United States: FINRA Proposes Limited Safe Harbor For Desk Commentaries From Certain Requirements Of FINRA Equity And Debt Research Rules

FINRA recently published a proposal1 to establish a limited safe harbor (the "Safe Harbor") for desk commentaries2 from certain requirements of FINRA's equity and debt research rules (the "FINRA Research Rules").

The comment period for the same expires on May 30, 2017.

Part I of this note provides an overview of the Safe Harbor's expected impact, if adopted; Part II provides background regarding relevant issues;3 Part III describes the types of communications eligible for the Safe Harbor; Part IV sets forth the policy-and-procedure and disclosure requirements of the Safe Harbor; and Part V provides analysis of the proposal.

OVERVIEW OF EXPECTED IMPACT

Debt Desk Commentaries

For desk commentaries regarding debt securities, the Safe Harbor would not materially expand relief from the requirements of FINRA's debt research rule (the "Debt Research Rule") beyond that already provided under the rule's exemptions for institutional-only debt research (the "Institutional-Only Debt Research Exemption"). The chief benefit of the Safe Harbor for firms distributing debt desk commentaries, then, would seem to be that FINRA has proposed a structure that explicitly acknowledges the permissibility of externally-distributed written commentaries by personnel sitting on sales and trading desks. 

Equity Desk Commentaries

Because FINRA's equity research rule (the "Equity Research Rule") does not have an institutional-only exemption, and because FINRA licensing is required for equity research analysts and research principals, the Safe Harbor would be the source of somewhat broader relief for equity desk commentaries. The Safe Harbor would still require many of the policy-and-procedure requirements of the Equity Research Rule, but company-specific disclosures will not be required, and personnel producing equity desk commentaries and those reviewing such commentaries would be exempted from FINRA research licensing requirements, among other exemptions.

BACKGROUND

Desk commentaries are brief written analyses generated by sales and trading desk personnel and distributed to institutional investors, generally with respect to near-term or very recent market events. Fundamental research, on the other hand, is more in-depth and is produced by personnel in a research department.

Since the enactment of the Equity Research Rule and, especially, the 2016 establishment of FINRA's Debt Research Rule, firms had struggled with the question of which policies and procedures to establish for desk commentaries and the personnel who produce them, given that some desk commentaries could arguably be "research reports" under the FINRA Research Rules. The definition of a research report under the Equity Research Rule is "any written...communication that includes an analysis of equity securities of individual companies or industries...and that provides information reasonably sufficient upon which to base an investment decision," subject to exceptions for certain types of analysis including macroeconomic analysis. The definition of debt research report is similar. The conundrum is that some desk commentaries, although brief, arguably provide analysis that is "reasonably sufficient upon which to base an investment decision," and thus would trigger the applicability of the FINRA Research Rules.

Given that both the Equity and Debt Research Rules require firms producing such reports to establish structural protections against conflicts of interest that may be impractical to apply to desk personnel, firms had to closely consider the impact of the FINRA Research Rules on desk commentaries.

In explaining the rationale for the Safe Harbor proposal, FINRA makes the important and welcome note that institutional investors value timely flow of information and trade ideas from desk personnel, and understand the types of potential conflicts that may exist in the generation of trade ideas.

Communications Eligible for Safe Harbor

The Safe Harbor is limited to communications that meet the following conditions.

  • Author. The communication must be produced by sales and trading and principal trading personnel who:

    • Are not primarily engaged in the preparation of research reports that do not meet the safe harbor content limitation (described below);
    • Do not require registration as a research analyst pursuant to NASD Rule 1050 because their primary job function is something other than to provide investment research; and,
    • Do not report directly or indirectly to research department personnel.
  • Content. The communication must be limited to brief observations (not including a rating, price target, or earnings estimate) regarding recent, current, or near term expected trading activity, trading ideas or opportunities, market conditions, economic statistics or company results, or regarding a recent recommendation or research report.
    • While the Safe Harbor prohibits desk commentary from including the author's own rating, price target, or earnings estimate, it would not preclude referencing a rating, price target, or earnings estimate in other published research, including from the firm's own research department, or discussing the directional effect of an event on an issuer's rating, price target, or earnings. 
  • Recipient. The communication may only be distributed to:

    • Consenting investors that meet the definition of "institutional account" under FINRA Rule 4512(c) and have satisfied the FINRA Rule 2111 institutional suitability standard with respect to equity or debt transactions or trading strategies, as applicable.

As noted in the "Recipient" bullet, the Safe Harbor is limited to desk commentaries distributed to consenting institutional investors. The Safe Harbor permits negative consent processes to be used to obtain consent from all investors meeting the definition of institutional account under Rule 4512(c) (which definition includes all entities with $50 million or more of total assets), whereas the Institutional-Only Debt Research Exemption requires affirmative consent from investors that meet the Rule 4512 test but not the definition of a Qualified Institutional Buyer. The proposal includes a 90-day transition period in which the Safe Harbor would be available even if the firm has not received the necessary consent.

POLICY-AND-PROCEDURE AND DISCLOSURE REQUIREMENTS OF THE SAFE HARBOR

Policy-and-Procedure Requirements

The following chart sets forth the policy-and-procedure obligations that must be fulfilled to comply with the Safe Harbor, and contrasts them with the obligations required by the Equity Research Rule and the Debt Research Rule (as applied to firms producing only institutional debt research).4 As the Safe Harbor refers to desk commentaries as research reports and personnel who produce such commentaries as research analysts, this chart does the same.

DESCRIPTION OF PROVISION EQUITY RESEARCH RULE EQUITY DESK COMMENTARY SAFE HARBOR DEBT RESEARCH RULE FOR ONLY INSTITUTIONAL RESEARCH DEBT DESK COMMENTARY SAFE HARBOR
Market manipulation: Prevent the use of research reports or research analysts to manipulate the market. Not expressly, but would be required based on other law and regulation and catch-all conflicts provision of rule Yes Not expressly, but would be required based on other law and regulation and catch-all conflicts provision of rule Yes
Prohibition on pre-publication review of reports by investment banking personnel Yes Yes Yes Yes
Policies to insulate analysts from pressure, review, oversight of certain personnel: Establish information barriers or other institutional safeguards to ensure that research analysts are insulated from review, pressure or oversight from persons involved in investment banking, sales and trading, principal trading (for debt research), and others who might be biased in their judgment and supervision. Yes Only with respect to insulation from pressure (not oversight or review). NB: other Safe Harbor provisions described below prohibit supervision or control by investment banking personnel FINRA: "In the context of desk commentary, FINRA does not interpret 'pressure'... to exist merely because a firm produces desk commentary on securities in which it trades or the authors of desk commentary report to such personnel .... Although FINRA does not interpret this requirement to require altering a firm's internal reporting lines, a firm must put in place policies and procedures reasonably designed to ensure that investment banking personnel or sales and trading and principal trading personnel do not overtly pressure a person who produces desk commentary to express a particular view."5 Only with respect to insulation from pressure (not oversight or review) Only with respect to insulation from pressure (not oversight or review) FINRA: "In the context of desk commentary, FINRA does not interpret 'pressure' ... to exist merely because a firm produces desk commentary on securities in which it trades or the authors of desk commentary report to such personnel .... Although FINRA does not interpret this requirement to require altering a firm's internal reporting lines, a firm must put in place policies and procedures reasonably designed to ensure that investment banking personnel or sales and trading and principal trading personnel do not overtly pressure a person who produces desk commentary to express a particular view."6
Prohibit retaliation: Prohibit direct or indirect retaliation or threats of same against research analysts by any employee as the result of an adverse, negative, or otherwise unfavorable research report that may negatively affect the firm's present or prospective business interests. Yes Yes Yes Yes
Promises of favorable research: Prohibit explicit or implicit promises of favorable research, a particular research rating or recommendation or specific research content as inducement for the receipt of business or compensation. Yes Yes Yes Yes
Objectivity of analysts, including prohibition on participating in investment banking pitches and solicitations: Restrict or limit activities by research analysts that can reasonably be expected to compromise their objectivity, including prohibiting: (i) participation in pitches and other solicitations of investment banking services transactions; and (ii) participation in road shows and other marketing on behalf of an issuer related to an investment banking services transaction. Yes Yes FINRA notes: "This condition would not prohibit a person in the sales and trading or principal trading department from engaging in ordinary course communications related to the distribution of securities in an offering, including, for example, forwarding written materials from the syndication desk to customers, provided that the person was not concurrently publishing desk commentary related to the issuer or the investment banking services transaction." Yes Yes FINRA notes: "This condition would not prohibit a person in the sales and trading or principal trading department from engaging in ordinary course communications related to the distribution of securities in an offering, including, for example, forwarding written materials from the syndication desk to customers, provided that the person was not concurrently publishing desk commentary related to the issuer or the investment banking services transaction."
Prohibit investment banking direction re marketing and communications: Prohibit investment banking department personnel from directly or indirectly: (i) directing a research analyst to engage in sales or marketing efforts related to an investment banking services transaction; and (ii) directing a research analyst to engage in any communication with a current or prospective customer about an investment banking services transaction. Yes Yes Yes Yes
<>Review by subject company: Prohibit prepublication review of research reports by a subject company. Yes, but subject company review for fact checking is permitted Yes. Subject company review for fact checking is prohibited FINRA notes: "FINRA believes it would be inconsistent with the scope and temporal nature of desk commentary to permit such review." Yes, but subject company review for fact checking is permitted Yes. Subject company review for fact checking is prohibited FINRA notes: "FINRA believes it would be inconsistent with the scope and temporal nature of desk commentary to permit such review."
Restrictions on analyst communications with customers: Prohibition on research analyst communication with current or prospective customer in the presence of investment banking personnel or company management about an investment banking services transaction. Yes Yes Yes Yes
Supervision or control by investment banking: Prohibit persons engaged in investment banking activities from supervision or control of research analysts, including influence or control over research analyst compensation evaluation and determination Yes Yes No No
Budget determinations: Limit determination of research dept. budget to senior management, excluding senior management engaged in investment banking (or, for debt, principal trading activities), and without regard to specific revenues or results derived from investment banking. Yes Yes No No
Basis of analyst compensation: Prohibit compensation of research analysts based on specific investment banking services or contribution to a firm's investment banking services or principal trading activities. Yes Yes. FINRA notes: "This requirement would not prohibit a firm from compensating a person in the sales and trading or principal trading department in the form of sales credits in connection with the distribution of securities in an offering, provided that the person had not published desk commentary related to those investment banking services transactions." No No

Disclosure Requirements

The Safe Harbor would require desk commentary to include a "health warning" similar to what is required for debt research distributed pursuant to the Institutional-Only Debt Research Exemption. The health warning would be required to state:

  • "This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to research reports prepared for retail investors"; and,
  • If applicable, "Clients should assume that this document is not independent of [Firm's] proprietary interests. [Firm] trades, and will continue to trade, the securities covered in this document for its own account and on a discretionary basis on behalf of certain clients. Such trading interests may be contrary to or entered into in advance of this document."

ANALYSIS

Debt Desk Commentaries

Generally, the Safe Harbor provides exemption from only the very same policy-and-procedure requirements that are excluded by the existing Institutional-Only Debt Research Exemption. The only respect in which the Safe Harbor expressly offers broader relief is that it permits consent to be received through a negative consent process for accounts that meet the "institutional account" standard of Rule 4512 (which definition includes all entities with $50 million or more of total assets) but not the definition of a Qualified Institutional Buyer. The Debt Research Rule requires affirmative consent from such investors for the Institutional-Only Debt Research Exemption to apply. 

It would seem then that the chief benefit of the Safe Harbor for firms producing debt desk commentaries is that FINRA has proposed a structure that explicitly acknowledges the permissibility of externally-distributed written commentaries by personnel sitting on sales and trading desks, provided that the Safe Harbor's conditions are complied with. Although there had been guidance from FINRA with respect to the Debt Research Rule that suggested that the rule did not prohibit desk commentaries if proper policies and procedures were established, the establishment of the Safe Harbor would presumably remove doubt as to FINRA's view.

Equity Desk Commentaries

Because the Equity Research Rule does not have an institutional-only research exemption and because FINRA rules require specific licensing for equity research analysts and research principals, the Safe Harbor for equity desk commentaries provides more significant substantive exemptions than those described for debt desk commentary.

First, the Safe Harbor provides an exemption from compliance with the licensing requirements for equity research analysts. Persons producing equity desk commentaries as well as research principals would therefore be excluded from the licensing requirements in respect of those activities.

The Safe Harbor also exempts equity desk commentary from certain of the substantive requirements of the Equity Research Rule, including committee review of analyst compensation and restrictions on analyst trading, as well as the particularized disclosures regarding conflicts of interest.

Footnotes

1 The proposal set forth in Regulatory Notice 17–16 is available at https://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-16.pdf

2 Desk commentaries are brief written analyses generated by sales and trading desk personnel and distributed to institutional investors, generally with respect to near-term and very recent market events. Fundamental research, on the other hand, is more in-depth and is produced by personnel in a research department.

3 For additional background, please see FINRA's New Fixed-Income Research Rule and Modifications to Equity Research Rule (Oct. 2015), currently available at: http://www.shearman.com/en/newsinsights/publications/2015/10/finra-rule-2242-and-rule-2241;  FINRA Proposes Revisions to Fixed-Income Research Rule (May 2016),  currently available at: http://www.shearman.com/en/newsinsights/publications/2016/05/finra-revisions-to-fixed-income-research-rule; and SEC Approves Changes to NASD and NYSE Rules Relating to Research Analyst Conflicts of Interest (Aug. 2003), , currently available at: http://www.shearman.com/~/media/files/newsinsights/publications/2003/08/sec-approves-changes-to-nasd-and-nyse-rules-rela__/files/download-pdf-sec-approves-changes-to-nasd-and-ny__/fileattachment/sd_08_03.pdf

 4 Please note that the columns regarding the Equity Research Rule and Debt Research Rule for Institutional-Only Research assume that the exemptions for firms with limited investment banking or principal trading activity are not available.

5 FINRA also notes: "As with the institutional debt exemption, compliance with this safe harbor condition would not require physical separation between persons who produce eligible desk commentary and sales and trading and principal trading department personnel, but absent such physical barriers, firms must implement and document other policies and procedures to achieve compliance with this condition."

6 Id.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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
 
In association with
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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.