
reasons, we are adopting the reporting history provision as proposed.
Timeliness
    Two commenters opposed the proposed timeliness requirement for 
issuer-specific research reports.\72\ They argued that broker-dealers 
would face operational hurdles in confirming a covered investment 
fund's timely filing of periodic reports.\73\ One commenter suggested 
that broker-dealer firms be allowed to accept compliance 
representations from covered investment funds for the reporting history 
and timeliness requirements.\74\ The other commenter requested that the 
timeliness requirement apply only when a broker-dealer initiates 
research coverage on a fund, rather than for each research report.\75\ 
Alternatively, the commenter also requested the Commission to permit 
broker-dealers to rely on the lack of any Form 12b-25 (indicating that 
a filing is late) filed by covered investment funds within the prior 12 
months.\76\
---------------------------------------------------------------------------

    \72\ See Fidelity Comment Letter; SIFMA Comment Letter I; SIFMA 
Comment Letter II.
    \73\ See Fidelity Comment Letter; SIFMA Comment Letter I. In a 
subsequent letter, one commenter noted the difficulty broker-dealers 
would have in identifying reports filed by registered investment 
companies that are part of series companies, pointing to a lack of 
functionality in EDGAR's mutual-fund specific search page. See SIFMA 
Comment Letter II. All registered investment company filings are 
available on EDGAR, however, and there are multiple ways to search 
the EDGAR system in addition to the mutual-fund specific page the 
commenter identified--including using a fund's filing number, which 
can be found in a fund's prospectus, or by using a Central Index Key 
(``CIK'') number.
    \74\ See Fidelity Comment Letter.
    \75\ See SIFMA Comment Letter I.
    \76\ See SIFMA Comment Letter II.
---------------------------------------------------------------------------

    Satisfaction of the timeliness requirement indicates a greater 
likelihood that a covered investment fund will make information 
available in a timely manner to inform investors of material 
information about the fund, including risks. We believe it is important 
for covered investment fund investors to have timely information from 
the fund when evaluating research reports, as it is for operating 
company investors. Rule 139 requires that an issuer satisfy the 
reporting history and timeliness requirements at the time the broker-
dealer publishes or distributes a research report.\77\ Modifying rule 
139b to allow confirming the timeliness of a fund's reporting only upon 
initiation of coverage, or to accept the compliance representations of 
covered investment funds, would provide less protection to investors 
than the Commission determined to be appropriate in rule 139. We also 
do not believe providing disparate treatment between funds and other 
issuers with respect to reporting

[[Page 64186]]

history and timeliness conditions is necessitated by operational or 
structural differences between the issuer types. As with the 12-month 
reporting history requirement, we believe that confirming the 
timeliness of periodic filings for covered investment funds would be 
substantially similar to confirming the timeliness of periodic filings 
in the operating company context.\78\ We do, however, agree with the 
commenter that a fund filing a Form 12b-25 (or lack thereof) would 
serve as a useful indication of the fund's timeliness. We believe that 
a broker-dealer may rely on the lack of a Form 12b-25 filing as 
confirmation that a fund's filings are timely under the rule unless the 
broker-dealer is actually aware through other means that the issuer has 
not in fact made timely filings. Accordingly, we are adopting the 
timeliness requirement as proposed.
---------------------------------------------------------------------------

    \77\ See rule 139(a)(1)(i)(A)(1)-(2).
    \78\ See Proposing Release, supra note 2, at 26794-95. A broker-
dealer has diligence and investigative obligations under section 11 
of the Securities Act in order to be able to claim a due diligence 
defense available thereunder. See Securities Offering Reform 
Adopting Release, supra note 23; rule 176 of the Securities Act [17 
CFR 230.176]. Like the reporting history requirement, broker-dealers 
could confirm the timeliness of a covered investment fund's reports 
through a check of the Commission's EDGAR system, which is free and 
readily available. This may allow the leveraging of operating 
efficiencies for broker-dealers already familiar with the 
requirement.
---------------------------------------------------------------------------

b. Market Following Requirement
    We are adopting a requirement that, in order for broker-dealers to 
use the rule 139b safe harbor to publish or distribute issuer-specific 
research reports, 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 new rule (the ``float requirement''). Specifically 
we are adopting a requirement that the aggregate market value of a 
covered investment fund, or the net asset value \79\ in the case of a 
registered open-end investment company (other than an exchange-traded 
fund (``ETF'')) \80\ i.e., a mutual fund, must equal or exceed the 
aggregate market value required by General Instruction I.B.1 to Form S-
3.\81\ This amount is currently $75 million.\82\ The FAIR Act permits 
us to set a float requirement for covered investment funds, as long as 
the minimum public float is not greater than what is required by rule 
139.\83\
---------------------------------------------------------------------------

    \79\ For mutual funds, 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 mutual funds, 
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).
    \80\ See rule 139b(a)(1)(i)(B); rule 139b(c)(4) (defining 
``exchange-traded fund'' for purposes of the new rule to have the 
meaning given the term in General Instruction A to Form N-1A).
    \81\ The new rule refers to General Instruction I.B.1 to Form S-
3. Under this instruction, aggregate market value is ``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.
    \82\ General Instruction I.B.1 to Form S-3.
    \83\ See section 2(b)(2)(B) of the FAIR Act.
---------------------------------------------------------------------------

    We are adopting the float requirement and level as proposed. 
However, as discussed below, the final rule includes two changes to the 
float calculation methodology for most covered investment funds. First, 
the final rule generally no longer requires that the fund issuer's 
aggregate market value or net asset value be calculated net of its 
affiliates' holdings.\84\ Second, the minimum float requirement must be 
satisfied at the initiation (or reinitiation) of research coverage and 
then once a quarter thereafter. The proposal, on the other hand, would 
have required that the minimum float requirement be satisfied each time 
a broker or dealer relied on the safe harbor to publish or distribute a 
research report on a covered investment fund.
---------------------------------------------------------------------------

    \84\ However, as discussed below, this change would not apply to 
the calculation of a commodity- or currency-based trust or fund's 
float.
---------------------------------------------------------------------------

Float Level
    Several commenters argued that a float requirement should be 
eliminated or reduced in the context of covered investment funds 
because such a requirement would limit the extent of research that 
could be produced.\85\ Two commenters argued that for funds, NAV 
relates to the underlying value of the portfolio and therefore makes it 
an inapt proxy for market following.\86\ 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.\87\ We continue to view as 
significant the relationship between public float, information 
dissemination to the market, and following by investment 
institutions.\88\ While market following for funds that price at or 
near NAV may not have the same degree of impact on the price of the 
fund shares that it may have for other issuers, market following serves 
other purposes as well, including ensuring that a mix of information 
about the fund's securities is available. We believe that providing a 
different calculation method for mutual funds is necessary to achieve 
the intent of the FAIR Act and is also consistent with the goals of the 
float requirement in rule 139. We also do not believe there is a reason 
to set the level of the minimum public float requirement based on a 
different set of considerations than for operating companies (i.e., the 
level of the security's market following).
---------------------------------------------------------------------------

    \85\ See SIFMA Comment Letter; ICI Comment Letter; Fidelity 
Comment Letter.
    \86\ See SIFMA Comment Letter; ICI Comment Letter.
    \87\ 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''); see also Securities Offering 
Reform, Securities Act Release No. 8501 (Nov. 3, 2004) [69 FR 67391 
(Nov. 17, 2004)] (discussing public float of a certain level as a 
factor indicating that an issuer has a demonstrated market 
following).
    \88\ See, e.g., S-3 Revisions Adopting Release, supra note 87.
---------------------------------------------------------------------------

    As noted by commenters, we recognize that the minimum public float 
requirement may impact the amount of research on covered investment 
funds. However, we continue to believe that this requirement is 
consistent with rule 139's framework and intent.\89\ As discussed 
previously, we believe that the intent of the FAIR Act was to extend 
the rule 139 framework to covered investment funds in a manner 
consistent with the treatment of other issuers subject to rule 139, 
except where necessary or appropriate. We do not believe it is 
necessary or appropriate to treat covered investment funds and other 
issuers differently here, except with respect to the calculation method 
for mutual funds as discussed below. We also believe that concern about 
coverage for smaller issuers--and balancing that concern with investor 
protection concerns when the broker-dealer distributing the report is 
participating in the issuer's offering--is not unique to covered 
investment funds. As discussed in the Proposing Release, 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 limited segment of investors (which the float requirement could help 
to address).\90\ The float requirement is designed to protect investors 
by excluding research reports on covered

[[Page 64187]]

investment funds with a relatively small amount of total assets, which 
serves as a reasonable proxy for a limited market following.\91\
---------------------------------------------------------------------------

    \89\ See Proposing Release, supra note 2, at 26796.
    \90\ See id.
    \91\ We believe that conditioning the availability of the safe 
harbor on the aforementioned reporting history and market valuation 
requirements will 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 limited trading or 
interest. See also infra discussion in the Economic Analysis at 
notes 350-354.
---------------------------------------------------------------------------

    With respect to the level of the minimum public float, the float 
requirement is not intended to include or exclude a certain percentage 
of funds or other issuers from research coverage. The float requirement 
is intended to act as a proxy for market following. As we have 
previously analyzed in other contexts, analyst research coverage of an 
issuer is one indicia of market following. We have previously observed 
that analyst coverage drops off significantly with smaller issuers, and 
few if any issuers with less than $75 million in public float have 
significant analyst coverage.\92\ Moreover, while certain data 
aggregators provide analyst research report coverage for a number of 
funds, most funds are not followed by dedicated research analysts akin 
to the analyst coverage that we have previously identified as being one 
indicia of market interest and following for operating companies.\93\ 
As a consequence, we have observed that covered investment fund issuers 
with a public float of less than $75 million generally do not have a 
market following that would add to the mix of information in the 
marketplace. Some commenters suggested using a lower public float 
requirement for funds on the basis of seeking to equalize the 
percentage of funds that would be subject to coverage with the 
percentage of issuers similarly subject to coverage in rule 139.\94\ 
Market following, however, appears to be a characteristic related to 
the size of a particular issuer, not to the statistical distribution of 
issuers in the market. In other words, there is no reason to believe 
that equalizing the percentage of issuers covered under rule 139 with 
the percentage of funds covered under rule 139b would result in a 
meaningful indication of market following because the result would 
depend on the distribution of issuers and funds by size. In addition, 
using a minimum public market value threshold that is the same as the 
parallel threshold in rule 139 may benefit market participants through 
regulatory consistency and reduce opportunities for investor 
confusion.\95\
---------------------------------------------------------------------------

    \92\ See Simplification of Registration Procedures for Primary 
Securities Offerings, Securities Act Release No. 6943 (July 16, 
1992) [57 FR 32461 (July 22, 1992)] (stating that one indicia of 
market interest and following of a company is the number of research 
analysts covering the company and that approximately two-thirds of 
the newly eligible companies, based on the reduction of the float 
requirement to $75 million, are followed by at least three research 
analysts). See also Securities Offering Reform Adopting Release, 
supra note 23, at 44728 n.53 (stating that issuers with a market 
capitalization of between $75 million and $200 million, in most 
cases, have between zero to five analysts following them, with 
approximately 50% having zero to two analysts following them).
    \93\ The Commission and the staff intend to monitor changes in 
analyst research coverage of funds and the impact of the minimum 
public market value requirement on the availability of research on 
covered investment funds and may in the future reduce, change, or 
eliminate the requirement to the extent that empirical evidence 
demonstrates that a lower threshold or different metric would be 
consistent with investor protection.
    \94\ See Fidelity Comment Letter; SIFMA Comment Letter I.
    \95\ See infra discussion following note 319.
---------------------------------------------------------------------------

    While a broker-dealer publishing a research report about a fund 
that does not meet the minimum public float could not rely on rule 
139b, other methods may be available to provide information about these 
funds by a broker-dealer participating in the offering, such as 
choosing to cover a smaller fund in a rule 482 communication.\96\ In 
addition, the public market value requirement is limited to issuer-
specific research reports, and does not apply to industry research 
reports.
---------------------------------------------------------------------------

    \96\ See rule 482 [17 CFR 230.482]. Rule 482 sets forth certain 
filing and other investor protection requirements. Id.
---------------------------------------------------------------------------

Float Calculation
    While we continue to believe that the float requirement serves a 
useful purpose, we recognize that the proposed float requirement could 
pose unique operational challenges for analysts covering certain 
covered investment funds. Accordingly, as discussed below, we are 
making certain changes to the timing and method of the float 
calculation that are designed to address these concerns for covered 
investment funds.
    One commenter stated that calculating a covered investment fund's 
public float, and determining the specific amount of affiliate holdings 
to be excluded in calculating the public float as proposed, is a 
practical challenge for broker-dealers because it was not clear to the 
commenter that third-party vendors or filings on EDGAR contain data 
regarding the value of covered investment funds, net of value held by 
affiliates.\97\ This commenter also noted that broker-dealers are 
unlikely to have information about beneficial owners of funds that are 
affiliates but hold the fund's shares through another record owner. 
Commenters also stated that the proposed float requirement more 
generally creates operational challenges given the need to track and 
test fluctuating market values to comply with it, given that many funds 
are continuously offered.\98\
---------------------------------------------------------------------------

    \97\ See SIFMA Comment Letter II. This commenter stated that 
broker-dealers satisfy the parallel minimum public float requirement 
under rule 139 by relying upon third-party data vendors, such as 
Bloomberg. We understand that third-party service providers do not 
currently calculate this number for covered investment funds, 
although they may do so in the future.
    \98\ See Fidelity Comment Letter; SIFMA Comment Letter I.
---------------------------------------------------------------------------

    We appreciate these concerns and are therefore adopting two 
modifications to the final rule. First, the final rule does not require 
that the fund's aggregate market value or net asset value be calculated 
net of affiliates' holdings for most covered investment funds.\99\ 
However, the final rule, like the proposal, would require that a 
commodity- or currency-based trust or fund's public float be calculated 
net of affiliate holdings, as under rule 139. Broker-dealers today can 
rely on rule 139 to publish research reports regarding these covered 
investment funds and we believe it appropriate to maintain consistency 
for issuers that can be covered under both rules, where consistent with 
the FAIR Act. Otherwise, exactly the same activity could be subject to 
different standards based on the rule that a broker-dealer chose to 
use. One commenter argued that determining affiliate ownership for such 
funds based on Forms 10-K and S-1 may quickly become outdated.\100\ We 
believe that for purposes of calculating affiliate ownership when 
determining a covered investment fund's public float, broker-dealers 
may rely on the covered investment fund's most recent ownership 
disclosures filed with the Commission for identifying the beneficial 
owners, despite the potential data limitations. As a consequence, we 
believe that a broker-dealer need not seek to identify unknown 
beneficial owners held through disclosed record owners, and also does 
not need to generally exclude record owners from the calculation of 
public float, except to the extent that they represent known beneficial 
owners. We believe this approach is reasonable and comparable to that 
used in the operating company context.
---------------------------------------------------------------------------

    \99\ See rule 139b(a)(1)(i)(B).
    \100\ See SIFMA II Comment Letter.
---------------------------------------------------------------------------

    Unlike rule 139, rule 139b does not permit affiliates of covered 
investment funds to rely on the safe harbor,

[[Page 64188]]

mitigating the risk that a fund with significant affiliate holdings 
would be the subject of market moving research by those same 
affiliates. We also appreciate that there is more limited information 
currently available regarding the holdings of affiliates of covered 
investment funds relative to operating companies, as noted by 
commenters.\101\ That many covered investment fund are continuously 
offered also adds operational challenges. A covered investment fund's 
investor base, and thus potential affiliates, may change day to day, 
making it more difficult to identify affiliate holdings. In addition, 
covered investment funds are subject to unique legal provisions that 
generally restrict affiliate ownership and provide additional legal 
protections when affiliate ownership is permitted.\102\ Accordingly, 
not requiring a broker-dealer to identify and exclude affiliate 
holdings is designed to address these challenges and appropriately 
tailors this requirement for covered investment funds.\103\
---------------------------------------------------------------------------

    \101\ See SIFMA Comment Letter II (noting that third party 
vendors do not currently provide float information net of affiliates 
for funds, and that for certain funds whose ownership is held in 
street name, affiliate ownership may be ``unknowable'').
    \102\ See, e.g., Investment Company Act sections 12, 17, and 57 
and rules thereunder.
    \103\ The instructions to Form S-3 discuss methodologies for 
calculating float net of affiliates. When calculating float for 
purposes of rule 139b, those instructions related to the exclusion 
of affiliate ownership must be disregarded.
---------------------------------------------------------------------------

    Second, the final rule will permit a broker-dealer to satisfy the 
minimum float requirement when it initiates (or reinitiates) coverage 
and then once a quarter thereafter (so long as it continues issuing or 
distributing research on that fund), rather than each time the broker-
dealer publishes or distributes a research report, as proposed.\104\ We 
recognize that in the operating company context where most issuers are 
not engaged in a continuous distribution, broker-dealers can rely on 
other research report rules that do not include a public float 
requirement. The requirement in proposed rule 139b that a covered 
investment fund have the requisite public float each time the broker-
dealer publishes a research report could therefore have involved 
greater operational challenges than those associated with the 
corresponding requirement in rule 139. A broker-dealer would generally 
only need to comply with the requirement in rule 139 for a discrete 
period of time while the issuer is in distribution, but would have been 
required to comply with the corresponding requirement in rule proposed 
139b every time the broker-dealer published a research report about a 
covered investment fund that was in continuous distribution where the 
broker-dealer is participating in the offering. We believe that 
requiring a broker-dealer to determine the float upon initiation or 
reinitiation of coverage will ensure that the float requirement is met 
at the outset of research coverage. We are requiring a quarterly re-
assessment of the float requirement to mitigate the risk that a covered 
investment fund's float declines over time and no longer meets the 
float requirement. We believe a quarterly assessment is appropriate as 
it aligns with the quarterly reporting schedule of most funds, and 
balances the risks of only periodically verifying a fund's float with 
the costs of more frequent or continuous assessments.
---------------------------------------------------------------------------

    \104\ See rule 139b(a)(1)(i)(B). If a broker-dealer were to 
cease publication or distribution of a covered fund research report 
and then initiate coverage again, this provision would require the 
fund's float to be above the minimum at the time that the broker or 
dealer begins relying on the safe harbor provided by rule 139b once 
more.
---------------------------------------------------------------------------

    We believe these adjustments appropriately tailor rule 139 to 
covered investment funds. For the reasons discussed below, we believe 
that the changes to the calculation and time of testing of the minimum 
public float requirement for covered investment funds under rule 139b 
are necessary or appropriate in the public interest, and for the 
protection of investors, and for the promotion of capital formation as 
they allow appropriately tailoring of rule 139 in applying it to 
covered investment funds while considering their unique structure and 
operational aspects.
    We proposed that the float threshold be calculated in terms of NAV 
rather than aggregate market value for mutual funds in order to reflect 
the market structure differences between mutual funds and all other 
covered investment funds.\105\ Absent this modification, the float 
requirement would categorically exclude broker-dealers from relying on 
rule 139b in their publication or distribution of mutual fund issuer-
specific research reports, which would appear inconsistent with the 
FAIR Act's directives. Mutual funds redeem their shares each day and 
therefore must compute their net asset value each day, providing a 
timely and reliable measure of the fund's size, akin to other issuers' 
public float; and investors' ability to purchase and redeem fund shares 
at net asset value provides timely share prices akin to the price 
discovery that occurs in a public trading market. As discussed further 
below, for other types of covered investment funds, such as closed-end 
funds and BDCs, which may or may not have public float, we believe it 
is appropriate, and consistent with the FAIR Act, to provide the same 
public float requirements--the manner of calculation and amount--as 
applies to issuer-specific research reports under rule 139. 
Accordingly, we are adopting this NAV calculation method as proposed.
---------------------------------------------------------------------------

    \105\ Id. at 26796 n.86.
---------------------------------------------------------------------------

Non-Traded Funds
    Finally, one commenter suggested that we revise rule 139b to permit 
an issuer-specific research report to cover a non-traded closed-end 
fund or BDC that does not have a ``public float,'' and thus which, 
under proposed rule 139b, could not be included in an issuer-specific 
research report.\106\ This commenter noted that the proposed rule did 
not extend the NAV calculation method beyond open-end funds, but 
pointed to a footnote in the proposal that discussed the potential for 
non-traded BDCs or CEFs to be able to use a variant of the NAV 
approach, and asked that we amend the final rule to allow them to do 
so.\107\
---------------------------------------------------------------------------

    \106\ See Sutherland Comment Letter.
    \107\ Id. The commenter argued that all non-traded covered 
investment funds that have a net asset value (less the value of 
shares held by affiliates) that equals or exceeds the aggregate 
market value required in General Instruction I.B.1. to Form S-3 
should be covered by new rule 139b.
---------------------------------------------------------------------------

    Although under the proposed rule the NAV calculation method was 
only available to mutual funds, we acknowledge that the Proposing 
Release discussion was inconsistent with the proposed rule text in that 
the Proposing Release discussed the possibility of non-traded BDCs and 
CEFs calculating a NAV based on their last publicly disclosed share 
price for purposes of proposed rule 139b.\108\
---------------------------------------------------------------------------

    \108\ Compare Proposing Release, supra note 2, at 26796 n.83 
(``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).'') with proposed rule 139b(a)(1)(i)(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 (emphasis added) (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.''
---------------------------------------------------------------------------

    We decline to amend the rule text to allow the NAV calculation 
method for non-traded BDCs and closed-end funds. We believe that it is 
inappropriate for non-traded BDCs and closed-end funds to satisfy the 
float requirement using a

[[Page 64189]]

NAV calculation because doing so would undermine the purpose of the 
requirement. As discussed previously, historically, the Commission has 
used public float as a proxy for a security's market following.\109\ We 
believe that the NAV method for mutual funds acts as an effective proxy 
for market following for mutual funds because mutual funds redeem their 
shares daily and therefore must compute their net asset value each day, 
providing a timely and reliable measure of the fund's size, akin to 
other issuers' public float; and investors' ability to purchase and 
redeem fund shares at net asset value provides timely share prices akin 
to the price discovery that occurs in a public trading market. Non-
traded BDCs and CEFs do not have an equivalent daily metric available, 
and often compute NAV on a significantly more infrequent basis, such as 
quarterly.
---------------------------------------------------------------------------

    \109\ See supra note 87 and accompanying text.
---------------------------------------------------------------------------

    In addition, we do not believe that providing a different 
calculation method for non-traded closed-end funds and non-traded BDCs 
is appropriate, because such funds do not have the same kind of 
structural differences that necessitate different treatment provided to 
open-end funds. For example, unlike mutual funds, non-traded closed-end 
funds and BDCs could meet the float requirement if they chose to be 
listed and would not have to undertake any structural changes. By 
opting not to list, non-traded BDCs and closed-end funds are similar to 
non-listed operating company issuers that, by choosing not to list, 
cannot meet the public float requirement of rule 139.
    Finally, we do not believe that our approach is inconsistent with 
the statute or congressional intent. Specifically, we note that the 
FAIR Act includes an interim effectiveness provision, whereby if the 
Commission has not adopted a covered investment fund research report 
rule within 270 days of the Act's enactment, broker-dealers could begin 
publishing or distributing covered investment fund research reports 
provided that certain rule 139 conditions are satisfied.\110\ One such 
specified condition is that an issuer-specific research report about a 
covered investment fund must satisfy the existing public float 
requirement of rule 139 during this interim effectiveness. As such, 
even during the interim effectiveness period provided under the FAIR 
Act and as a result of the conditions in rule 139, non-traded BDCs and 
CEFs would not be able to satisfy the public float requirement and thus 
by congressional design would not receive the benefit of the FAIR Act's 
safe harbor. In light of the reasons discussed above, we have 
determined not to amend the proposed rule text as the commenter 
recommended to expressly include non-traded BDCs and CEFs within the 
safe harbor.
---------------------------------------------------------------------------

    \110\ See supra note 3; section 2(d) of the FAIR Act. The FAIR 
Act's interim effectiveness provision became effective as of July 3, 
2018 and by its terms will terminate upon the adoption of a covered 
investment fund research report rule. Currently, at least one 
broker-dealer is issuing covered investment fund research reports in 
reliance on the interim effectiveness provision. See, e.g., Rachel 
Evans, In a Passive World, Bank of America's New ETF Team Picks 
Stocks (Oct. 17, 2018), available at https://www.bloomberg.com/news/articles/2018-10-17/in-a-passive-world-bank-of-america-s-new-etf-team-picks-stocks?srnd=etfs.
---------------------------------------------------------------------------

c. Regular-Course-of-Business Requirement
    We are adopting as proposed a condition to rule 139b that a broker-
dealer's publication or distribution of research reports be ``in the 
regular course of its business'' \111\ (the ``regular-course-of-
business'' requirement). Although the regular-course-of-business 
requirement is generally similar to the existing provisions of rule 
139, it differs in one 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).\112\
---------------------------------------------------------------------------

    \111\ Rule 139b(a)(1)(ii).
    \112\ Rule 139(a)(1)(iii) [17 CFR 230.139(a)(1)(iii)].
---------------------------------------------------------------------------

    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.'' \113\ Accordingly, rule 139b 
incorporates the ``initiation or reinitiation'' requirement from rule 
139 and specifies that it applies only to research reports regarding a 
covered investment fund that does not have a class of securities in 
substantially continuous distribution.\114\ Determining whether a class 
of securities is in substantially continuous distribution would be 
based on an analysis of the relevant facts and circumstances.
---------------------------------------------------------------------------

    \113\ Section 2(b)(1) of the FAIR Act.
    \114\ See rule 139b(a)(1)(ii).
---------------------------------------------------------------------------

    One commenter asked for clarification that the scope and meaning of 
``substantially continuous distribution'' includes traded registered 
closed-end investment companies and BDCs engaged in at-the-market 
(``ATM'') offering programs over consecutive quarters pursuant to rule 
415(a)(4) under the Securities Act.\115\ Determining whether a class of 
securities is in ``substantially continuous distribution'' is an 
analysis based on the relevant facts and circumstances. With respect to 
traded funds that offer ATM programs over consecutive quarters pursuant 
to rule 415(a)(4) under the Securities Act, we believe that a covered 
investment fund that engages in ongoing distributions of its shares on 
a frequency consistent with open-end investment companies is in 
substantially continuous distribution, but one that does so on a less 
frequent basis may not be.
---------------------------------------------------------------------------

    \115\ See Sutherland Comment Letter. This commenter also asked 
for clarification regarding non-traded registered closed-end 
investment companies and non-traded BDCs offering shares on a 
continuous basis under Securities Act rule 415(a)(1)(ix). Although 
these funds would not be covered in issuer-specific research reports 
because they would not have the requisite public float, we believe 
that a ``continuous'' offering under rule 415(a)(1)(ix) would 
include a ``substantially continuous offering'' for purposes of rule 
139b. See infra section II.B.2.b.
---------------------------------------------------------------------------

    One commenter asked that we clarify whether broker-dealers that 
have published and distributed communications styled as ``research 
reports'' in compliance with rule 482 would meet the regular-course-of-
business requirement.\116\ This commenter also mentioned that some 
broker-dealers have published and distributed research reports on other 
issuers (such as non-covered investment funds, or on operating 
companies) in reliance on the rule 139 safe harbor. We believe that a 
broker-dealer can satisfy the regular-course-of-business requirement 
through either of the methods discussed by this commenter.\117\ A 
broker-dealer publishing or distributing an issuer-specific research 
report can satisfy the regular-course-of-business requirement if at the 
time of reliance on rule 139b it has distributed or published at least 
one research report about the issuer or its securities, or has 
distributed or published at least one such report following a period of 
discontinued coverage. In addition, the condition may be satisfied by 
publishing or distributing research reports on a covered investment 
fund when a broker-dealer is

[[Page 64190]]

not participating in the offering of that fund.\118\
---------------------------------------------------------------------------

    \116\ See Fidelity Comment Letter.
    \117\ See also Securities Offering Reform Adopting Release, 
supra note 23, at 44763-64. There is no minimum time period for the 
broker or dealer to have distributed or published research reports, 
only that the particular broker or dealer has initiated or 
reinitiated coverage. Id.
    \118\ This would also include other types of research or rule 
482 stylized ``research reports,'' discussed below.
---------------------------------------------------------------------------

    One commenter indicated that broker-dealers should not be required 
to have a traditional research department in order to rely on the 
rule.\119\ A traditional research department is not a requirement to 
meet the condition, but would be a factor in indicating compliance with 
the regular-course-of-business requirement. We discussed a number of 
other factors that may evidence compliance with this condition in the 
Proposing Release.\120\
---------------------------------------------------------------------------

    \119\ See SIFMA Comment Letter I (also asking the Commission to 
clarify that the regular-course-of-business requirement would 
definitively be satisfied where the research is produced by 
traditional research analysts within a traditional research 
department--regardless of whether it previously produced research on 
a particular type of security).
    \120\ See Proposing Release, supra note 2, at 26796-99 (These 
factors included whether the broker-dealer: Has a compliance 
structure in place with relevant policies and procedures governing 
their publication of research and their distribution of registered 
investment company advertisements; has a research department with 
research analysts covering particular issuers or industries; 
maintains policies and procedures governing its research protocols; 
and regularly publishes or distributes research on any other type of 
company or business other than covered investment funds.).
---------------------------------------------------------------------------

    Several commenters expressed concerns that the regular-course-of-
business requirement was too restrictive.\121\ For example, one 
commenter stated that requiring broker-dealers to satisfy the regular-
course-of-business requirement by having a history of publishing or 
distributing research on the same types of securities as covered in the 
research report is inconsistent with the FAIR Act and congressional 
intent, and may preclude coverage by new broker-dealer entrants.\122\ 
We do not believe that the regular-course-of-business requirement is 
inconsistent with the FAIR Act, congressional intent, or would preclude 
new broker-dealer entrants from relying on the rule 139b safe harbor, 
as suggested by the commenter. We believe the FAIR Act and 
congressional intent are clear in their directive to extend the rule 
139 safe harbor to covered investment fund research reports. Rule 139 
includes a regular-course-of-business requirement, and we believe it is 
appropriate for rule 139b to also include the same type of requirement. 
Commenters did not identify, and we are not aware of, any 
distinguishable differences in the operation of covered fund issuers 
that would necessitate different treatment from other issuers subject 
to rule 139 with respect to a regular-course-of-business requirement.
---------------------------------------------------------------------------

    \121\ See SIFMA Comment Letter I; ICI Comment Letter; Fidelity 
Comment Letter; see also BlackRock Comment Letter.
    \122\ See SIFMA Comment Letter I.
---------------------------------------------------------------------------

    Moreover, broker-dealers that wish to newly begin publishing or 
distributing research reports on funds could meet this condition 
through any of the methods discussed above.\123\ Once a broker-dealer 
has established a history of issuing such research reports pursuant to 
any of these (or potentially other) methods in the regular course of 
business, it could satisfy the condition and begin relying on rule 
139b.
---------------------------------------------------------------------------

    \123\ See supra notes 116-118 and accompanying text.
---------------------------------------------------------------------------

    Similarly, another commenter stated that in place of the regular-
course-of-business requirement, we should require broker-dealers' 
policies and procedures to include rule 139b compliance.\124\ We are 
not incorporating this suggested change. Maintaining policies and 
procedures to comply with rule 139b is one of several factors we would 
assess in determining whether the broker-dealer has engaged in research 
report publication and distribution in the regular course of business, 
but such a factor alone does not establish that the regular-course-of-
business requirement has been met.
---------------------------------------------------------------------------

    \124\ See ICI Comment Letter; see also BlackRock Comment Letter.
---------------------------------------------------------------------------

    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.\125\ We 
continue to believe requiring that research reports be published or 
distributed in the regular course of a broker-dealer's business under 
rule 139b, consistent with the requirements of rule 139, could reduce 
the potential that covered investment fund research reports could be 
used to circumvent the prospectus requirements of the Securities 
Act.\126\ For the reasons discussed in this section, we are adopting 
the regular-course-of-business requirement as proposed.
---------------------------------------------------------------------------

    \125\ 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)].
    \126\ See Proposing Release, supra note 2, at 26797; see also 
Securities Offering Reform Adopting Release, supra note 23.
---------------------------------------------------------------------------

2. Industry Research Reports
    Rule 139b sets forth conditions for industry research reports that 
parallel the corresponding conditions under rule 139 and are intended 
to provide appropriate parameters to address the risk of circumvention 
of the prospectus requirements of the Securities Act.\127\
---------------------------------------------------------------------------

    \127\ See supra notes 49-50 and accompanying text; see also 
supra paragraph accompanying notes 12-15.
---------------------------------------------------------------------------

a. Reporting Requirement
    Under the rule 139b 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 reporting 
requirement generally tracks an existing requirement for industry 
research reports under rule 139 but has been modified so that it would 
be applicable to industry research reports that include covered 
investment fund issuers.\128\ Like the parallel provision of rule 139, 
the reporting requirement under rule 139b helps ensure that there is 
publicly available information about the relevant issuers and that 
investors are able to use such information in making their investment 
decisions. Commenters did not present any concerns regarding the 
reporting requirement for purposes of industry research reports, and we 
are adopting it as proposed.
---------------------------------------------------------------------------

    \128\ 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.).
---------------------------------------------------------------------------

b. Regular-Course-of-Business Requirement
    Under rule 139b, as proposed, a broker-dealer must publish or 
distribute research reports in the regular course of its business in 
order to rely on the new rule's safe harbor.\129\ The regular-course-
of-business requirement for industry research reports similarly applies 
to issuer-specific research reports,\130\ and it also tracks an 
existing requirement for industry research reports under rule 139.\131\
---------------------------------------------------------------------------

    \129\ Rule 139b(a)(2)(iv) (the broker-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).
    \130\ See supra section II.B.1.c.
    \131\ See rule 139(a)(2)(v) [17 CFR 230.139(a)(2)(v)].
---------------------------------------------------------------------------

    Like the parallel provision in rule 139, rule 139b's regular-
course-of-business requirement for industry research reports includes 
the requirement that, at the time of publication or distribution of the

[[Page 64191]]

industry research report, the broker-dealer is including similar 
information about the issuer or its securities in similar reports.\132\ 
However, unlike rule 139, the ``similar information'' requirement under 
rule 139b applies 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.'' \133\ We believe that the ``similar 
information'' requirement is akin to the ``initiation or reinitiation'' 
requirement, in that both would have the effect of limiting a broker-
dealer's ability to rely on the rule 139b 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 ``initiation or reinitiation'' 
requirement, we are also excluding covered investment funds from the 
``similar information'' requirement if they have a class of securities 
in substantially continuous distribution.
---------------------------------------------------------------------------

    \132\ Rule 139b(a)(2)(iv).
    \133\ See supra notes 113-114 and accompanying text.
---------------------------------------------------------------------------

    We provided guidance in section II.B.1.c above on how a broker-
dealer can meet the regular-course-of-business requirement in the 
context of issuer-specific research reports, and such guidance would be 
equally applicable in meeting the requirement in the context of 
industry research reports. We are adopting the requirement as proposed 
for the reasons discussed in this section and in the similar section 
for issuer-specific research reports.
c. Content Requirements for Industry Research Reports
    Rule 139b's safe harbor for publication or distribution of industry 
research reports is also conditioned on certain content requirements. 
We are adopting these requirements as proposed.
    Specifically, under rule 139b, 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''),\134\ or alternatively contain 
a comprehensive list of covered investment fund securities currently 
recommended by the broker-dealer (the ``comprehensive list 
requirement'').\135\ These requirements are designed to result in 
industry research reports that cover a broad range of investment 
companies or securities.\136\ At the same time, the comprehensive list 
requirement would permit a different presentation of research about 
multiple covered investment funds than the industry representation 
requirement would permit.\137\ Because the affiliate exclusion applies 
to all covered investment fund research reports--i.e., both issuer-
specific research reports and industry research reports--a broker-
dealer seeking to rely on rule 139b by satisfying either the industry 
representation requirement or the comprehensive list requirement cannot 
include any covered investment fund issuer that is an affiliate of the 
broker-dealer, or for which the broker-dealer serves as an investment 
adviser (or is an affiliated person of the investment adviser) in a 
covered investment fund research report, including industry research 
reports.\138\
---------------------------------------------------------------------------

    \134\ Rule 139b(a)(2)(ii)(A).
    \135\ Rule 139b(a)(2)(ii)(B).
    \136\ See Research Reports, Securities Act Release No. 6492 
(Oct. 6, 1983) [48 FR 46801 (Oct. 14, 1983)].
    \137\ Under 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.
    \138\ See rule 139b(a)(2)(ii)(B) (excluding from the 
comprehensive list securities of a covered investment fund that is 
an affiliate of the broker-dealer, or for which the broker-dealer 
serves as investment adviser (or for which the broker-dealer is an 
affiliated person of the investment adviser)); see also supra 
section II.A.1. In the final rule, we also made a change to rule 
139b(a)(2)(ii) to clarify that the industry research report 
provisions are with respect to covered investment fund research 
reports and the affiliate exclusion set forth therein. Thus, a 
broker-dealer cannot include a covered investment fund issuer in any 
industry specific report (i.e., industry representation requirement 
or the comprehensive list requirement) if the broker-dealer's 
relationship to the issuer meets any of the affiliations designated 
in the affiliated exclusion.
---------------------------------------------------------------------------

    Several commenters argued that a broker-dealer should be able to 
include affiliated funds in industry research reports about covered 
investment funds.\139\ Another commenter argued that industry research 
reports with a substantial number of funds should satisfy the purposes 
of the affiliate exclusion if they contain similar information about 
each fund and no particular fund is afforded materially greater space 
or prominence.\140\ Another commenter suggested that, in some 
instances, because affiliated funds may be as or more suitable than 
non-affiliated funds, broker-dealers should be allowed to include 
affiliated funds in industry research reports.\141\ Several commenters 
also argued that we should permit broker-dealers to include both 
affiliated and non-affiliated funds in industry research reports, but 
only provide the rule 139b safe harbor for the non-affiliated funds 
included in the report. They suggested that any information about 
affiliated funds included in such a report not benefit from the safe 
harbor, and thus any discussions of those funds be subject to the 
requirements of rule 482.\142\
---------------------------------------------------------------------------

    \139\ See ICI Comment Letter; Fidelity Comment Letter; SIFMA 
Comment Letter I; see also BlackRock Comment Letter.
    \140\ See SIFMA Comment Letter I.
    \141\ See Fidelity Comment Letter.
    \142\ See SIFMA Comment Letter I; Fidelity Comment Letter.
---------------------------------------------------------------------------

    We believe extending the rule 139b safe harbor to affiliated funds 
in industry research reports (whether industry representation or 
comprehensive list reports) would not be consistent with the intent and 
plain language of section 2(f)(3) of the FAIR Act.\143\ We also believe 
that allowing for a mix of affiliated funds and non-affiliated funds to 
appear together in a single research report, as suggested by 
commenters, in reliance on two separate and distinct characterizations 
of that communication (i.e., under rule 139b such a research report 
would be deemed not an offer under the Securities Act, and under rule 
482 such a research report would be deemed to be a 10(b) omitting 
prospectus) would be an untenable regulatory framework. Not only would 
there be differing presentation, liability, and filing standards for 
the different portions of the report, but we believe that it could 
create challenges for regulators and others and confusion for investors 
because the information presented for each type of fund would likely 
differ.\144\

[[Page 64192]]

Accordingly, we clarify that broker-dealers may not selectively apply 
the rule 139b safe harbor to certain aspects of a research report. The 
safe harbor must apply to the entirety of the report or it does not 
apply at all. Broker-dealers may, however, instead choose to issue a 
rule 482 communication that is styled as an industry research report 
about affiliated funds or about affiliated and non-affiliated funds; in 
either case, such a communication would be subject to the requirements 
of rule 482 and not gain the benefit of the rule 139b safe harbor.
---------------------------------------------------------------------------

    \143\ This section excludes from the definition of covered 
investment fund research report any 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-dealer 
that is an investment adviser (or an affiliated person of an 
investment adviser) for the covered investment fund.
    \144\ For example, communications subject to rule 482 must be 
filed with the Commission pursuant to section 24(b) of the 
Investment Company Act. 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. 17 CFR 270.24b-3. Unless the 
entirety of the research report was filed, reviewing isolated and 
selective portions of a research report related to affiliated funds 
may not allow for effective review of such materials.
---------------------------------------------------------------------------

    One commenter raised the concern that excluding affiliated funds 
from an industry research report subject to the comprehensive list 
requirement may create a false impression that an affiliated fund is 
excluded because it does not meet an investor's criteria.\145\ We 
acknowledge this possibility. If a broker-dealer is concerned that a 
research report purporting to include a comprehensive list of funds may 
confuse investors, the broker-dealer could include an explanation of 
why affiliated funds are excluded from the research report. For 
example, a broker-dealer could include a statement in the report 
indicating that it does not include information about affiliated funds 
due to relevant securities regulations.
---------------------------------------------------------------------------

    \145\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

    One commenter argued that rule 139b should not include industry 
report content requirements because covered investment funds do not 
have the same market conditioning or ``gun-jumping'' concerns as 
securities covered in research reports published or distributed in 
reliance on rule 139.\146\ Since many covered investment funds 
continuously distribute their securities, conditioning the market 
concerns can remain throughout the offering for issuers covered under 
rule 139b. Market conditioning is a concern that information about a 
fund or its securities might supersede the information provided in 
their offering prospectus. With respect to research reports, this 
concern is heightened for issuer-specific research reports and 
therefore they are subject to more stringent conditions than industry 
research reports. Market conditioning, however, remains a concern for 
industry research reports, as well. The content requirements for 
industry reports are designed to help ensure that industry reports 
become a part of the mix of information in the marketplace, rather than 
circumventing the prospectus requirements of the Securities Act or the 
issuer-specific conditions.
---------------------------------------------------------------------------

    \146\ See ICI Comment Letter (citing an SEC staff report issued 
in 1969 noting that ``gun-jumping'' concerns primarily arise during 
the pre-filing stage of a securities offering and casting doubt on 
the doctrine's applicability to non-participants in a securities 
offering). This commenter made the same argument regarding industry 
report presentation requirements. See infra note 152. See also 
BlackRock Comment Letter. Rule 139b is not limited to non-
participants. Broker-dealers participating in the distribution of 
the covered investment fund's securities may rely on the rule 
provided the applicable conditions are satisfied.
---------------------------------------------------------------------------

    The language from rule 139's industry representation requirement is 
replicated 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.'' \147\ As discussed in the 
Proposing Release, 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.\148\ Therefore, the 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).\149\ We believe 
that this requirement tracks rule 139 to the extent practicable and 
appropriate, and we did not receive comments on this aspect of the 
proposal. For the reasons discussed above, we are adopting the industry 
research report content requirements as proposed.
---------------------------------------------------------------------------

    \147\ Rule 139(a)(2)(iii) [17 CFR 230.139(a)(2)(iii)].
    \148\ See Proposing Release, supra note 2, at 26800.
    \149\ Rule 139b(a)(2)(ii)(A).
---------------------------------------------------------------------------

d. Presentation Requirement for Industry Research Reports
    As proposed, the rule 139b safe harbor for industry research 
reports is conditioned on a presentation requirement. Under the new 
rule, analysis of any covered investment fund issuer or its securities 
included in an industry research report cannot be given materially 
greater space or prominence in the publication than that given to any 
other covered investment fund issuer or its securities.\150\
---------------------------------------------------------------------------

    \150\ Rule 139b(a)(2)(iii).
---------------------------------------------------------------------------

    We believe that the concerns underlying the rule 139 presentation 
requirements apply equally in the context of covered investment fund 
research reports.\151\ 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.
---------------------------------------------------------------------------

    \151\ See Proposing Release, supra note 2, at 26801.
---------------------------------------------------------------------------

    One commenter argued that rule 139b should not include industry 
report presentation requirements because covered investment funds do 
not have the same market conditioning or ``gun-jumping'' concerns as 
those securities covered in research reports published or distributed 
in reliance of rule 139.\152\ As discussed above, market conditioning 
remains a concern for industry research reports.\153\ The presentation 
requirements for industry reports are designed to help ensure that 
industry reports become a part of the mix of information in the 
marketplace, rather than circumventing the prospectus requirements of 
the Securities Act or the issuer-specific conditions. For the same 
reasons discussed above, we disagree with this commenter.\154\ 
Accordingly, we are adopting this requirement as proposed.
---------------------------------------------------------------------------

    \152\ See ICI Comment Letter; see also BlackRock Comment Letter.
    \153\ See supra note 146 and accompanying paragraph.
    \154\ See id.
---------------------------------------------------------------------------

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

    The proposed rule would not have required standardized performance 
presentation for covered investment fund research reports. However, the 
Commission requested comment on whether the final rule should require 
research reports about registered investment companies to be subject to 
standardized performance presentation requirements. The Commission 
expressed its concern that not including standardized performance 
measures in research reports could lead to investor confusion. The 
Commission also noted its longtime recognition that investors tend to 
consider investment performance to be a particularly significant factor 
in evaluating or comparing investment companies and had previously 
identified a number of circumstances in which performance could be 
disclosed in a misleading manner.\155\
---------------------------------------------------------------------------

    \155\ See Proposing Release, supra note 2, at 26802. 
Additionally, the Commission noted its concern that rule 482 or rule 
34b-1 could be circumvented by recasting registered investment 
company advertisements or selling materials as research reports. Id.

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

[[Page 64193]]

    In a change from the proposal, we are adopting a condition in rule 
139b that if fund performance information is included in a research 
report, it must be presented in accordance with certain standardized 
presentation requirements dependent on the type of covered investment 
fund covered.\156\ For research reports that include registered open-
end fund performance, we are requiring that fund performance be 
presented according to the presentment and timeliness requirements of 
rule 482.\157\ For research reports that include closed-end fund 
performance, one commenter argued for standardized presentation 
requirements for all covered investment funds and recommended that 
closed-end funds comply with the requirements of Form N-2 instead of 
rule 482, which does not offer any standardized performance 
requirements for closed-end funds.\158\ We agree with the commenter, 
and are therefore requiring that closed-end fund performance be 
presented in a manner that is in accordance with the instructions to 
item 4.1(g) of Form N-2, although other historical measures of 
performance may also be included if any other measurement is set out 
with no greater prominence.
---------------------------------------------------------------------------

    \156\ Rule 139b(a)(3).
    \157\ See id. (requiring that a research report discussing fund 
performance of a registered open-end management investment company 
must present it in accordance with the performance requirements of 
paragraphs (d) and (e) of rule 482 [17 CFR 230.482] and must also 
comply with the timeliness requirement of performance data in 
paragraph (g) of rule 482).
    \158\ See ICI Comment Letter; see also BlackRock Comment Letter.
---------------------------------------------------------------------------

    Specific statutory provisions and rules apply to advertising the 
performance of registered investment companies.\159\ 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.\160\ Therefore, 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.\161\ As discussed in the Proposing Release, given 
the breadth of the definition of ``research report'' under the FAIR Act 
(and the definition of ``research report'' 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 rule 139b safe harbor.\162\ Among other things, rule 482 requires 
standardized presentation of performance data included in registered 
open-end investment company advertisements.\163\ Alternatively, if 
other performance measures are presented, they must be accompanied by 
certain standardized performance data.\164\
---------------------------------------------------------------------------

    \159\ 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).
    \160\ See rule 482 under the Securities Act [17 CFR 230.482].
    \161\ See id. 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).
    \162\ See Proposing Release, supra note 2, at 26801.
    \163\ See rule 482(d)(1)-(4) under the Securities Act (for open-
end investment companies other than money market funds) [17 CFR 
230.482(d)(1)-(4)]; rule 482(e) under the Securities Act (for money 
market funds) [17 CFR 230.482(e)].
    \164\ See rule 482(d)(5) [17 CFR 230.482(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. See id.
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    Because a broker-dealer's publication or distribution of a covered 
investment fund research report under rule 139b is 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 under rule 34b-1 under 
the Investment Company Act that must be accompanied or preceded by a 
statutory prospectus now could be considered covered investment fund 
research reports (which need not be preceded or accompanied by a 
statutory prospectus).\165\ Rule 34b-1 incorporates many of the rule 
482 requirements relating to performance disclosure and makes these 
requirements applicable to supplemental sales literature.\166\ As 
discussed in the Proposing Release, 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,\167\ there could be 
circumstances where, under rule 139b, broker-dealers publish or 
distribute communications that historically have been viewed as 
registered investment company advertisements or selling materials.
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    \165\ See section 2(a)(10)(a) of the Securities Act; rule 
139b(a). See also rule 34b-1 under the Investment Company Act [17 
CFR 270.34b-1]. 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.
    \166\ See rule 34b-1(b)(1)-(2) [17 CFR 270.34b-1(b)(1)-(2)].
    \167\ See, e.g., supra sections II.A.1 (affiliate exclusion) and 
II.B.1.c and II.B.2.b (regular-course-of-business requirements). 
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 infra section II.D.1.
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    We received two comment letters addressing this issue.\168\ One 
commenter suggested that the presentation of performance information in 
research reports about registered investment companies should not be 
subject to the standardized performance requirements of rule 482.\169\ 
This commenter stated that because rule 482 is intended to apply to 
advertisements, such presentation requirements might undermine analysis 
or insights that a

[[Page 64194]]

research analyst may seek to convey about one or more covered 
investment funds by highlighting a particular aspect of performance 
information. This commenter also stated that SRO rules would address 
the investor confusion concern raised by the Commission. We disagree 
that applying standardized performance presentation requirements would 
undermine a research analyst's analysis or insights because rule 482 
does not preclude non-standardized performance information. Rather, it 
requires standardized performance information to be presented if non-
standardized performance information is presented. We believe SRO rules 
may address some investor confusion concerns, but we believe requiring 
presentation performance requirements would more fully address these 
concerns.
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    \168\ See SIFMA Comment Letter I; ICI Comment Letter; see also 
BlackRock Comment Letter.
    \169\ SIFMA Comment Letter I.
---------------------------------------------------------------------------

    Another commenter stated that the Commission should require that 
fund-specific performance information in covered investment fund 
research reports be presented in accordance with the applicable 
standardization requirements.\170\ This commenter stated that investors 
tend to consider fund performance a significant factor in evaluating or 
comparing funds and that standardized fund performance reporting 
requirements have served investors well. Furthermore, this commenter 
noted that discrepancies in performance between a broker-dealer's 
research report and what a fund may report or disclose in regulatory 
filings or advertisements would risk confusing investors. We agree with 
both of the commenter's points. This commenter also noted that if the 
final rule does not require standardized presentation requirements for 
fund performance information, the Commission should require a clear and 
prominent disclosure whenever fund-specific performance is not in 
accordance with these standards.
---------------------------------------------------------------------------

    \170\ ICI Comment Letter. This commenter also suggested the 
disclosure of Form N-2 performance data for closed-end funds. See 
also BlackRock Comment Letter.
---------------------------------------------------------------------------

    The final rule thus requires that a research report that includes 
open-end fund performance information must present this information in 
accordance with rule 482 presentment and timeliness requirements. A 
research report must present closed-end fund performance information in 
accordance with the instructions to item 4.1(g) set forth in Form N-2 
(although other historical measures of performance may also be included 
if the other measurement is set out with no greater prominence than the 
measurement that is in accordance with the instructions to item 4.1(g) 
of Form N-2).
    Rule 139b(a)(3) requirements would not preclude research report 
analysts from presenting performance information in their preferred 
manner; rather, it requires that standardized performance information 
also be included if non-standardized performance information is 
presented. To satisfy this requirement, analysts may choose to present 
non-standardized performance information in a way they believe 
highlights a particular insight or analysis, so long as it is presented 
alongside the standardized performance information consistent with rule 
482 requirements or Form N-2, if applicable.\171\
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    \171\ See rule 139b(a)(3).
---------------------------------------------------------------------------

    As noted in the proposal, covered investment fund research reports 
relying on the rule 139b safe harbor are subject to the antifraud 
provisions of the federal securities laws.\172\ 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.\173\ This guidance provided factors to be weighed when 
determining whether fund performance in sales literature is adequately 
disclosed. The guidance factors in rule 156 \174\ are informative in 
evaluating whether any presentations of registered investment company 
performance in these research reports could be misleading because they 
reflect principles that would help guide this analysis (such as 
providing information to investors that is informative and that does 
not create unrealistic investor expectations \175\). We believe that 
incorporating these rule 482 and Form N-2 presentation standards in 
rule 139b reduces the potential for confusion between (i) registered 
open-end management investment company advertisements and selling 
materials covered by rule 482 and registered closed-end investment 
company selling materials covered by Form N-2 and (ii) rule 139b 
research reports. Moreover, we believe it would reduce the potential 
for investor confusion resulting from divergent standards in the 
presentation of performance data.
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    \172\ See section 2(c)(1) of the FAIR Act (stating that nothing 
in the FAIR Act shall be construed as in any way limiting the 
applicability of the antifraud or anti-manipulation provisions of 
the federal securities laws and rules adopted thereunder to a 
covered investment fund research report, including section 17 of the 
Securities Act, section 34(b) of the Investment Company Act, and 
sections 9 and 10 of the Exchange Act).
    \173\ See Amendments to Investment Company Advertising Rules, 
Securities Act Release No. 8294 (Sept. 29, 2003) [68 FR 57759 (Oct. 
6, 2003)]; see also rule 156 under the Securities Act [17 CFR 
230.156].
    \174\ 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.
    \175\ See Amendments to Investment Company Advertising Rules, 
Securities Act Release No. 8101 (May 17, 2002) [67 FR 36712 (May 24, 
2002)].
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D. Role of Self-Regulatory Organizations

1. SRO Content Standards and Filing Requirements for Covered Investment 
Fund Research Reports
SRO Content Standards
    The FAIR Act contemplates that SRO content standards applicable to 
research reports would apply to covered investment fund research 
reports.\176\ 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.\177\ As discussed in more detail below, we 
are adopting rule 24b-4 to implement this provision of the FAIR Act. 
New 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

[[Page 64195]]

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.\178\
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    \176\ 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 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 research reports on covered 
investment funds that are investment companies subject to section 
24(b) of the Investment Company Act. For example, registered closed-
end investment companies, BDCs, 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 research report that is not subject to section 24(b) of the 
Investment Company Act would not be subject to filing requirements 
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.
    \177\ See id.
    \178\ See rule 24b-4.
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    Currently, the SRO content standards relevant to communications 
that would be considered covered investment fund research reports under 
rule 139b include the applicable content standards of FINRA rules 2210, 
2241, and 2242.\179\ FINRA's rule governing communications with the 
public (FINRA rule 2210) contains general content standards that apply 
broadly to member communications,\180\ 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.'' \181\
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    \179\ See infra note 183 (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 rule 139b).
    \180\ See FINRA rule 2210(d)(1).
    \181\ 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.'' \182\ In order to provide clarity 
and facilitate consistent and predictable application of rule 24b-4, we 
interpret section 2(b)(4) of the FAIR Act as excluding covered 
investment fund research reports from section 24(b) of the Investment 
Company Act so long as they continue to be subject to the general 
content standards in FINRA rule 2210(d)(1) (or substantially similar 
SRO rules). Accordingly, by operation of rule 24b-4, covered investment 
fund research reports under 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).\183\ 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 Investment Company Act or rule 497 
under the Securities Act,\184\ and therefore would no longer be subject 
to routine review.\185\ We received no comments on SRO content 
standards specifically, but some commenters suggested that FINRA rules 
(particularly with respect to definitions and filing requirements 
thereunder) be modified or harmonized with rule 139b, which we discuss 
below.\186\
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    \182\ Section 2(b)(4) of the FAIR Act.
    \183\ A subset of communications that would fall within the 
definition of ``covered investment fund research report'' under 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 new 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).
    \184\ See infra notes 187-189 and accompanying text.
    \185\ 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.'').
    \186\ See, e.g., Fidelity Comment Letter; SIFMA Comment Letter 
I.
---------------------------------------------------------------------------

Filing Requirements for Covered Investment Fund Research Reports
    Rule 24b-4, as adopted, modifies the filing requirements that 
currently apply to certain broker-dealer communications regarding 
registered investment companies. 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 \187\ and rule 497 under 
the Securities Act.\188\ 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.\189\
---------------------------------------------------------------------------

    \187\ See supra note 144.
    \188\ See rule 497 of the Securities Act [17 CFR 230.497]. Rule 
497, which 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.
    \189\ See supra note 144; see also 17 CFR 230.497(i).
---------------------------------------------------------------------------

    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.\190\ Such communications styled

[[Page 64196]]

as ``research reports'' that previously had been subject to the filing 
requirements of section 24(b) of the Investment Company Act no longer 
would be subject to these requirements by operation of rule 24b-4, as 
adopted, because they would be subject to the general content standards 
of FINRA rule 2210(d)(1).\191\
---------------------------------------------------------------------------

    \190\ See infra section III.C.3.
    \191\ 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 165-167.
---------------------------------------------------------------------------

    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.\192\ However, FINRA provides a number of exclusions from the 
filing requirements.\193\ For example, with respect to research reports 
(as that term is defined in FINRA rule 2241), 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.\194\ Because covered investment fund research 
reports are not required to be filed with the Commission pursuant to 
section 24(b), as directed by the FAIR Act, 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.
---------------------------------------------------------------------------

    \192\ 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 
187-189 and accompanying text.
    \193\ See generally FINRA rule 2210(c)(7).
    \194\ See FINRA rule 2210(c)(7)(O).
---------------------------------------------------------------------------

    However, 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.'' \195\ 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.\196\ 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.\197\
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    \195\ See section 2(c)(2) of the FAIR Act.
    \196\ Id. See also 15 U.S.C. 80a-24(b); FINRA rule 2210.
    \197\ 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).
---------------------------------------------------------------------------

    Two commenters requested that FINRA's filing requirements be 
modified in light of the FAIR Act.\198\ One commenter recommended that 
the Commission work with FINRA to harmonize FINRA's research rules with 
rule 139b and that broker-dealers relying on rule 139b be exempted from 
FINRA's filing requirements with respect to covered investment fund 
research reports.\199\ Another commenter suggested that the relevant 
statutory language of the FAIR Act \200\ should be interpreted to be 
limited to covered investment fund research reports made in reliance of 
the 139b safe harbor that only provide ``information'' that a user 
would not be able to use for research and analysis.\201\ This commenter 
asserted that only covered investment fund research reports that solely 
provide information would fall within the scope of what an SRO could 
require to be filed under its authority. Moreover, one commenter argued 
that because the definition of ``research report'' under the FAIR Act 
was broader than FINRA's definition of research report, that this may 
cause confusion and conflicting interpretive views on what 
communications are deemed research for purposes of the safe harbor and 
filing exclusion.\202\
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    \198\ See SIFMA Comment Letter I; Fidelity Comment Letter.
    \199\ See Fidelity Comment Letter.
    \200\ The FAIR Act provides that the Act does not limit the 
authority of any self-regulatory organization 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.
    \201\ SIFMA Comment Letter I.
    \202\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

    As we discussed above, section 2(c)(2) of the FAIR Act states that 
nothing in the FAIR Act shall be construed as in any way limiting the 
authority of an SRO, which includes FINRA, to require the filing of 
communications with the public, including covered investment fund 
research reports, the purpose of which is not to provide research and 
analysis of covered investment funds. To the extent FINRA would seek to 
amend its rules, any such proposed rule changes would be filed with the 
Commission pursuant to section 19(b)(1) of the Exchange Act and rule 
19b-4 thereunder.
2. SRO Limitations
    The FAIR Act also 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.\203\ Proposed rule 139b incorporated this provision of 
the FAIR Act, and we received no comments on this aspect of the 
proposal. We note that 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 rule 139b. To provide additional context 
for the 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 rule 139b as 
proposed.\204\
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    \203\ Section 2(b)(3) of the FAIR Act.
    \204\ See rule 139b(b).
---------------------------------------------------------------------------

E. Conforming and Technical Amendments

    Rule 101 of Regulation M under the Exchange Act \205\ 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. We proposed, in connection with our adoption of 
Securities Act rule 139b, a conforming

[[Page 64197]]

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 rule 139b are satisfied.
---------------------------------------------------------------------------

    \205\ 17 CFR 242.101(a).
---------------------------------------------------------------------------

    The conforming amendment is intended to align the treatment of 
research under 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 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. The conforming amendment is 
intended to harmonize treatment of research under the Securities Act 
and Exchange Act rules. We received no comments on this aspect of the 
proposal. We are adopting the conforming amendment as proposed.
    In October 2016, the Commission adopted new rules and forms and 
amended other rules and forms under the Investment Company Act to 
modernize the reporting and disclosure of information by registered 
investment companies.\206\ The Commission, among other things, adopted 
Form N-CEN, a new form for registered investment companies to report 
census-type information to the Commission, and rescinded Form N-SAR, a 
form on which the Commission had previously collected census-type 
information on management investment companies and unit investment 
trusts. To implement these changes, the Commission revised references 
to rules and forms to remove references to Form N-SAR and replace them 
with references to Form N-CEN, but inadvertently did not revise Form 
12b-25. We are making a technical amendment to Form 12b-25 to replace 
references to Form N-SAR with references to Form N-CEN and to remove 
the checkbox and accompanying text related to transition reports on 
Form N-SAR.\207\
---------------------------------------------------------------------------

    \206\ See Reporting Modernization Release, supra note 53.
    \207\ Transition reports on Form N-SAR were covered by rule 
30b1-3 under the Investment Company Act, which was rescinded by the 
Reporting Modernization Adopting Release. See Reporting 
Modernization Adopting Release, supra note 53, at 81929 n.781 and 
accompanying and following text.
---------------------------------------------------------------------------

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.\208\ 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.\209\
---------------------------------------------------------------------------

    \208\ 15 U.S.C. 77b(b); 15 U.S.C. 78c(f); 15 U.S.C. 80a-2(c); 15 
U.S.C. 80b-2(c).
    \209\ 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 
costs and benefits of the rules we are adopting, as well as the effects 
of these rules on efficiency, competition, and capital formation 
compared to the baseline. Where possible, we attempt to quantify the 
economic effects we discuss, although in many cases we are unable to do 
so and instead rely on qualitative characterizations. In the Proposing 
Release, we requested comment on our analysis of these effects.\210\ We 
did not receive comments that provided any additional quantification of 
these effects, nor did commenters provide data that could facilitate a 
more quantitative analysis. We therefore continue to be unable to 
produce reasonable quantitative estimates for most of the economic 
effects, and--as in the Proposing Release--rely on qualitative economic 
assessments instead.\211\
---------------------------------------------------------------------------

    \210\ See Proposing Release, supra note 2.
    \211\ See id.
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B. Baseline

    The Commission's economic analysis evaluates the costs and benefits 
of the rules being adopted relative to a baseline that represents the 
best assessment of relevant markets and market participants in the 
absence of these rules. In this section, we begin by characterizing the 
relevant market structure and participants.\212\ We then proceed to 
describe the relevant regulatory structure.
---------------------------------------------------------------------------

    \212\ 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 rules we are adopting directly affect broker-dealers, but their 
indirect effects extend to covered investment funds, other producers of 
research on covered investment funds, and consumers of information 
about covered investment funds.\213\
---------------------------------------------------------------------------

    \213\ The rules we are adopting, 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 rule 
139b has the effect of capturing five common types of investment 
vehicles: Mutual funds, ETFs, certain currency and commodity exchanged 
traded products (``ETPs''), \214\ closed-end funds, and BDCs.\215\ 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.\216\ 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.\217\
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    \214\ 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 rule 139b(c)(2)(ii).
    \215\ See supra section II.A.3.
    \216\ Mutual fund, ETF, and ETP statistics are based on data 
from CRSP mutual fund database (2017Q4). Closed-end fund statistics 
are based on data from CRSP monthly stock file (Dec. 2017). BDC 
statistics are based on the Commission's listing of registered BDCs. 
Securities and Exchange Commission, Business Development Company 
Report: January 2012-July 2018 (Sept. 28, 2018), available at 
https://www.sec.gov/open/datasets-bdc.html.
    \217\ See supra note 216. Market value of BDC shares are based 
on information obtained from CRSP, Compustat, and Audit Analytics.
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BILLING CODE 8011-01-P

[[Page 64198]]

[GRAPHIC] [TIFF OMITTED] TR13DE18.000


[[Page 64199]]


[GRAPHIC] [TIFF OMITTED] TR13DE18.001

    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.\218\ Mutual funds comprise the bulk (84%) of 
covered investment funds.\219\ Nearly half of U.S. households hold 
mutual fund shares \220\ and the vast majority (89%) of mutual fund 
shares are held through retail accounts (i.e., accounts of retail 
investors, or households).\221\ Consequently, at least 75% of the 
public market value of all covered investment funds is held through 
retail accounts. By analyzing institutional holdings from year-end 2017 
Form 13F filings we estimate that across ETF and ETPs, the mean 
institutional holding \222\ was 45%.\223\ For BDCs, we estimate the 
mean institutional holding was 30%, while for closed-end funds, we 
estimate the mean institutional holding was 21%. Based on these 
figures, we further estimate that shares representing 86% of the public 
market value of all covered investment funds are held through retail 
accounts.\224\
---------------------------------------------------------------------------

    \218\ See Investment Company Institute, 2017 Investment Company 
Fact Book (2017), available at https://www.icifactbook.org/ (``ICI 
Fact Book'').
    \219\ See supra note 217.
    \220\ 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.
    \221\ Percentage by value. See ICI Fact Book, supra note 218, 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.
    \222\ 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).
    \223\ Year-end 2017 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 (Sept. 27, 2010), available at 
https://www.sec.gov/files/480.pdf.
    \224\ 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 221 and accompanying text.

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[[Page 64200]]

    As depicted in Figure 3, the covered investment fund market is 
dynamic. In 2017, 638 covered investment funds were created, while 853 
were closed or merged into other covered investment funds.\225\
[GRAPHIC] [TIFF OMITTED] TR13DE18.002

b. Broker-Dealers
---------------------------------------------------------------------------

    \225\ See supra note 216.
---------------------------------------------------------------------------

    The broker-dealers directly affected by the rules we are adopting 
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 \226\ and make certain assumptions when 
characterizing the baseline.
---------------------------------------------------------------------------

    \226\ We rely here primarily on broker-dealers' quarterly FOCUS 
reports.
---------------------------------------------------------------------------

    We believe that broker-dealers that do not derive revenues from the 
distribution of covered investment funds are less likely to be directly 
affected by the rules we are adopting.\227\ As discussed above, 
registered investment companies represent the vast majority of covered 
investment funds.\228\ Broker-dealers report revenues from the 
distribution of investment company shares in regulatory filings,\229\ 
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.\230\ As shown in

[[Page 64201]]

Figure 4, among the affected broker-dealers, the importance of revenues 
from the distribution of covered investment funds varies widely.\231\ 
However, in aggregate, these revenues accounted for 13% of affected 
broker-dealers' total revenues.\232\ 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.
---------------------------------------------------------------------------

    \227\ 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 rule 139b.
    \228\ See supra section III.B.1.a.
    \229\ 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'').
    \230\ We describe these dealers as ``affected,'' but 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.
    \231\ This suggests that the degree to which the ``affected'' 
broker-dealers are affected by the rule will also vary widely.
    \232\ Estimates are based on staff analysis of FOCUS filings. 
    [GRAPHIC] [TIFF OMITTED] TR13DE18.003
    
BILLING CODE 8011-01-C
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 are 
included within the definition of ``covered investment fund'' under 
rule 139b.\233\ The Commission estimates that in 2017, there were 1,417 
broker-dealers that reported revenues from the distribution of covered 
investment funds.\234\ We assume that these broker-dealers will have 
incentives to publish or distribute research reports about covered 
investment funds. However, due to the large number of covered 
investment funds, we do not expect that many broker-dealers' in-house 
research departments (if they have such departments) are currently 
capable of providing research on a large percentage of covered 
investment funds. Most covered investment funds are not followed by 
dedicated research analysts akin to the analyst coverage that the 
Commission has previously identified as being one indicator of market 
interest and following for operating companies.
---------------------------------------------------------------------------

    \233\ See supra section III.B.1.b.
    \234\ See id.
---------------------------------------------------------------------------

    Existing Commission and SRO rules do not delineate a category of 
``research reports'' pertaining to covered investment funds. 
Consequently, it is not possible to identify with precision broker-
dealer communications under the baseline that would be considered 
``research reports'' as defined in 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.\235\ FINRA member firms--the vast majority \236\ of 
broker-dealers--file these communications with FINRA.\237\ The number 
of communications filed with FINRA help to provide an estimate of the 
number of communications currently published or distributed by broker-
dealers that could potentially be considered ``research reports'' under 
rule 139b. FINRA staff has 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

[[Page 64202]]

rule 34b-1, for a total of 56,235 communications.\238\ 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 rule 139b. First, these data do 
not reflect the affiliate exclusion incorporated in the rule 139b 
definition of ``covered investment fund research report,'' which has 
the effect of excluding from the safe harbor research reports that are 
published or distributed by persons covered by the affiliate 
exclusion.\239\ 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 broker-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 
rule 139b safe harbor.
---------------------------------------------------------------------------

    \235\ See supra note 162 and accompanying text.
    \236\ Based on staff analysis of FOCUS filings, we estimate that 
as of year-end 2017, there were 3,882 registered broker-dealers, 
3,755 of which were members of FINRA.
    \237\ See supra note 189 and accompanying text.
    \238\ 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 note 
165.
    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.
    \239\ See supra notes 18-21 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 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 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.\240\ 
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.\241\ As discussed 
above, the FAIR Act and the rule 139b definition of ``research report'' 
do not require a communication to provide information reasonably 
sufficient upon which to base an investment decision.\242\ Also, unlike 
the definition of ``research report'' in FINRA rule 2241, the FAIR Act 
and the rule 139b definitions of ``research report'' 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 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).
---------------------------------------------------------------------------

    \240\ See FINRA rule 2241(a)(11).
    \241\ See FINRA rule 2242(a)(3).
    \242\ See supra note 40 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). Data aggregators provide various forms of information 
and analysis about covered investment funds, ranging from automated 
fund rankings, to analyst research reports.\243\ Because data and 
analysis provided by these firms play an important role in investors' 
information environment under the baseline, these firms will be 
affected by changes to the competitive environment resulting from the 
rules we are adopting.\244\ 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.\245\
---------------------------------------------------------------------------

    \243\ While various firms provide automated fund rankings for 
much of the covered investment fund universe, true ``analyst 
coverage'' is considerably more limited. Morningstar provides 
``analyst ratings'' for certain open-end funds, closed-end funds, 
and ETFs. Based on queries of the Morningstar database, as of 
October 2018, only 1,562 open-end funds, no closed-end funds, and 
200 ETFs had a Morningstar analyst rating. We calculated that in 
total, as of December 2017, there were 9,564 mutual funds, 596 
closed-end funds, and 1,629 ETFs and ETPs. See supra note 216.
    \244\ See infra section III.C.5.
    \245\ 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.
---------------------------------------------------------------------------

2. Regulatory Structure
    The objective of this analysis is to consider the effects of 
regulations being adopted pursuant to the FAIR Act's statutory mandate. 
Thus, for the purposes of the baseline, we take into account the 
regulatory structure in place immediately prior to the enactment of the 
FAIR Act. We also note that on July 3, 2018, the interim effectiveness 
provision of the FAIR Act came into effect.\246\ This provision allows 
broker-dealers to rely on the rule 139 safe harbor when publishing or 
distributing covered investment fund research reports. In addition, 
under this provision, covered investment funds are deemed to be 
securities that are listed on a national securities exchange and are 
not subject to section 24(b) of the Investment Company Act. While the 
effectiveness of this provision is now part of the regulatory 
framework, in light of its recent effectiveness and the

[[Page 64203]]

limited time duration until it will be replaced by rule 139b, as a 
practical matter, it is unclear to what extent broker-dealers will rely 
on the interim provision to publish or distribute research reports 
about covered investment funds.
---------------------------------------------------------------------------

    \246\ See section 2(d) of the FAIR Act.
---------------------------------------------------------------------------

a. Legal and Regulatory Framework Applicable to Statements Included in 
Covered Investment Fund Research Reports
    A broker-dealer's publication or distribution of a covered 
investment fund research report could 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.\247\ 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.\248\ 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.\249\ In addition, rule 482 
advertisements regarding open-end investment companies, trust accounts, 
and money markets funds are subject to requirements on the standardized 
presentation of performance information.\250\
---------------------------------------------------------------------------

    \247\ See supra note 5 and accompanying text.
    \248\ 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 167 and 
accompanying text.
    \249\ 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].
    \250\ 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 166, 248.
---------------------------------------------------------------------------

    Additionally, certain SRO rules governing content standards may 
apply to advertisements styled as ``research reports'' under rule 482 
or to communications that would be covered investment fund research 
reports under rule. These include FINRA rule 2210, which contains 
general content standards that apply broadly to member 
communications.\251\ 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.\252\
---------------------------------------------------------------------------

    \251\ See FINRA rule 2210(d)(1).
    \252\ See supra note 183 (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 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.\253\
---------------------------------------------------------------------------

    \253\ In the Proposing Release, we asked commenters to supply 
data that could aid us in quantifying these costs. No such data was 
provided in the comment letters received. See Proposing Release, 
supra note 2, at 26812.
---------------------------------------------------------------------------

b. Filing Requirements
    Under the baseline, 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 \254\ 
and registered investment company sales material, including rule 482 
``omitting prospectus'' advertisements as well as supplemental sales 
literature,\255\ are required to be filed with the Commission under 
section 24(b) of the Investment Company Act.\256\ Broker-dealers that 
are FINRA members are also subject to certain additional filing 
requirements under current FINRA rule 2210.\257\
---------------------------------------------------------------------------

    \254\ 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 161.
    \255\ See supra note 248.
    \256\ Rule 24b-3 under the Investment Company Act deems these 
materials to have been filed with the Commission if filed with 
FINRA. See supra notes 144, 189 and accompanying text.
    \257\ 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 176-178, 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 provisions of the rules 
we are adopting 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 new rules. We 
conclude with a discussion of alternatives considered.
1. FAIR Act Statutory Mandate
a. Benefits
    We believe that the 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 
new rules a broker-dealer could publish or distribute covered 
investment fund research reports without reliance on rule 482 or rule 
34b-1 and without being required to file these reports under section 
24(b) of the Investment Company Act and the rules and regulations 
thereunder.\258\ Broker-dealers publishing or distributing covered 
investment fund research reports in reliance on the expanded safe 
harbor will not be subject to the liability provisions of section 
12(a)(2) of the Securities Act,\259\ rule 34b-1, or the filing 
requirements of section 24(b) of the Investment Company Act.\260\ Thus, 
they will 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).\261\ 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'' will 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

[[Page 64204]]

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.
---------------------------------------------------------------------------

    \258\ See supra section II.D.1.
    \259\ See supra note 249.
    \260\ See supra section II.D.1.
    \261\ However, 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,\262\ and--perhaps more 
importantly--that broker-dealers may enjoy a comparative advantage in 
its production.\263\ However, other studies have questioned the 
investment value of such research to investors \264\ or its continued 
relevance.\265\
---------------------------------------------------------------------------

    \262\ 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).
    \263\ 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).
    \264\ 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, 40.1 Journal of Accounting and 
Economics 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).
    \265\ 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'').\266\ Although individual securities within a covered 
investment fund's portfolio may be 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'' \267\ 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.\268\ 
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 a 
valuable source of information for investors evaluating relative fund 
performance.\269\
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    \266\ 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.
    \267\ We mean this in the sense of providing a signal about 
future investment performance.
    \268\ 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).
    \269\ 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 will increase as a result of 
broker-dealers' increased publication and distribution of covered 
investment fund research reports. The rules we are adopting will also 
allow for greater flexibility in the type of information that broker-
dealers may communicate to customers.\270\ 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.\271\
---------------------------------------------------------------------------

    \270\ Currently such communications would be subject to rule 482 
requirements, including standards on the presentation of performance 
information. See supra section II.C.
    \271\ See Matthew Gentzkow & Jesse M. Shapiro, Media Bias and 
Reputation, 114 Journal of Political Economy 2, 280-316 (Apr. 1, 
2006).
---------------------------------------------------------------------------

b. Costs
    Prior experience and academic research suggests that, unchecked, 
broker-dealers' conflicts of interest can lead to bias in research 
reports,\272\ and that such bias has the potential to adversely affect 
investor welfare.\273\

[[Page 64205]]

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 rule 139b safe harbor could 
increase opportunities for broker-dealers to promote funds from which 
they derive the most financial benefits.\274\ If such conflicts are 
unrecognized by or unknown to investors, they could negatively affect 
investor welfare. Although market mechanisms \275\ as well as existing 
regulation \276\ may limit the extent of such actions, there is the 
potential that they could nonetheless impose costs on investors--
particularly retail investors.\277\
---------------------------------------------------------------------------

    \272\ 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).
    \273\ 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 Global Research Analyst Settlement, Litigation 
Release No. 18438 (Oct. 31, 2003) (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 2010 
Modifications to Global Research Analyst Settlement, Litigation 
Release No. 21457 (Mar. 19, 2010).
    \274\ Such concerns were also noted by one commenter. See 
Morningstar Comment Letter.
    \275\ See infra section III.C.1.b(2).
    \276\ See infra section III.C.1.b(1).
    \277\ 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,\278\ and also rule 139b,\279\ will 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 
will be limited potential for the greatest conflicts of interest to 
impose costs on investors.
---------------------------------------------------------------------------

    \278\ See section 2(f)(3) of the FAIR Act.
    \279\ See rule 139b(a).
---------------------------------------------------------------------------

    Other conflicts of interest may nevertheless arise from incentives 
in fund distribution arrangements.\280\ Distributing broker-dealers may 
receive compensation from sales loads, 12b-1 fees,\281\ 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.\282\ 
Associated persons of broker-dealers (i.e., analysts) may face similar 
conflicts of interests arising from incentives in their compensation 
agreements.\283\ Finally, broker-dealers may have fewer direct or non-
pecuniary incentives.\284\ However, in all of these cases, the risk 
that such conflicts of interest could result in actions that negatively 
impact information communicated to investors is 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.\285\
---------------------------------------------------------------------------

    \280\ 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).
    \281\ See rule 12b-1 under the Investment Company Act [17 CFR 
270.12b-1].
    \282\ See infra note 298 (noting that the Commission has 
historically found broker-dealers to have violated sections 17(a)(2) 
and (3) of the Securities Act by making recommendations of more 
expensive mutual fund share classes while omitting material facts).
    \283\ Such conflicts of interest arising from incentives in 
compensation agreements involving research analysts 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.
    \284\ 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 183.
     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)].
    \285\ 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 rulemaking. 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.\286\ Although one commenter registered similar 
concerns,\287\ no commenters provided any data that would facilitate 
such a quantitative analysis.\288\ 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 adopting,\289\ and certain market mechanisms will reduce these 
costs.
---------------------------------------------------------------------------

    \286\ 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, 60 Journal of Banking & Finance 1, 284-295 
(2015).
    \287\ See Morningstar Comment Letter.
    \288\ In the Proposing Release, we requested comment on our 
characterization of these costs. See Proposing Release, supra note 
2, at 26816.
    \289\ 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.\290\ As discussed in detail 
above,\291\ the definition of ``research report'' for purposes of 
Regulation AC and FINRA rules 2241 and 2242 is narrower than the 
definition of ``research report'' for purposes of the FAIR Act and rule 
139b. However, to the extent a research report meets both the 
definition of a research report under rule 139b and the definition of 
research report as defined in Regulation AC, Regulation AC will be 
applicable to that research report (and, if it meets the definition of 
``research report'' in FINRA rule 2241, FINRA rule 2241 also will apply 
if the research report otherwise were within the scope of rule 2241 
\292\). These rules may help promote objective and reliable 
research.\293\
---------------------------------------------------------------------------

    \290\ See supra note 35; see also Proposing Release, supra note 
2, at 26791 n.37.
    \291\ See supra note 183.
    \292\ See id.
    \293\ 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)]. 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).

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[[Page 64206]]

    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.'' \294\
---------------------------------------------------------------------------

    \294\ See supra section II.D.1.
---------------------------------------------------------------------------

    If a broker-dealer recommends \295\ a covered investment fund to 
its customers, additional obligations under the federal securities laws 
and FINRA rules will apply. As a general matter, broker-dealers must 
deal with their customers fairly \296\--and, as part of that 
obligation, have a reasonable basis for any recommendation.\297\ 
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.\298\
---------------------------------------------------------------------------

    \295\ See, e.g., Additional Guidance on FINRA's New Suitability 
Rule, FINRA Regulatory Notice 12-25 (May 2012), at Q.2, (regarding 
the scope of ``recommendation''), n.25.
    \296\ 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.'').
    \297\ 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).'').
    \298\ 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,\299\ which we believe can 
mitigate the effects of conflicts of interest on research reports.\300\ 
With respect to broker-dealers' research on operating companies, 
analysts' career concerns \301\ have also been found to have similar 
effects, and, in principle, broker-dealers' reputations could as 
well.\302\ However, we believe it is unlikely that analyst career 
concerns or broker-dealer reputation will play as significant a role in 
the context of covered investment fund research reports which we expect 
to be aimed primarily at retail investors. Research reports about 
operating companies have traditionally been provided to institutional 
customers as part of a bundle of services provided by full-service 
brokerages.\303\ In this setting, broker-dealers benefit from 
institutional investors' willingness to pay for broker-dealers' 
additional bundled services (e.g., research).\304\ Such institutional 
customers are generally capable of producing similar reports, and so 
can evaluate the quality of broker-dealers' research.\305\ Thus, they 
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.\306\ With retail investors, information asymmetries are 
greater: Retail investors do not generally possess the capabilities to 
replicate an analyst report or evaluate its quality.\307\ Moreover, the 
problem of evaluating the performance of analysts is harder in the 
context of covered

[[Page 64207]]

investment funds.\308\ Because institutional investors are not major 
investors in covered investment funds,\309\ we believe they are 
unlikely to provide market discipline in this context.\310\
---------------------------------------------------------------------------

    \299\ See infra section III.C.5.
    \300\ 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).
    \301\ 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, 60 The 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'')
    \302\ 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 301 (analyst reputation mitigates bias, but 
institutional reputation does not).
    \303\ 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''). We note however, that this model has been disrupted by 
the European MiFID II regulations that took effect in 2018. See e.g. 
CFA Institute, MiFID II: A New Paradigm for Investment Research, 
available at https://www.cfainstitute.org/-/media/documents/support/advocacy/mifid_ii_new-paradigm-for-research-report.ashx
    \304\ 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 may 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).
    \305\ 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 analysts' 
recommendations while retail investors do not).
    \306\ See supra section III.B.1.c.
    \307\ See Mehran and Stulz Article, supra note 303.
    \308\ 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).
    \309\ See supra section III.B.1.a.
    \310\ 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 biases resulting from conflicts of 
interest need not adversely impact investors if investors 
disregard,\311\ discount,\312\ or de-bias \313\ the recommendations of 
conflicted analysts.\314\ 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,\315\ may fail 
to de-bias or otherwise condition their trades based on the credibility 
of the recommendation,\316\ and could thus be led to invest in 
underperforming securities.\317\
---------------------------------------------------------------------------

    \311\ See Dugar and Nathan Article, supra note 272.
    \312\ See Michaely and Womack Article, supra note 273.
    \313\ See Lin and McNichols Article, supra note 272.
    \314\ Institutional market participants generally attribute bias 
in sell-side analysts' research reports to conflicts of interest. 
See Michaely and Womack Article, supra note 273.
    \315\ 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).
    \316\ See id.; Malmendier and Shanthikumar Article, supra note 
305.
    \317\ See Mikhail Walther and Willis Article, supra note 315. 
See also Malmendier and Shanthikumar Article, supra note 305. 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).
---------------------------------------------------------------------------

2. Rule 139b
    As discussed above, rule 139b conditions eligibility for the safe 
harbor on satisfaction of several conditions.\318\ 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).\319\ We 
believe that modeling rule 139b on rule 139 will benefit market 
participants through regulatory consistency. We address these 
conditions in turn in the sections that follow.
---------------------------------------------------------------------------

    \318\ See supra section II.B.
    \319\ See supra paragraph accompanying notes 12-15.
---------------------------------------------------------------------------

a. Affiliate Exclusion
    Under the affiliate exclusion of rule 139b,\320\ a broker-dealer 
who is an affiliate of a covered investment fund (or is an investment 
adviser or an affiliated person of the investment adviser to a covered 
investment fund), would not be eligible for the safe harbor of 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.\321\ 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.\322\ 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 new rules.
---------------------------------------------------------------------------

    \320\ See section 2(f)(3) of the FAIR Act. See supra section 
II.A.1.
    \321\ See supra section III.C.1.b.
    \322\ See supra notes 18-21 and accompanying text.
---------------------------------------------------------------------------

    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. The affiliate exclusion and 
associated guidance \323\ will reduce the potential for retail 
investors to receive research reports containing materials from persons 
whose financial incentives create the greatest conflicts of 
interest.\324\
---------------------------------------------------------------------------

    \323\ See supra section II.A.1.
    \324\ Persons covered by the affiliate exclusion may have strong 
financial interests to increase sales of associated covered 
investment funds. See supra paragraph accompanying note 278.
---------------------------------------------------------------------------

    The affiliate exclusion is also likely to limit the benefits of the 
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. We believe that under the 
affiliate exclusion, it would be inappropriate for such broker-dealers 
to publish or distribute research report provided by a covered 
investment fund or the fund's affiliates.\325\ Thus, the 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.
---------------------------------------------------------------------------

    \325\ Among other things, we believe 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 rule. See supra paragraph accompanying note 30.

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

[[Page 64208]]

b. Regular-Course-of-Business Requirement
    Under rule 139b, research reports (both issuer-specific research 
reports and industry research reports) 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.\326\ 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.\327\ The regular-course-of-business 
requirement of 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.\328\
---------------------------------------------------------------------------

    \326\ See supra sections II.B.1.c and II.B.2.b.
    \327\ See supra notes 112-114 and accompanying text.
    \328\ See section 2(b)(1) of the FAIR Act; see also supra note 
101 and accompanying text.
---------------------------------------------------------------------------

    Given the breadth of the definition of ``research report'' under 
the FAIR Act (and the definition of ``research report'' that we are 
adopting under rule 139b), certain communications that are currently 
treated as covered investment fund advertisements under Securities Act 
rule 482 could fall under the rule 139b definition of ``research 
report.'' \329\ 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 BDCs. This may result in investors not being able to 
readily discern what constitutes a research report and what constitutes 
an advertisement about these issuers. We continue to 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.\330\ 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.\331\
---------------------------------------------------------------------------

    \329\ See supra note 162 and accompanying text.
    \330\ See Proposing Release, supra note 2, at 26797.
    \331\ See Proposing Release, supra note 2, at 26797-98 
(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 
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.\332\ 
Institutional customers are generally capable of producing similar 
reports, and so can more readily evaluate the quality of broker-
dealers' research.\333\ In these circumstances, broker-dealers have a 
compelling business rationale for producing high-quality research as 
distinct from sales materials.
---------------------------------------------------------------------------

    \332\ See Mehran and Stulz Article, supra note 303.
    \333\ See id; see also Malmendier and Shanthikumar Article, 
supra note 305.
---------------------------------------------------------------------------

    In contrast, we expect covered investment fund research reports to 
be produced by broker-dealers that distribute covered investment funds 
to retail investors.\334\ 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 will not be as 
clear.
---------------------------------------------------------------------------

    \334\ See supra section III.B.1.c.
---------------------------------------------------------------------------

    Second, 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.\335\ 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.\336\ 
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.
---------------------------------------------------------------------------

    \335\ The regular-course-of-business requirement generically 
requires ``research reports'' to be published or distributed in the 
regular course of a broker-dealer's business and is not limited to 
covered investment fund research reports. See Proposing Release, 
supra note 2, at 26797.
    \336\ See supra notes 267-268 and accompanying text.
---------------------------------------------------------------------------

    We noted in the Proposing Release that due to the aforementioned 
distinctions in the information environment and business rationale, we 
believed that the regular-course-of-business requirement in the context 
of rule 139b may be more challenging to apply in practice than the 
regular-course-of-business requirement in the context of rule 139 and 
that the potential benefits of this requirement in rule 139b may be 
more limited. We also noted that the effects of the regular-course-of-
business requirement would be clearer in cases where, in the case of 
issuer-specific research reports, the 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 would condition the availability of the safe harbor on the 
research report not representing the initiation or reinitiation of 
coverage by the broker-dealer publishing or distributing said research 
report. However, because the universe of covered investment funds is 
dominated

[[Page 64209]]

by funds with a class of securities that could be considered to be in 
substantially continuous distribution,\337\ the bright-line test of the 
regular-course-of-business requirement would impact only a small subset 
of funds.
---------------------------------------------------------------------------

    \337\ See supra section III.B.1.a.
---------------------------------------------------------------------------

    Related concerns were voiced by several commenters who questioned 
the feasibility of satisfying the regular-course-of-business 
requirement under the proposed rules.\338\ As discussed above, we have 
included additional guidance to mitigate concerns about the 
interpretation of the regular-course-of-business requirement.\339\ 
While we believe that this guidance should address commenters' concerns 
about the feasibility of satisfying the regular-course-of-business 
requirement, we acknowledge that--due to the reasons discussed above--
broker-dealers evaluating whether their research activities satisfy the 
regular-course-of-business requirement are likely to face more 
uncertainty when those activities relate to covered investment funds 
than when those activities relate to operating companies. However, we 
believe that broker-dealers would only issue covered investment fund 
research reports if the benefits are likely to outweigh the costs, 
including uncertainty.
---------------------------------------------------------------------------

    \338\ See supra sections II.B.1.c, II.B.2.b.
    \339\ See supra paragraph accompanying note 118.
---------------------------------------------------------------------------

c. Reporting History and Minimum Market Value Requirements for Issuers 
Appearing in Issuer-Specific Research Reports
    Under rule 139b, a broker-dealer's publication or distribution of 
issuer-specific research reports does 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.\340\ Issuers are 
also 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 section 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 rule as well as to 
have timely filed all required reports during the preceding 12 calendar 
months.\341\
---------------------------------------------------------------------------

    \340\ See rule 139b(a)(1)(i)(B).
    \341\ Including Forms N-CSR, 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 rule 139b(a)(1)(i)(A).
---------------------------------------------------------------------------

    The covered investment funds market is dynamic.\342\ In 2017, more 
than six hundred covered investment funds entered the market, while 
more than eight 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.\343\ 
Thus, for covered investment funds, the universe of young--and 
potentially less-followed--issuers is large.\344\ 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.\345\ 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.\346\
---------------------------------------------------------------------------

    \342\ See supra section III.B.1.a.
    \343\ 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.
    \344\ For example, Morningstar notes that funds with short track 
records are unlikely to be provided coverage. See Morningstar, 
Morningstar Manager Research Coverage Decision-Making (June 2018), 
available at https://morningstardirect.morningstar.com/clientcomm/Morningstar_Manager_Research_Coverage_Decision_Making.pdf.
    \345\ See supra section III.B.1.a.
    \346\ See supra note 310 and accompanying text.
---------------------------------------------------------------------------

    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 report--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 limited trading or 
interest.\347\
---------------------------------------------------------------------------

    \347\ For example, while Morningstar provides analyst ratings 
for 200 ETFs and 1,562 open-end funds, among ETFs and open-end funds 
falling below the $75 million minimum public market value threshold, 
only 27 received an analyst rating. See supra notes 243 and 344.
---------------------------------------------------------------------------

    As noted by several commenters, because young and small covered 
investment funds are relatively common, the costs associated with these 
conditions on the availability of a safe harbor could be 
significant.\348\ In particular, as shown in Table 1, the $75 million 
minimum public market valuation condition will 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.\349\ Research reports about nearly half of 
extant ETFs, ETPs will not qualify for the safe harbor.\350\ 
Availability of the safe harbor would be least impacted for research 
reports about BDCs and closed-end funds.\351\
---------------------------------------------------------------------------

    \348\ See SIFMA Comment Letter I; ICI Comment Letter; Fidelity 
Comment Letter; see also BlackRock Comment Letter.
    \349\ 30% of all covered investment funds have public market 
valuations less than $75 million. See Table 1.
    \350\ 41% of ETF and ETPs have public market valuations less 
than $75 million. See Table 1.
    \351\ 12% of closed-end funds and 7% of BDCs have public market 
valuations less than $75 million. See Table 1.
---------------------------------------------------------------------------

    Although small funds represent a very small fraction of covered 
investment fund assets, they are relatively large in number.\352\ 
Because nearly one-third of covered investment funds will not satisfy 
the eligibility criteria for the safe harbor, we believe that those 
funds will be less likely to receive coverage by broker-dealers insofar 
as the inability to rely on the safe harbor reduces broker-dealers' 
willingness to publish and distribute research reports.
---------------------------------------------------------------------------

    \352\ See Table 1.

[[Page 64210]]



  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 are based on data from CRSP mutual fund database
 (2017Q3). Close-end fund statistics are based on data from CRSP monthly stock file (Dec. 2017). BDC statistics
  are based on Commission's listing of registered BDCs, and regulatory filings (2017) compiled by Compustat and
                                                Audit Analytics]
----------------------------------------------------------------------------------------------------------------
                                                                                Funds with public market value
                                                                                         <$75 million
                        Covered investment fund type                         -----------------------------------
                                                                               Number of funds
                                                                                     (%)         Fund assets (%)
----------------------------------------------------------------------------------------------------------------
Open-end....................................................................                30                <1
Closed-end..................................................................                12                <1
ETF/ETP.....................................................................                41                <1
BDC.........................................................................                 7                <1
                                                                             -----------------------------------
    Total...................................................................                30                <1
----------------------------------------------------------------------------------------------------------------

    Several commenters raised concerns that--in addition to the 
aforementioned costs--compliance with the reporting history and minimum 
market value requirements as proposed could be operationally 
challenging for broker-dealers.\353\ In general, we do not believe that 
verifying covered investment funds' reporting history and public market 
valuation represents a significant additional burden for broker-dealers 
in this position.\354\
---------------------------------------------------------------------------

    \353\ See SIFMA Comment Letter I; see also Fidelity Comment 
Letter.
    \354\ For example, much of this information is currently 
accessible through the publicly available EDGAR system and/or third-
party data providers.
---------------------------------------------------------------------------

    Another commenter noted that some broker-dealers provide investors 
research about large numbers of funds on a largely automated basis, and 
that ensuring compliance with the reporting history and minimum public 
market value requirements would create ``operational hurdles'' for 
these broker-dealers.\355\ We believe that broker-dealers that choose 
to automate publication of research reports will make significant 
investments in technology to implement this automation, and that 
broker-dealers with infrastructure capable of automating publication of 
research reports should have little difficulty implementing the 
procedures required for similarly automating the verification of these 
requirements.\356\ However, in a change from the proposal, final rule 
139b will not require the minimum public market valuation condition to 
be verified at the time of reliance.\357\ Rather, the final rule 
requires that this condition be satisfied at the time of the broker's 
or dealer's first publication or distribution of a research report on 
the covered investment fund, and at least quarterly thereafter.\358\ We 
believe this change should simplify compliance without materially 
affecting the provisions' effectiveness.\359\
---------------------------------------------------------------------------

    \355\ See Fidelity Comment Letter; see also paragraphs 
accompanying supra notes 64, 73.
    \356\ We note that a software system capable of automatically 
generating non-trivial research reports about a given covered 
investment funds would contain data access modules providing 
programmatic access to the covered investment fund's historical 
filings and pricing data. Conditional on the existence of such 
modules, implementation of tests for the reporting history and 
minimum market value requirements would represent a de minimis cost.
    \357\ See supra section II.B.1.b.
    \358\ See rule 139b(a)(1)(i)(B).
    \359\ We believe that implementing periodic assessments would be 
simpler and less costly than implementing an assessment at the time 
of reliance. At the same time, we do not believe that there would be 
a material difference in the set of covered investment funds 
captured by the minimum public valuation threshold under these two 
approaches. See supra paragraph accompanying note 104.
---------------------------------------------------------------------------

    Finally, one commenter raised concerns that because of shortcomings 
in the data currently available about affiliates' holdings, it may not 
be possible for broker-dealers to establish the public market value of 
a covered investment fund if affiliate holdings are to be excluded from 
the calculation.\360\ Although we believe that that the information 
required to make this calculation may be available to broker-dealers, 
we understand that it may not currently be generally available in a 
structured form amenable to automation. This could present operational 
difficulties for broker-dealers developing processes for automated 
report publication. In a change from the proposal, final rule 139b 
eliminates the requirement that the public market valuation calculation 
be calculated net of affiliates' holdings for most covered investment 
funds. We believe that this change is unlikely to materially affect the 
effectiveness of the minimum public market value requirement \361\ 
while eliminating a plausible obstacle to its automated verification in 
the vast majority of cases. We acknowledge, however, that retaining the 
requirement to adjust for affiliate holdings in the public market 
valuation calculation for commodity- and currency-based trusts could 
reduce the amount of automated coverage provided to such trusts by 
broker-dealers.\362\
---------------------------------------------------------------------------

    \360\ See SIFMA Comment Letter II.
    \361\ Covered investment funds are subject to unique legal 
provisions that generally restrict affiliate ownership and provide 
additional legal protections when affiliate ownership is permitted. 
See, e.g., Investment Company Act sections 12, 17, and 57 and rules 
thereunder. In addition, unlike rule 139, rule 139b does not permit 
affiliates of covered investment funds to rely on the safe harbor, 
mitigating the risk that a fund with significant affiliate holdings 
would be the subject of market moving research by those same 
affiliates.
    \362\ See supra note 99.
---------------------------------------------------------------------------

d. Reporting Requirement for Issuers Appearing in Industry Reports
    Under 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).\363\ As discussed above, these 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

[[Page 64211]]

beyond marginally improving economic efficiency by more closely 
aligning regulations with their intended context.
---------------------------------------------------------------------------

    \363\ See 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 calendar 
months. See supra section II.B.1.a.
---------------------------------------------------------------------------

e. Content and Presentation Requirements for Industry Research Reports
    Under rule 139b, the content and presentation standards for 
industry research reports of rule 139 are tailored to the context of 
covered investment funds. Under 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.\364\ We believe that in the absence of content and 
presentation requirements such as these, 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 content and presentation standards we are adopting 
have benefits similar to those of the parallel content and presentation 
requirements in rule 139, and provide meaningful limits for industry 
research reports.\365\
---------------------------------------------------------------------------

    \364\ See supra sections II.B.1, II.B.2.
    \365\ See supra sections II.B.2.c, II.B.2.d.
---------------------------------------------------------------------------

    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.
f. Presentation of Performance Information
    Given the definition of ``research report'' under the FAIR Act (and 
the definition of ``research report'' being adopted 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 rule 139b safe harbor.\366\ In the Proposing Release, 
we raised concerns that not including provisions similar to rule 482 in 
proposed rule 139b 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.\367\ 
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.
---------------------------------------------------------------------------

    \366\ See supra note 162 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 rule 
139b. See supra note 165 and accompanying text.
    \367\ See Proposing Release, supra note 2, at 26825.
---------------------------------------------------------------------------

    As discussed above, unlike in the Proposing Release, final rule 
139b incorporates provisions on the presentation of performance 
information in research reports about registered investment companies 
that mirror those of rule 482 and--with respect to closed-end funds--
Form N-2.\368\ Incorporating these presentation standards in rule 139b 
reduces the potential for confusion between (i) registered open-end 
management investment company advertisements and selling materials 
covered by rule 482 and registered closed-end investment company 
selling materials covered by Form N-2 and (ii) rule 139b research 
reports.\369\ Additionally, incorporating some of these provisions into 
rule 139b would reduce the potential for investor confusion resulting 
from divergent standards in the presentation of performance data.
---------------------------------------------------------------------------

    \368\ Rule 482 does not set forth requirements on the 
presentation of performance information in research reports about 
registered closed-end investment companies. See supra section II.C.
    \369\ See supra paragraph accompanying notes 165-167.
---------------------------------------------------------------------------

    Because fees can represent a significant drag on investment 
returns,\370\ 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,\371\ 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.\372\ 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 unsophisticated investors. We believe that these 
additional requirements on the presentation of performance information 
will limit opportunities for selective performance disclosure and will 
curtail opportunities to circumvent the performance reporting 
requirements of rule 482 and Form N-2.
---------------------------------------------------------------------------

    \370\ See, e.g., Mark M. Carhart, On Persistence in Mutual Fund 
Performance, 52 The Journal of Finance 1, 57-82 (Mar. 1997).
    \371\ See Erik R. Sirri & Peter Tufano, Costly Search and Mutual 
Fund Flows, 53 The Journal of Finance 5, 1589-1622 (Oct. 1, 1998).
    \372\ See supra section III.C.1.b.
---------------------------------------------------------------------------

    By limiting opportunities for selective performance disclosure, we 
believe that final rule 139b will also reduce the potential for 
investor confusion. Under the final rule, there will 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 reports issued by 
different broker-dealers. These results would benefit investors. As 
discussed in the Proposing Release, the extent of the benefits 
resulting from requirements on the presentation of performance 
information depends on their 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 in 
the Proposing Release, we believe 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. We believe that rule 482 standards on 
the presentation of performance information have been effective at 
limiting selective disclosure in applicable registered investment 
company advertisements, and that they will be similarly effective for 
research reports falling under rule 139b. Moreover, as noted above, we 
believe that retail investors will be the primary consumers of such 
research reports, and that such investors would be most likely

[[Page 64212]]

to benefit from these additional provisions.
    As discussed in the Proposing Release, we believe that the most 
significant costs associated with additional requirements on the manner 
in which performance information may be presented would result from 
their potential to limit the manner in which the content of broker-
dealers' research reports is presented. Although we are not preventing 
alternative performance measures from being included in research 
reports, by limiting the prominence afforded to such performance 
measures we 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.
    We believe that broker-dealers' direct compliance costs under these 
additional provisions would be minimal. Because we believe that broker-
dealers that will publish research reports are likely currently 
distributing advertisements under rule 482, these broker-dealers likely 
already have processes and systems to produce charts and tables of 
performance measures using timely data under the presentation standards 
required by the final rules. However, we acknowledge that the final 
rules' will impose costs on broker-dealers that did not previously 
distribute advertisements under rule 482 and they would need to develop 
processes and systems to implement these presentation standards. We 
estimate the one-time implementation costs attributable to the new 
presentation standards for each broker-dealer publishing research 
reports to be approximately 5 hours or $1,310.\373\ Further, we expect 
the systems necessary to satisfy the requirement for timely data under 
rule 482(g) would generally be available to broker-dealers publishing 
research reports.
---------------------------------------------------------------------------

    \373\ Calculated as 5 hours x Senior Business Analyst at $262 
per hour = $1.310. The hourly wage rate is from SIFMA's Management & 
Professional Earnings in the Securities Industry 2013, modified to 
account for an 1,800-hour work year; multiplied by 5.35 to account 
for bonuses, firm size, employee benefits and overheard; and 
adjusted to account for the effects of inflation.
---------------------------------------------------------------------------

3. Rule 24b-4
    Rule 24b-4 excludes 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 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).\374\ 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 rule.\375\
---------------------------------------------------------------------------

    \374\ See supra note 183 and accompanying text.
    \375\ 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), 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).\376\ 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 new 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 were subject to FINRA's filing requirements 
would no longer be subject to routine review.\377\ 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 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.\378\
---------------------------------------------------------------------------

    \376\ See id.
    \377\ See supra section II.D.1.
    \378\ But see supra note 195 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.
---------------------------------------------------------------------------

4. Amendments to Rule 101 of Regulation M and Form 12b-25
    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.\379\ 
However, rule 101 provides an exception for research activities that 
satisfy the conditions of Securities Act rule 138 or rule 139. The 
conforming amendment expands this exception to include research 
activities that satisfy the conditions of rule 139b. We believe that 
broker-dealers would generally be unable to make use of the rule 139b 
safe harbor absent this conforming amendment. Consequently, we do not 
consider its effects separately.
---------------------------------------------------------------------------

    \379\ See supra section II.E.
---------------------------------------------------------------------------

    As discussed above, we are making a technical amendment to Form 
12b-25 to replace references to Form N-SAR with references to Form N-
CEN and to remove the checkbox and accompanying text related to 
transition reports on Form N-SAR.\380\ The amendments to Form 12b-25 
that the Commission is adopting are ministerial actions that correct 
outdated references and therefore will have no separate economic 
effect, including no effect on competition.
---------------------------------------------------------------------------

    \380\ See id.
---------------------------------------------------------------------------

5. Effects on Efficiency, Competition, and Capital Formation
    The primary effects on economic efficiency and capital formation 
resulting from 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 \381\--is valuable to investors, we expect it to increase 
allocative efficiency, with

[[Page 64213]]

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.\382\ 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).
---------------------------------------------------------------------------

    \381\ See supra section III.C.1.a.
    \382\ 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 \383\ on the availability of the safe 
harbor in rule 139b 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 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.\384\ In addition, we 
believe that the Commission's various tailoring of the new rules to the 
covered investment fund context will yield marginal efficiency 
improvements from reductions in regulatory ambiguity.
---------------------------------------------------------------------------

    \383\ See supra section III.C.2.
    \384\ 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.\385\ 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,\386\ we 
believe that most broker-dealers will continue to rely on content 
licensed from independent firms.\387\ We also believe that there are 
competitive implications stemming from the guidance we have given to 
address possible circumvention of the affiliate exclusion.\388\ 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.
---------------------------------------------------------------------------

    \385\ See supra section III.B.1.c.
    \386\ See supra section III.B.1.a.
    \387\ We expect that broker-dealers that choose to publish 
research on covered investment funds will generally not license it 
to their competitors.
    \388\ See supra section III.C.2.a.
---------------------------------------------------------------------------

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 $75 million minimum public market value 
requirement will promote investor protection by limiting research 
reports to issuers that have a demonstrated market following.\389\ 
However, we acknowledge that it will mean that research reports about 
significant numbers of smaller covered investment funds would not 
qualify for inclusion in research reports under the safe harbor.\390\ 
We believe that this will reduce the effect of the new rules on the 
availability of research reports about smaller covered investment 
funds.\391\
---------------------------------------------------------------------------

    \389\ See supra section II.B.1.b.
    \390\ See SIFMA Comment Letter I; see also ICI Comment Letter; 
BlackRock Comment Letter.
    \391\ 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 undermining investor protection (because it 
would not materially increase the number of qualifying funds without a 
demonstrated market following). 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

[[Page 64214]]

value requirement that is greater than what is required under rule 
139).
[GRAPHIC] [TIFF OMITTED] TR13DE18.004

    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. Figure 5 shows that although the safe harbor would not be 
available to significant numbers of covered investment funds under the 
$75 million threshold, material increasing its availability would only 
be 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. 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.\392\ At the same 
time, we believe that imposing the threshold would only restrict the 
availability of research for covered investment funds that have small 
economic significance. As shown in Figure 7, covered investment funds 
falling below the $75 million threshold account for less than 1% of the 
dollars invested in each of the four covered investment fund types.
---------------------------------------------------------------------------

    \392\ One commenter suggested lowering the threshold to no more 
than $20 million; see SIFMA Comment Letter I. Another commenter 
noted that 41% of all ETFs and exchange-traded products would be 
excluded by the $75 million threshold; see Fidelity Comment Letter. 
Although these commenters argued that lowering the threshold could 
benefit investors by increasing the number of funds for which 
covered investment fund research reports were available, they did 
not address the question of the potential cost to investors 
resulting from a lower threshold. See supra section III.C.2.c.

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

[[Page 64215]]

[GRAPHIC] [TIFF OMITTED] TR13DE18.005

[GRAPHIC] [TIFF OMITTED] TR13DE18.006

    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.\393\ 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

[[Page 64216]]

higher minimum public market value thresholds.
---------------------------------------------------------------------------

    \393\ See supra note 83 and accompanying text.
---------------------------------------------------------------------------

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 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. 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).\394\ 
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 research 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 on its ``industry,'' the effects of a covered 
investment fund issuer on its fund ``type'' is very limited.
---------------------------------------------------------------------------

    \394\ 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.\395\ 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.\396\ 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.
---------------------------------------------------------------------------

    \395\ See id.
    \396\ See supra section III.C.1.b.
---------------------------------------------------------------------------

c. Approach to Regular-Course-of-Business Requirement
    As discussed in section III.C.2.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.\397\ Thus, we requested comment on and have considered 
various alternative approaches to the regular-course-of-business 
requirements.\398\ 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.\399\ 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.\400\ 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).\401\
---------------------------------------------------------------------------

    \397\ See supra section II.B.2.b.
    \398\ See Proposing Release, supra note 2, at 26797-98. We did 
not receive comments specifically addressing the economic effects of 
alternative approaches to the regular-course-of-business 
requirement.
    \399\ See id.
    \400\ See id.
    \401\ 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's having operated for some amount of time, could lead to 
the publication of reports that are more likely to be recognized as 
research.\402\ 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.\403\
---------------------------------------------------------------------------

    \402\ See id.
    \403\ See Chemmanur and Fulghieri Article, supra note 302; 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 
301 (where sell-side research analysts' reputation mitigates 
manifestation of conflicts of interest from underwriting 
relationships, while institutional reputation does not).
---------------------------------------------------------------------------

    In rule 139b, we have chosen not to incorporate these more specific 
alternative approaches to the regular-

[[Page 64217]]

course-of-business requirement. While we note the potential benefits of 
such approaches in enhancing the value that covered investment fund 
research reports may provide investors, we also understand that these 
more specific alternatives may restrict the flow of relevant 
information to investors.
d. Presentation of Performance Information
    As discussed above, we have chosen to incorporate rule 482 and Form 
N-2 requirements on the presentation of performance information in 
final rule 139b.\404\ We also considered the alternatives of including 
rule 156 guidance factors (or a subset thereof), requirements relating 
to disclosure of nonrecurring fees, and requirements on the timeliness 
of performance data.\405\ We also considered a requirement in rule 139b 
to incorporate general narrative disclosure into a research report 
about a registered investment company, aimed at reducing potential 
investor confusion.\406\ 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).\407\
---------------------------------------------------------------------------

    \404\ See supra sections II.C and III.C.2.f.
    \405\ See Proposing Release, supra note 2, at 26825-26.
    \406\ See id.
    \407\ See id.
---------------------------------------------------------------------------

    In general, imposing additional requirements on the presentation of 
performance information would further reduce opportunities for research 
reports to present fund performance information in a manner 
inconsistent with similar information presented in advertisements and 
supplemental sales literature. We believe that these additional 
requirements would therefore reduce investor confusion and 
opportunities for the safe harbor to be used to present misleading 
information to investors.\408\ However, imposing these additional 
requirements would increase compliance costs for broker-dealers. In 
particular, imposing rule 156 (or similar) guidance factors would make 
determinations of compliance with the provisions of rule 139b less 
certain. This could make broker-dealers reluctant to rely on the rule 
139b safe harbor and impede the publication and distribution of broker-
dealer research on covered investment funds.
---------------------------------------------------------------------------

    \408\ See id.
---------------------------------------------------------------------------

    The alternatives of including various forms of disclosures to the 
effect that a ``research report'' is not subject to the Commission's 
regulations applicable to sales and advertising would impose the lowest 
costs on broker-dealers. However, we believe that requiring disclosure 
to this effect is unlikely to have significant beneficial effects in 
the retail context.

IV. Paperwork Reduction Act

    New rule 139b contains ``collection of information'' requirements 
within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\409\ Specifically, rule 139b(a)(3) requires that broker-
dealers that provide performance information in their covered 
investment fund research reports about (i) open-end funds must be in 
accordance with specified rule 482 presentation requirements or (ii) 
closed-end funds must be in accordance with a specified instruction set 
forth in Form N-2. The title for this collection of information is: 
``Rule 139b Disclosure of Standardized Performance,'' a new collection 
of information. We are requesting comment on this collection of 
information requirement in this Release, and intend to submit these 
requirements to the Office of Management and Budget (``OMB'') for 
review under the PRA.\410\ If approved, responses to the new collection 
of information requirement would not be mandatory for broker-dealers 
seeking to rely upon rule 139b but would be necessary for those broker-
dealers that would like to provide performance information in their 
covered investment fund research reports. Responses to the information 
collections will not be kept confidential. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid OMB control number.
---------------------------------------------------------------------------

    \409\ 44 U.S.C. 3501-3521.
    \410\ In the Proposing Release, we did not submit a PRA analysis 
because--although there was a set of requests for comment on the 
subject--the proposal did not include a standardized performance 
disclosure requirement, and we believed our proposal did not contain 
a ``collection of information'' requirement within the meaning of 
the PRA. See Proposing Release, supra note 2, at 26826.
     As discussed in the Proposing Release, supra note 2, at 26826, 
and 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 rule 139b safe harbor. This 
could result in a reduction in the information collection burdens 
for rules 482 and 34b-1 if fewer materials are filed. In connection 
with the extension of a currently approved collection for rules 482 
and 34b-1, the Commission will adjust the burdens associated with 
these collections of information to reflect these changes, as 
appropriate. At this time, we do not have any comments regarding 
overall burden estimates for the final rule. This Release is 
requesting such comments.
---------------------------------------------------------------------------

    In the Proposing Release, we solicited comment on whether rule 139b 
should include a standardized performance disclosure requirement.\411\ 
In response to comments received, we have decided to adopt such a 
requirement.\412\ We believe that standardized performance presentation 
is an appropriate requirement because investors tend to consider fund 
performance a significant factor in evaluating or comparing investment 
companies, and the requirement addresses potential investor confusion 
if a communication were not easily recognizable as research as opposed 
to an advertising prospectus or supplemental sales literature. Rule 
139b requires that research reports about open-end funds that include 
performance information must present it in accordance with paragraphs 
(d), (e), and (g) of rule 482. Rule 139b also requires that research 
reports about closed-end funds that include performance information 
must present it in accordance with instructions to item 4.1(g) of Form 
N-2.
---------------------------------------------------------------------------

    \411\ See Proposing Release, supra note 2, at 26803-04.
    \412\ See supra section II.C.
---------------------------------------------------------------------------

    It is difficult to provide estimates of the burdens and costs for 
those broker-dealers that will include performance information in a 
rule 139b research report. As discussed above, this is difficult to 
estimate because current data collected does not reflect the affiliate 
exclusion, does not include the entire universe of covered investment 
funds, and it is uncertain what percentage of communications currently 
filed as rule 482 advertising prospectuses (or rule 34b-1 supplemental 
sales materials) will instead be published in reliance on rule 139b, as 
covered investment fund research reports.\413\ For purposes of the PRA, 
we estimate that 10% of the rule 482 and rule 34b-1 communications 
currently filed by broker-dealers with FINRA (approximately 65,000) 
could be considered as rule 139b covered investment fund research 
reports. We estimate that broker-dealers will publish annually 6,500 
(10% of 65,000) covered investment fund research reports. Moreover, we 
assume for purposes of the PRA that all estimated rule 139b research 
reports will include fund performance information. We further

[[Page 64218]]

estimate that 1,417 broker-dealers would likely be respondents to the 
collection of information with a frequency of 4.6 responses per 
year.\414\ We further estimate that 50% of these broker-dealers will 
have experience in complying with standardized performance requirements 
under rule 482. For the 50% of this subset of broker-dealers that do 
not have experience with complying with rule 482, we estimate that 
there will be a one-time implementation cost for each broker-dealer of 
5 internal burden hours. Additionally, we estimate that each research 
report will require 3 hours of ongoing internal burden hours by a 
broker-dealers' personnel to comply with the rule 139b collection of 
information requirements, which for each broker-dealer is estimated to 
be 13.8 internal burden hours.\415\ Accordingly, we estimate that the 
standardized performance presentation requirements will result in an 
average annual hour burden of about 16.3 hours per broker-dealer \416\ 
in the first year of compliance and about 13.8 hours per broker-dealer 
for each of the next two years. Amortized over three years, the average 
annual hour burden will be about 14.63 hours per broker-dealer.\417\
---------------------------------------------------------------------------

    \413\ See supra note 239 and accompanying paragraph.
    \414\ See supra note 230 and accompanying text. 6,500 covered 
investment fund research reports/1,417 broker-dealers = 4.6 annual 
responses per broker-dealer.
    \415\ 4.6 annual responses per broker-dealer x 3 internal burden 
hours = 13.8 annual internal burden hours per broker-dealer.
    \416\ (50% of * 13.8 hours ongoing compliance) + (50% * (13.8 
hours ongoing compliance + 5 hours of initial compliance hours)).
    \417\ ((16.3 internal burden hours in year 1) + (13.8 internal 
burden hours in year 2) + (13.8 internal burden hours in year 3))/3.
---------------------------------------------------------------------------

    In sum, we estimate that rule 139b's requirements will impose a 
total annual internal hour burden of 20,731 hours on broker-
dealers.\418\ We do not think there is an external cost burden 
associated with this collection of information.
---------------------------------------------------------------------------

    \418\ 14.63 annualized burden hours * 1,417 broker-dealers.
---------------------------------------------------------------------------

Request for Comment

    We request comment on our approach and the accuracy of the current 
estimates. Pursuant to 44 U.S.C. 3506(c)(2)(A), the Commission solicits 
comments to: (1) Evaluate whether the collections of information are 
necessary for the proper performance of the functions of the agency, 
including whether the information will have practical utility; (2) 
evaluate the accuracy of the Commission's estimate of the burden of the 
collections of information; (3) determine whether there are ways to 
enhance the quality, utility, and clarity of the information to be 
collected; and (4) evaluate whether there are ways to minimize the 
burden of the collections of information on those who are required to 
respond, including through the use of automated collection techniques 
or other forms of information technology.
    The agency has submitted the proposed collections of information to 
OMB for approval. Persons wishing to submit comments on the collection 
of information requirements of the proposed amendments should direct 
them to the Office of Management and Budget, Attention Desk Officer for 
the Securities and Exchange Commission, Office of Information and 
Regulatory Affairs, Washington, DC 20503, and should send a copy to 
Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F 
Street NE, Washington, DC 20549, with reference to File No. S7-11-18. 
As OMB is required to make a decision concerning the collections of 
information between 30 and 60 days after publication of the proposal, a 
comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days of publication. Requests for materials 
submitted to OMB by the Commission with regard to these collections of 
information should be in writing, refer to File No. S7-11-18, and be 
submitted to the Securities and Exchange Commission, Office of FOIA 
Services, 100 F Street NE, Washington, DC 20549.

V. Final Regulatory Flexibility Act Analysis

    This Final Regulatory Flexibility Act Analysis has been prepared in 
accordance with section 4(a) of the Regulatory Flexibility Act 
(``RFA'').\419\ It relates to new rule 139b, new rule 24b-4, and 
revisions to the rules under the Securities Act and the Exchange Act to 
implement the FAIR Act. An Initial Regulatory Flexibility Analysis 
(``IRFA'') was prepared in accordance with the RFA and included in the 
Proposing Release.\420\ The Proposing Release included, and solicited 
comment on, the IRFA.
---------------------------------------------------------------------------

    \419\ See 5 U.S.C. 604(a).
    \420\ See Proposing Release, supra note 2, at 26826-29.
---------------------------------------------------------------------------

A. Need for, and Objectives of, the Rules and Rule Amendments

    Rule 139b provides that, if certain conditions are satisfied, a 
broker-dealer's publication or distribution of a covered investment 
fund research report is 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. 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 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 new rule 139b). The 
revision to rule 101 under Regulation M is 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 rule 139b under the 
Securities Act are met. The new rules and rule revisions 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 new rules and rule revisions are discussed in more 
detail in section II above.

B. Significant Issues Raised by Public Comments

    In the Proposing Release, we requested comment on each aspect of 
the IRFA, including the number of small entities that would be affected 
by the proposed rules and amendments, the existence or nature of the 
potential impact of the proposals on small entities discussed in the 
analysis and how to quantify the impact of the proposed rules. We did 
not receive comments specifically addressing the impact of the rules 
and amendments on small entities subject to the rule.

C. Small Entities Subject to the Rules

    The new rules affect broker-dealers that publish or distribute 
covered investment fund research reports. As such, broker-dealers that 
are small

[[Page 64219]]

entities are affected by the adopted 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),\421\ and it is not affiliated with any person 
(other than a natural person) that is not a small business or small 
organization.\422\ As of December 31, 2017, the Commission estimates 
that there were approximately 1,043 broker-dealers that would be 
considered small entities as defined above.\423\ To the extent a small 
broker-dealer publishes or distributes covered investment fund research 
reports and seeks to rely on the rule 139b safe harbor--and is without 
a significant research department or wants to rely on pre-publication 
materials distributed by a covered investment fund, its adviser, or 
affiliated persons--it may be significantly affected by the final 
rules. Generally, we believe larger broker-dealers engage in these 
activities, and we did not receive comments on whether and how the 
rules we are adopting today affect small broker-dealers. We also did 
not receive comment on the number of small entities that would be 
affected by our adoption, including any available empirical data.
---------------------------------------------------------------------------

    \421\ 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.
    \422\ See rule 0-10(c)(2) under the Exchange Act [17 CFR 240.0-
10(c)(2)].
    \423\ 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 rule 139b and the 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 rule 139b and the revision to Regulation 
M.
    Rule 139b extends the safe harbor under rule 139 to broker-dealers' 
publication or distribution of covered investment fund research 
reports. As a result of the FAIR Act communications that historically 
have been treated as covered investment fund advertisements under rule 
482 now could fall under the new 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.\424\ 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.\425\ 
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.\426\ These filings are 
typically done by broker-dealers' compliance staff. The Commission 
implemented section 2(b)(4) of the FAIR Act via new 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.\427\ 
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).\428\ Thus, covered investment fund 
research reports, by operation of rule 24b-4, would no longer be 
subject to filing requirements under section 24(b) because they would 
be subject to the general content standards of FINRA rule 
2210(d)(1).\429\ Rule 24b-4 would affect broker-dealers that, in lieu 
of a safe harbor such as that 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. The Commission estimates that there were approximately 
1,043 broker-dealers, as of December 31, 2017, that would be considered 
small entities as defined above.\430\ 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 
will be reduced. However, large and small broker-dealers will not be 
affected differently by rule 24b-4.
---------------------------------------------------------------------------

    \424\ See 15 U.S.C. 80a-24(b); 17 CFR 270.24b-3; supra section 
II.D.1.
    \425\ See supra section II.D.1.
    \426\ See supra notes 187-189 and accompanying text. Rule 24b-3 
under the Investment Company Act deems these materials to have been 
filed with the Commission if filed with FINRA. See id.
    \427\ See rule 24b-4; see also discussion accompanying supra 
notes 179-183.
    \428\ See supra paragraph accompanying notes 183-185.
    \429\ See supra section II.D.1.
    \430\ See supra note 423.
---------------------------------------------------------------------------

    The amendments are discussed in detail in Section II above. We 
discuss the economic impact, including the estimated compliance costs 
and burdens, of the amendments in Section III above.

E. Agency Action To Minimize Effect on Small Entities

    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 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 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 conditions, would

[[Page 64220]]

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 new rules impose 
any significant new compliance obligations, because the new 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 rule 
139b's framework, including its scope and conditions, is modeled after 
and generally tracks rule 139.\431\ Rule 139 does not incorporate 
conditions that 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 rule 
139b incorporate conditions that would affect the availability of the 
new 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.\432\ This 
could have had the effect of limiting the availability of the 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,\433\ we are 
not adopting a regular-course-of-business requirement, in either the 
new rule 139b provisions on issuer-specific research reports or the 
provisions on industry reports, other than a requirement that tracks 
the provisions of rule 139 (modified as directed by the FAIR Act).
---------------------------------------------------------------------------

    \431\ See supra paragraph accompanying notes 12-15.
    \432\ See supra section III.C.6.c.
    \433\ See id.
---------------------------------------------------------------------------

    Nor do we believe that clarifying, consolidating, or simplifying 
the amendments for small entities would satisfy those objectives. 
Because rule 139b's framework (including its scope and conditions) is 
modeled after and generally tracks rule 139, rule 139b, like rule 139, 
does not treat small broker-dealers differently than large broker-
dealers, including by clarifying, consolidating, or simplifying any 
conditions.
    Further, with respect to using performance rather than design 
standards, the rule generally uses performance standards for all 
broker-dealers relying on the 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 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 rule is defined broadly, as discussed 
above \434\). However, we note that the 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 new rule, 
regardless of their size.\435\ 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 rule is 
not used to circumvent the prospectus requirements of the Securities 
Act.\436\
---------------------------------------------------------------------------

    \434\ See supra section II.A.2.
    \435\ See, e.g., supra sections II.B.1.a (Reporting History and 
Timeliness Requirements) and II.B.1.b (Market Following 
Requirement).
    \436\ See supra notes 49-50 and accompanying text.
---------------------------------------------------------------------------

VI. Statutory Authority

    We are adopting 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 249

    Reporting and recordkeeping requirements, Securities.

17 CFR Part 270

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

Text of Rules and Amendments

    For the reasons set out in the preamble, title 17, chapter II of 
the Code of the Federal Regulations is 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.
* * * * *

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

[[Page 64221]]

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-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) At the time of the broker's or dealer's initial publication or 
distribution of a research report on the covered investment fund (or 
reinitation thereof), and at least quarterly thereafter;
    (1) If the covered investment fund is of the type defined in 
paragraph (c)(2)(i) of this section, the aggregate market value of 
voting and non-voting common equity held by affiliates and non-
affiliates equals or exceeds the aggregate market value specified in 
General Instruction I.B.1 of Form S-3 (Sec.  239.13 of this chapter);
    (2) If the covered investment fund is of the type defined in 
paragraph (c)(2)(ii) of this section, the aggregate market value of 
voting and non-voting common equity held by non-affiliates equals or 
exceeds the aggregate market value specified in General Instruction 
I.B.1 of Form S-3 (Sec.  239.13 of this chapter); or
    (3) If the covered investment fund is a registered open-end 
investment company (other than an exchange-traded fund) its net asset 
value (inclusive of shares held by affiliates and non-affiliates) 
equals or exceeds the aggregate market value specified in General 
Instruction I.B.1 of Form S-3 (Sec.  239.13 of this chapter); 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 
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;
    (ii) The covered investment fund 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.
    (3) Disclosure of standardized performance. In the case of a 
research report about a covered investment fund that is a registered 
open-end management investment company or a trust account (or series or 
class thereof), any quotation of the issuer's performance must be 
presented in accordance with the conditions of paragraphs (d), (e), and 
(g) of Sec.  230.482. In the case of a research report about a covered 
investment fund that is a registered closed-end investment company, any 
quotation of the issuer's performance must be presented in a manner 
that is in accordance with instructions to item 4.1(g) of Form N-2 
(Sec. Sec.  239.14 and 274.11a-1 of this chapter), provided, however, 
that other historical measures of performance may also be included if 
any other measurement is set out with no greater prominence than the 
measurement that is in accordance with the instructions to item 4.1(g) 
of Form N-2.
    (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.

[[Page 64222]]

    (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 
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 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

0
7. The authority citation for part 249 continues to read, in part, as 
follows:

    Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C. 
5461 et seq.; and 18 U.S.C. 1350; Sec. 953(b), Pub. L. 111-203, 124 
Stat. 1904; Sec. 102(a)(3), Pub. L. 112-106, 126 Stat. 309 (2012); 
Sec. 107, Pub. L. 112-106, 126 Stat. 313 (2012), and Sec. 72001, 
Pub. L. 114-94, 129 Stat. 1312 (2015), unless otherwise noted.
* * * * *

0
8. Amend Form 12b-25 (referenced in Sec.  249.322) as follows:
0
a. On the cover page accompanying the checkboxes, removing the phrase 
``Form N-SAR'' and adding in its place ``Form N-CEN'';
0
b. On the cover page below the checkboxes, removing the checkbox and 
accompanying phrase ``Transition Report on Form N-SAR'';
0
c. In Part II, removing the phrase ``Form N-SAR'' and adding in its 
place ``Form N-CEN''; and
0
d. In Part III, removing the phrase ``Form N-SAR'' and adding in its 
place ``Form N-CEN''.

    Note: the text of Form 12b-25 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

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

0
9. 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
10. 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 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: November 30, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018-26613 Filed 12-12-18; 8:45 am]
 BILLING CODE 8011-01-P

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