United States: SEC Approves Long-Anticipated FINRA Research Rules

Last Updated: July 24 2015
Article by Amy Natterson Kroll and John V. Ayanian

New FINRA Rule 2241 consolidates and expands upon legacy NASD and NYSE rules to address equity research analyst activities, equity research reports, and conflicts of interest relating to equity research analysts. New FINRA Rule 2242 for the first time regulates debt research analyst activities, debt research reports, and related conflicts of interest.

On July 16, the Securities and Exchange Commission (SEC) approved two Financial Industry Regulatory Authority (FINRA) proposed rule changes pertaining to research analysts and research reports.1 The first rule change amends and consolidates into new FINRA Rule 2241 existing legacy NASD Rule 2711 and NYSE Rule 472 with regard to equity research activities (the SRO Rules). The second results in new FINRA Rule 2242, which for the first time imposes SRO regulation on debt research reports and debt research analysts. FINRA has not announced when these changes will take effect.

The approved rule changes follow years of consideration of amendments to FINRA's original proposal for a new debt research rule2 (first presented in a concept release in 2011) and almost a year of consideration by the SEC Staff of both the new debt research Rule 2242 and the proposed amendments to the SRO Rules and their consolidation into new FINRA Rule 2241.3

While the two FINRA rules track each other in many areas, there are differences. This LawFlash provides a high-level overview focusing primarily on the changes to the SRO Rules reflected in FINRA Rule 2241 that pertain to equity research activities. In addition, this LawFlash discusses the changes to the licensing requirements for equity research analysts that the SEC approved in conjunction with the approval of FINRA Rule 2241. We will publish a subsequent LawFlash with detailed information about new Rule 2242 pertaining to debt research activities, however, we note in this LawFlash those changes with regard to equity research activities that also will apply to debt research activities.

New FINRA Rule 2241—Equity Research Analysts and Equity Research Reports

Joint Due Diligence

The Supplemental Material section of FINRA Rule 2241 expressly prohibits joint due diligence by research analysts and investment banking department personnel prior to the selection by the issuer of the underwriters for an investment banking services transaction, to the extent that such joint due diligence prohibition does not run contrary to the Jumpstart Our Business Startups (JOBS) Act. FINRA has informed the SEC that it would not interpret the joint due diligence prohibition to apply where the activities involve a communication with the management of an Emerging Growth Company (EGC)4 that is attended by both the research analyst and an investment banker.5  This is a significant (though not surprising) change, especially in light of recent FINRA enforcement actions and FAQs from FINRA regarding research analysts and investment banking activities stating this position.6

  • New FINRA Rule 2242 includes the same limitations on joint due diligence by debt research analysts and investment bankers.

Identifying and Managing Conflicts of Interest

New FINRA Rule 2241 includes a section titled "Identifying and Managing Conflicts of Interest."7 This section is, in FINRA's view, a prudential approach to regulation of equity research activities. It incorporates many elements of the SRO Rules that require member firms to establish, maintain, and enforce written policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to research analysts' interactions amongst themselves and with others, including "investment banking and sales and trading personnel, subject companies and customers." 

This new section addresses practices related to the preparation, content, and distribution of research reports; public appearances by research analysts; and the interactions among research analysts and investment banking, sales, and trading personnel, subject companies, and customers.

  • The express inclusion of potential conflicts between research activities and sales and trading personnel raises a number of issues beyond the information barriers and limitations FINRA already imposes through its Rule 5280. We will provide a more detailed analysis of these issues in our next LawFlash.

New FINRA Rule 2241 also requires that policies and procedures be reasonably designed to promote "objective and reliable research reflecting truly held opinions of research analysts" and to "prevent the use of research or research analysts to manipulate or condition the market or favor the interests of the member firm, or of particular current or prospective customers."

New FINRA Rule 2241 also imposes significantly reduced quiet periods when compared to the SRO Rules. Quiet periods during which member firms cannot publish and distribute research are now:

  • 10 days after completion of an IPO for underwriters and dealers, and
  • 3 days after the completion of a secondary offering for managers and co-managers of the offering.

New FINRA Rule 2241 retains the exceptions to the quiet periods noted above to allow for significant news or events about a subject company, and the three-day quiet period is lifted after secondary offering for issues that are actively traded as defined in Regulation M if the research is issued in reliance on the safe harbor in Rule 139 under the Securities Act of 1933.  New FINRA Rule 2241 does not include any quiet periods before or after expiration, waiver, or termination of a lock-up agreement.

  • New FINRA Rule 2242 includes many of the above-described provisions regarding managing conflicts of interest, particularly with regard to debt research that will be distributed to retail investors.

Disclosures 

New FINRA Rule 2241 retains the required disclosures found in the SRO Rules and also adds a new disclosure requirement that is triggered "if a member or its affiliates maintain a significant financial interest in the debt or equity securities of the subject company,"8 including, at a minimum, as required in the SRO Rules if the member or its affiliates beneficially own 1% or more of any class of common equity of the subject company.

Furthermore, member firms will now be required to disclose in research reports any other material conflicts of interest of the research analyst or the member firm known "by any associated person of the member with the ability to influence the content of a research report" or that such person has "reason to know,"9 in addition to the requirement in the SRO Rules that calls for disclosure if the analyst had such knowledge. An "associated person" with such ability is defined as any person (other than legal and compliance personnel) who reviews the content of a report or has exercised authority to review or change the research report prior to publication or distribution.10

  • The provisions described above can also be found in new FINRA Rule 2242.

Distribution of Equity Research Reports to Different Groups

The Supplemental Material to New FINRA Rule 2241 incorporates a concept introduced when FINRA Rule 2242 regarding debt research was first proposed, specifically, that research products and services may be provided to different classes of customers provided that:

    • the products are consistent with the meaning of the member's rating system for each respective product (for example, research regarding products with long-term investment horizons should have ratings that correspond to the long-term investment horizons and research about products with short-term investment horizons should have ratings systems that correspond to the short-term horizons);
    • the products are not differentiated based on the timing of receipt of a recommendation, rating, or other potentially market-moving information, or to allow certain customers to trade in advance of other customers; and
    • there is disclosure in the case that alternative research products and services may reach different conclusions or recommendations that could impact the price of the equity security.11

  • The above-described concept remains in new FINRA Rule 2242's Supplemental Material with regard to distribution of debt research reports.

Definitions

  • "Sales and Trading Personnel" is a new term not previously defined in connection with equity research activities. New FINRA Rule 2241 defines "sales and trading personnel" as "persons in any department or division, whether or not identified as such, who perform any sales or trading service on behalf of a member."
  • "Research Report" is amended to expressly exclude communications pertaining to open-end registered investment companies that are not listed or traded on an exchange, as well as private placement memoranda and comparable offering related documents prepared in connection with investment banking services transactions.12
  • "Research Analyst Account" is amended to clarify that the term does not include a registered investment company over which a research analyst or a member of the research analyst's household has discretion or control, provided that the research analyst or member of the household has no financial interest in the investment company other than a performance or management fee.13 

Personal Trading by Research Analysts

  • New FINRA Rule 2241 expressly allows a research analyst to trade against a recommendation in the face of "financial hardship" as defined in the member firm's policies and procedures managing conflicts of interest.14
  • Supplemental Material to new FINRA Rule 2241 also allows a firm that has a policy prohibiting the research analyst accounts from holding securities, or options on or derivatives of such securities, of the companies in the research analyst's coverage universe, to permit the research analysts' accounts to trade in a manner inconsistent with his or her recommendation, provided that the trades are pursuant to a "reasonable plan to liquidate the holdings and that plan is approved by the firm's legal or compliance department.15
  • The above-described concepts also are included in new FINRA Rule 2242.

Registration Requirements

In addition to New FINRA Rule 2411, the SEC approved amendments to legacy NASD Rule 1050 and incorporated NYSE Rule 344.

For purposes of NASD Rule 1050 and NYSE Rule 344 (which require specific licenses for research analysts), the definition of "research analyst" has been amended to mean those associated persons of member firms "whose primary job function is to provide investment research . . . " This amendment provides leeway for such persons—often sales and trading or other personnel within a firm—who may from time to time produce equity research reports, but whose primary job is not to provide investment research. The SEC recognizes that the amended definition would exclude general registered representatives and traders in an effort to "provide relief for those who produce research reports on an occasional basis."16 

We will continue to evaluate these new rules and will be issuing additional LawFlashes in the coming weeks.

Footnotes

1 SEC Release No. 34-75471 (July 16, 2015) ("SEC Rel. No. 34-75471"); SEC Release No. 34-75472 (July 16, 2015) ("SEC Rel. No. 34-75472").

2 Debt Research Reports, FINRA Regulatory Notice 11-11 (March 2011)

3 See, SR-FINRA-2014-047 (Nov. 14, 2014) and SR-FINRA-2014-048 (Nov. 14, 2015)

4 See FINRA Rule 2241(a)(1).

5 SEC Rel. No. 34-75471 at 11.

6 See, FINRA Publishes Guidance on Research Conflict of Interest Rules, Morgan, Lewis & Bockius LLP (June 3, 2015)

7 FINRA Rule 2241(b).

8 FINRA Rule 2241(c)(4)(A).

9 FINRA has informed the SEC that "reason to know" does not impose a duty of inquiry. See, SEC Rel. No. 34-75471 at 16-17.

10 FINRA Rule 2241(c)(4)(I).

11 Supplemental Material .07.

12 FINRA Rule 2241 (a)(11). "Investment banking services" transactions continued to be defined as transactions where a member firm acts as a underwriter or participates in a selling group in an offering for an issuer; acts as a financial adviser in a merger or acquisition, provides venture capital equity lines of credit, private investment, public equity transactions or similar investments, or serves as placement agent for an issuer.  FINRA Rule 2241(a)(5).

13 FINRA Rule 2241(a)(9).

14 FINRA Rule 2241(b)(2)(J)(ii).

15 Supplemental Material .10.

16 SEC Rel. No. 34-75471 at 23.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions