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FINRA Research Proposals

February 24, 2015

NY2 748082

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Applicable Rules • Analyst Settlement • SRO Rules

• FINRA Rule 2711 currently applies only to equity securities

• Rules 137-139 (Research Safe Harbors) • Apply to equity and debt securities

• Regulation AC • Applies to equity and debt securities

• FINRA Proposal Revising Equity Research Rules • FINRA Proposal Addressing Debt Research

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ANALYST SETTLEMENT

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Analyst Settlement -Timeline April 2000: Dotcom bust; scrutiny of research reports and analysts begins. July 2002: NASD (now FINRA), and NYSE (together, “SROs”) issue joint memorandum

explaining the application of FINRA’s Rule 2711 and NYSE Rule 472 (together, the “SRO Rules”). April 2003: SEC establishes Regulation AC, which requires that broker-dealers:

Include in research reports certifications by the research analyst that the views expressed in the report accurately reflect his or her personal views, and Disclose whether or not the analyst received compensation or other payments in connection with

his or her specific recommendations or views. October 2003: U.S. District Court establishes guidelines that require certain financial

institutions to separate their investment banking and research functions. December 2005: SROs issue a joint report “On the Operation and Effectiveness of the

Research Analyst Conflict of Interest Rules,” including many recommended amendments to the SRO Rules that have now been adopted. March 2010: District Court modifies the settlement to permit chaperoned research

analyst and investment banking participation in joint due diligence sessions under certain circumstances.

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Analyst Settlement Global settlement technically applies only to the settling firms and

their successors. As a practical matter, it has much broader application since many institutional investors have required non-settling securities firms to agree to follow its provisions. Most settlement provisions apply only in respect of a research report

that is both (i) prepared by the firm, and (ii) that relates to either (A) a U.S. company, or (B) a non-U.S. company for which a U.S. market is the principal equity trading market. SRO Rules establish a similar (and somewhat broader) set of

guidelines.

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SRO Rules

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FINRA and Analyst Reports – Rule 2711 Designed to address conflicts of interest in connection with the preparation and

publication of research reports and public appearances relating to equity securities Prohibits offering favorable research to induce issuers to award investment banking

business Imposed structural reforms to increase analyst independence, including a prohibition

on investment banking personnel supervising analysts or approving research reports Prohibits linking analyst compensation to a specific investment banking transaction Prohibits submitting a research report to the issuer prior to the report's publication,

with a narrow exception for verifying facts Mandated “quiet periods” of 40 calendar days and ten calendar days for managers

and co-managers following IPOs and follow-on offerings, respectively, with exceptions for significant news or events and (in the case of follow-on offerings) for securities that meet the average daily trading volume (ADTV) test in Rule 101 of Regulation M and that also meet the requirements of SEC Rule 139 Required increased disclosures of conflicts of interest in research reports and public

appearances by analysts Restricts personal trading by analysts Requires disclosure in research reports of data and price charts showing a firm's

ratings track record

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Rule 2711 – 2003 Amendments (cont'd) Additional rules were adopted in 2003, after the enactment of Sarbanes-

Oxley Act: Prohibits analyst participation in efforts to solicit investment banking business (with an

exception for communications “the sole purpose of which is due diligence”) Applies the quiet periods following IPOs and follow-on offerings to views expressed by analysts

in public appearances Imposes a 25-day IPO quiet period for all participating underwriters and dealers other than

managers or co-managers Imposed a 15-day quiet period prior to or following the expiration, waiver or termination of a

lock-up agreement (with exceptions for significant news or events and for research reports or public appearances regarding securities that meet the ADTV test in Rule 101 of Regulation M and that also meet the requirements of SEC Rule 139) Members must publish a notice to customers in the event of termination of coverage of a

company, with a final research report, recommendation and rating Prohibits any non-research personnel reviewing or approving, with a narrow exception for

reviews for the purpose of checking factual accuracy Prohibits a firm from directly or indirectly "retaliating" against an analyst because of an

unfavorable research report or a public statement about an investment banking client

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Rule 2711 – 2005 Amendments Additions in June 2005: Prohibit an analyst from participating in a roadshow relating to an investment

banking services transaction Prohibit an analyst from communicating with a customer in the presence of

investment banking personnel or company management about an investment banking services transaction Prohibit investment banking personnel from "directing" an analyst to engage in

sales or marketing efforts related to an investment banking services transaction or to discuss such a transaction with a customer Any communication by an analyst with a customer "or internal personnel" related to

an investment banking services transaction must be "fair, balanced and not misleading, taking into consideration the overall context in which the communication is made"

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Rule 2711 – 2012 JOBS Act Amendments Amendments approved October 11, 2012 to conform to changes

effected by the JOBS Act for offerings by Emerging Growth Companies (“EGCs”). No post-IPO or follow-on offering quiet periods for EGCs - Lock up periods

discussed in Rule 2711 (f)(1), (f)(2) and (f)(4) “shall not apply to the publication or distribution of a research report or a public appearance following an initial public offering or secondary offering of the securities” of an EGC Rule 2711(c)(4) was amended to provide that while research analysts are

prohibited from soliciting business for investment banking, they are not prevented from attending a pitch meeting in connection with an initial public offering of an EGC that is also attended by investment banking personnel; provided, however, that a research analyst may not engage in otherwise prohibited conduct in such meetings including efforts to solicit investment banking business; effective retroactive to April 5, 2012, the date the JOBS Act was enacted.

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Research Quick Guide to Offerings

Is the Issuer conducting an IPO?

Does research cover the Issuer?

Has the Issuer filed all required SEC

reports over preceding 12

months?

Is the Issuer a WKSI?

Does the Issuer’s float exceed $75

million?

Is the Issuer a U.S. corporation?

Research cannot initiate coverage until 40 days (if manager) or 25 days (if

underwriter or dealer) after IPO

Is the Issuer a foreign private

issuer that meets requirements of Rule 138/139?(2)

Research cannot initiate coverage or publish reports on

the Issuer until 10 days (if manager) after follow-on

offering

Research can publish both issuer and industry-specific reports

(subject to conditions for reports)

Research may publish report on security that is not the subject of IB mandate (i.e., (1) equity if security offered is non-convertible debt and (2) debt if security offered is equity

or convertible debt)

Yes

No

Yes

Yes

Yes

Yes

Yes

Yes

No

No

No

No

No

No

(1) The Jumpstart Our Business Startups (JOBS) Act (April 2012) defines “emerging growth company” (“ECG”) as an issuer with total gross revenues of less than $1 billion (subject to inflationary adjustment) during its most recently completed fiscal year. A company remains an ECG until the earliest of: the last day of the fiscal year during which the issuer has total annual gross revenues in excess of a $1 billion (subject to inflationary indexing); the last day of the issuer’s fiscal year following the fifth anniversary of the date of the first registered sale of common equity securities of the issuer under the Securities Act; the date on which such issuer has, during the prior three-year period, issued more than $1 billion in non-convertible debt; or the date on which the issuer is deemed a “large accelerated filer.” An issuer will not be able to qualify as an ECG if it first sold its common stock in an IPO prior to December 8, 2011.

(2) Meets all of the registrant requirements of Form F–3 (other than the reporting history); and either: (i) satisfies the public float threshold of Form F–3; or (ii) is issuing non-convertible securities (if the issuer has issued at least $1 billion of non-convertible securities in transactions registered under the Securities Act, other than equity securities, for cash during the past three years or the issuer has outstanding at least $750 million of non-convertible securities, other than common equity, issued in primary offerings for cash registered under the Securities Act); and (iii) either (A) has its equity securities trading on a designated offshore securities market and has had them so traded for at least 12 months; or (B) has a worldwide public float of $700 million or more. (3) The JOBS Act prohibits any SRO and the SEC from adopting any rule/regulation that would restrict a broker-dealer from participating in certain meetings relating to ECGs. Post-offering, no SRO or the SEC may adopt any rule/regulation prohibiting a broker-dealer from publishing or distributing a research report or making a public appearance with respect to the securities of an ECG.

Start here Is the Issuer an “emerging

growth company”? (1)

Yes

No

Research may publish or distribute a research report about an ECG at

any time and the report will not be deemed an “offer” under the

Securities Act even if the broker-dealer will participate or is

participating in the offering(3)

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FINRA Enforcement

December 2014 – FINRA fined 10 firms a total of $43.5 million for allowing their equity research analysts to solicit investment banking business and for offering favorable research coverage in connection with the 2010 planned initial public offering of Toys"R"Us. Findings that each of the ten firms: Used its equity research analyst as part of its solicitation for a role in the IPO;

equity research analysts made separate presentations to Toys"R"Us' management and sponsors for the purpose of ensuring that the analysts' views on key issues, including valuation factors, were aligned with the views expressed by the firms' investment bankers. Understood that the performance of their analysts at the presentations would be a

key factor in determining whether the firm received an underwriting role in the IPO. As detailed in the settlement documents, implicitly or explicitly at the initial pitch

meetings or in follow-up communications offered favorable research coverage in return for a role in the IPO.

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FINRA Enforcement (cont’d)

FINRA also found that six of the 10 firms had inadequate supervisory procedures related to research analyst participation in investment banking pitches

“This settlement affirms our commitment to policing the boundaries between research and investment banking to ensure that research is not improperly influenced."

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Research Proposals

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FINRA Research Proposals • FINRA Equity Research Proposal • Proposal amends and adopts NASD Rule 2711 as consolidated

FINRA Rule 2241 • Retains most of the principal provisions of Rule 2711; however, the

proposal: • Introduces a more principles-based, less prescriptive approach • Places greater reliance on a member firm’s compliance policies and

procedures • Introduces more flexibility with respect to quiet periods • Expands the exemption for member firms with limited investment banking

activity

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Definitions • Investment banking definition: expanded to include all acts in

furtherance of a public or private offering on behalf of an issuer • Research report definition: would no longer include a report relating

to a mutual fund not listed or traded on an exchange

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Conflicts of interest • Member firms would be required to establish, maintain and enforce

written policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to research

Pre-publication review: at a minimum, policies must: • prohibit prepublication review, clearance or approval of research reports

by investment banking personnel • prohibit review, clearance or approval by other persons not directly

responsible for the preparation, content and distribution of research reports, other than legal and compliance

• Eliminates ability under current rules for investment banking to review reports for factual accuracy

• Requires that review by personnel (other than legal and compliance) be documented

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Conflicts of interest (cont’d) • Coverage universe: policies and procedures at a minimum must:

• Limit investment banking personnel’s input or influence on coverage determinations

• Research personnel/management must make final decisions regarding coverage

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Conflicts of interest (cont’d) • Oversight and control of research analysts:

• Policies and procedures must at a minimum prohibit investment banking personnel from supervising or controlling research analysts, including exerting influence or control over research analyst compensation evaluations and determinations

• Research budget: • Restrict research department determinations to senior management,

excluding senior management engaged in investment banking activities

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Conflicts of interest (cont’d) • Compensation: policies and procedures must:

• Prohibit compensation of research analysts based upon specific investment banking or contributions to investment banking

• Require that compensation of research analysts primarily responsible for the preparation of the substance of a research report be reviewed and approved at least annually by a compensation committee that does not include any representatives from the firm’s investment banking department

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Conflicts of interest (cont’d) • Information barriers: Policies and procedures must establish

information barriers or other safeguards to ensure the research analysts are insulated from the review or oversight of investment banking personnel, sales and trading personnel or others that may be biased in their judgment

• FINRA rule does not explicitly require physical separation • However, the FINRA proposal notes that FINRA would expect

physical separation except in extraordinary circumstances where the costs are unreasonable due to the firm’s size and resources

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Conflicts of interest (cont’d) • Anti-retaliation:

• Policies and procedures must prohibit investment bankers and other employees from directly or indirectly retaliating (or threatening to retaliate) against research analysts as the result of any adverse research report or public appearance

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Conflicts of interest (cont’d) • Quiet Periods:

• Requires that policies and procedures define quiet periods to consist of: a minimum of 10 days (reduced from 40 days) in the case of an IPO, and a minimum of 3 days (reduced from 10 days) in the case of a follow-on offering

• During the quiet period, the firm must not publish research or make public appearances if the member has participated as an underwriter or dealer in the IPO or as a manager or co-manager of a follow-on offering

• Retains current exception for EGC research reports • Eliminates quiet period around expiration, termination or waiver of a lock-

up agreement

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Conflicts of interest (cont’d) • Solicitation and marketing:

• Imposes new policies that restrict research analyst activities that can reasonably be expected to compromise objectivity

• Preserves the prohibition on analyst participation in pitches and other solicitation of investment banking business

• Distinction between permissible activities in the case of EGC and non-EGC offerings

• Pitch materials cannot include any information about the firm’s research in a manner that suggests the member firm would provide coverage (for example, pitch materials cannot include a research analyst’s industry ranking in a way that suggests the outcome of future research)

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Conflicts of interest (cont’d) • Joint due diligence:

• Policies and procedures must prohibit a research analyst’s participation in due diligence with investment banking personnel prior to the selection of the underwriters for the investment banking transaction

• Following the award of a mandate, joint diligence sessions are permitted with the appropriate safeguards

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Conflict of interest (cont’d) • Favorable Research and Prepublication Review:

• Prohibits promise of favorable research, a particular research recommendation or a rating or specific content as an inducement for the receipt of business or compensation

• Prohibits review of a research report by a subject company for purposes other than factual verification

• Non-investment banking personnel and subject company representatives can review sections of the report for factual accuracy; however, the draft reviewed by them cannot contain the summary recommendation, rating, price target

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Conflict of interest (cont’d) • Personal trading:

• Requires that policies and procedures restrict research analyst account trading in securities covered by the research analyst, as well as trading in any derivatives of such securities

• Policies also must ensure that research analyst accounts, supervisors of research analysts and associated persons able to affect or influence the content of research reports do not benefit from knowledge of the content or the timing of the report before recipients of the report have a reasonable opportunity to act on the information in the report

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Content • Essentially maintains current disclosure requirements • Beyond current requirements, the proposal would require that a

member firm establish policies and procedures that are reasonably designed to ensure that:

• Purported facts in reports are based on reliable information; • Reports disclose when a member firm or its affiliates have a “significant

financial interest in the debt or equity of the subject company” including at a minimum beneficial ownership of 1% or more of any class of common equity securities of the subject company

• Reports disclose any material conflicts known not only by research analysts but also by any associated person with the ability to influence the content of the report

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Public appearances • The proposal maintains current disclosure requirements • However, proposal would also require that in connection with a public

appearance a research analyst disclose if the member or affiliate maintains a significant financial interest in the debt or equity of the subject company

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Distribution of reports • Consistent with the current rule, the proposal requires that research

not be distributed selectively to internal trading personnel or to selected customers of the firm

• Different research products may be distributed to different customers, but differentiation cannot be based on timing of sharing market sensitive information

• Research dissemination practices must be disclosed to all customers • When distributing third-party reports, the firm must ensure the report

not contain any untrue statement of material fact and is not otherwise false or misleading

• Firm distributing third-party report must disclose any significant interest in securities of the subject company as well as any other material conflict that may have influenced the choice of research provider

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Limited investment banking activity • Firms with limited investment banking activity permitted to have

investment banking personnel participate in compensation review for research analysts

• Would exempt firms from current provisions restricting or limiting research coverage decisions and budget determinations

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Debt research • FINRA Rule 2242 would impose requirements on the publication and

distribution of debt research reports generally comparable to those for equity research reports

• Debt research report: any written (including electronic) communication that includes an analysis of a debt security or an issuer of a debt security and, in either case, that provides information reasonably sufficient upon which to base an investment decision

• Excludes: • A recommendation regarding a particular industry, or a particular type of debt

security, would not be “sufficient upon which to base an investment decision” • Discussions of broad-based indices • Market or technical commentary • Analyses of particular types of debt securities

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Debt-conflicts of interest • As with equity research, member firms are required to establish,

maintain and enforce written policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to the preparation, content, and distribution of debt research reports

• Prohibits: • performance of joint due diligence prior to the award of a mandate • sales and trading and principal trading personnel from influencing debt research • research analyst from identifying or recommending specific trading transactions to

sales and trading personnel inconsistent with the analyst’s current reports as well as from disclosing the timing of or contents of a pending report

• Communications between a research analyst and customer should be fair and balanced

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Debt-approval of reports • Policies and procedures must at a minimum • Prohibit prepublication review, clearance or approval of reports by

investment banking, sales and trading, or principal trading personnel and any non-research report, other than legal and compliance

• Subject company may review only for purpose of verifying facts • Same qualifications and requirements as those applicable in the case

of pre-publication review of equity research reports

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Debt-Coverage and budgetary decisions • A member firm’s policies and procedures at a minimum:

• Restrict or limit input by investment banking, sales and trading and principal trading personnel to ensure research management make final decisions regarding coverage

• Limit determination of debt research budget to senior management, excluding senior management engaged in investment banking or principal trading activities and without regard to specific revenues or results derived from investment banking

• Certain firms (eligible for limited banking exemption or principal trading exemption) would be relieved from this requirement

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Debt-Supervision, review and compensation • Policies and procedures at a minimum must:

• Limit supervision of debt research analysts to personnel not engaged in investment banking, sales and trading or principal trading activities

• Include information barriers or other institutional safeguards to ensure debt research is insulated from influence from banking, sales and trading, etc.

• Ensure compensation determinations are not based on specific investment banking or trading transactions or contributions to a firm’s principal trading activities

• Banking and trading are precluded from having input into compensation of debt research analysts

• Compensation must be reviewed at least annually by a committee that reports to the board of directors and does not include any representation from investment banking or principal trading

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Debt-anti-retaliation • Policies and procedures must prohibit member firm employees from

directly or indirectly retaliating against a debt research analyst for publishing research or making a public appearance that may adversely affect the firm’s business interests

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Debt-personal trading • Restrict trading by a debt research analyst account in securities

covered by the debt research analyst, derivatives of such securities, and any fund the performance of which is materially dependent upon the performance of securities covered by debt research analyst

• The procedures would also be required to ensure that debt research analyst accounts and supervisors of debt research analysts and any associated persons who have the ability to influence the content of debt research reports do not benefit in their trading from knowledge or content or timing of debt research reports before the reports are disseminated

• The institutional debt research report exemptions would provide an exception from these requirements

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Debt-prohibition against solicitation • Debt research analyst cannot:

• Participate in pitches or solicitations of investment banking business • Participate in road shows and other marketing on behalf of issuers

related to such transactions • Engage in sales or marketing related to an investment banking

transaction • Engage in any communication with a current or prospective customer

about an investment banking transaction

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Debt-content • Content requirements: similar to those required for equity research,

except in the case of institutional debt research reports subject to the exemption

• Public appearances: requirements are similar to those required in the case of equity research

• Distribution of reports: similar to the requirements for equity research, debt research cannot be selectively disseminated

• Distribution of third-party reports: similar to requirements for equity research

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Debt-exemption for limited principal trading activity • Exemption is available to member firms that engage in limited

principal trading activity where: in absolute value on an annual basis, the member’s trading gains or losses on principal trades in debt securities are $15 million or less over the previous three years, on average per year; and the member employs fewer than 10 debt traders

• A firm meeting the limited principal trading activity definition may claim an exemption from certain provisions regarding the separation of debt research from sales and trading; provided that the firm implement measures to ensure that debt research analysts are insulated from pressure from banking and sales and trading

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Debt-eligible institutional investors • Debt research distributed solely to eligible solely to institutional

investors would be exempt from requirements relating to: supervision, coverage determinations, budget and compensation decisions, and disclosure requirements

• Eligible institutional investors must opt in to receive institutional debt research

• Opt in process differs depending upon type of investor

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Debt-eligible institutional investors (cont’d) • For a QIB: if the member firm has a reasonable basis to believe that

a QIB customer is capable of evaluating investment risks independently, both in general and with regard to the particular transactions and investment strategies involving a debt security; and the QIB affirmatively indicates that it is exercising independent judgment pursuant to FINRA’s suitability requirement, then a member can distribute debt research to that QIB customer via negative consent

• For an institutional account (not a QIB): the member firm must obtain affirmative written consent