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Research Re-Imagined SECURITIES INDUSTRY AND FINANCIAL MARKETS ASSOCIATION Compliance & Legal Society Annual Seminar JW Marriott Grande Lakes Orlando, FL TA Panel: Research Re-Imagined March 17, 2020 CLE Outline By: Dana G. Fleischman Partner Latham & Watkins LLP © 2020 Dana G. Fleischman All rights reserved. Research Analyst Conflicts of Interest – History and Recent Developments1 By: Dana G. Fleischman Partner Latham & Watkins LLP I. KEY EVENTS IN THE DEVELOPMENT OF U.S. RULES RELATING TO RESEARCH ANALYST CONFLICTS OF INTEREST Following the “technology boom” in the late 1990s, which was alleged by some to have been fueled by glowing research reports prepared by analysts who were employed by broker-dealers with an interest in obtaining or retaining investment banking business of the issuers that were the subject of the reports, various regulators moved to adopt more stringent rules and regulations designed to prevent investment banking personnel and investment banking considerations from influencing such research analysts and the content of their research reports. A. FINRA Research Conflicts Rules.2 1. On May 10, 2002, the Securities and Exchange Commission (the “SEC”) issued Release No. 34-45908 approving changes proposed by the NASD and the NYSE to their rules governing equity research analysts (in particular, approving new NASD Rule 2711 and changes to NYSE Rules 472 and 351) (the “May 2002 Research Rules”). On June 26, 2002, the NASD and NYSE issued a joint memorandum containing a discussion and interpretation of certain of the May 2002 Research Rules. See NASD Notice to Members 02-39 and NYSE Information Memo 02-26. 2. On October 3, 2002, the NYSE and the NASD issued a joint press release announcing new rule proposals intended to further strengthen the May 2002 Research Rules. The SEC approved the new rule proposals on July 29, 2003 (See SEC Release No. 34-48252) (the “July 2003 Research Rules,” and together with the May 2002 Research Rules, the “Legacy Research Rules”). In March 2004, the NASD and NYSE issued a second joint memorandum 1 This outline is of necessity summary in nature and should not be relied on as legal advice. The information contained in this outline is current as of January 17, 2020. The author gratefully acknowledges the assistance of Brett Ackerman, an associate of Latham & Watkins LLP, in the preparation of this outline. 2 “FINRA” refers to the Financial Industry Regulatory Authority, Inc., which was formed in July 2007 to consolidate the National Association of Securities Dealers, Inc. (the “NASD”), and the member regulation, enforcement and arbitration functions of the New York Stock Exchange, Inc. (the “NYSE”). For purposes of this outline, the legacy rules of the NASD and NYSE are referred to as NASD Rules and NYSE Rules, respectively, irrespective of whether such rules have since been adopted by FINRA as part of the consolidated FINRA rulebook (See footnote 4). In addition, this outline refers to the NASD or the NYSE, respectively, in connection with activities taken by such entities prior to the formation of FINRA. providing further interpretive guidance with respect to the Legacy Research Rules. See NASD Notice to Members 04-18 and NYSE Information Memo 04-10. 3. On April 21, 2005, the SEC approved additional amendments to the Legacy Research Rules with respect to analyst participation in roadshows and other matters. 4. A “Joint Report by NASD and the NYSE on the Operation and Effectiveness of the Research Analyst Conflict of Interest Rules” (the “Joint Report”) was issued in December 2005. The Joint Report includes a review of the Legacy Research Rules and recommends certain changes to them, in some cases, suggesting the elimination or modification of certain current requirements to enhance information flow to investors and minimize burdens on member firms. The Joint Report further noted that the NYSE and the NASD would monitor the extent to which firms have adopted The Bond Market Association’s (“BMA”) Guiding Principles to Promote the Integrity of Fixed Income Research (the “BMA Guiding Principles”).3 5. In July 2006, the NASD and the NYSE published a joint notice to members noting that they had conducted examinations of certain member organizations to assess how those firms have addressed conflicts of interest with respect to fixed income research and had found many instances in which firms had failed to adhere to the BMA Guiding Principles. See NASD Notice to Members 6-36 (July 2006); NYSE Information Memo 6-55 (Aug. 2006). 6. On October 17, 2006, the SEC issued Release No. 34-54616 giving notice of immediate effectiveness and publishing for comment joint rule changes by the NASD and NYSE to codify certain interpretations contained in NASD Notices to Members 02-39 and 04-18 and NYSE Information Memos 02-26 and 04-10, including those relating to the definitions of “research report” and “public appearance” and the disclosures required in connection with the distribution of third party research. In conjunction with the codification of the prior interpretive positions, the NASD and NYSE also issued two additional interpretations with respect to the inclusion of research analyst information in pitch materials and participation by research analysts in roadshows and other widely attended sales force or investor presentations. See NASD Notice to Members 07-04 and NYSE Information Memo 07-11. 3 The BMA Guiding Principles were published in May 2004 by the BMA (which, in 2006, merged with the former Securities Industry Association to form SIFMA) and provided a “best practices” guide for firms in connection with the publication of fixed income research. Although based on the equity research conflict rules, the BMA Guiding Principles were specifically tailored to address the significant differences between the fixed income and equity markets. 2 7. On January 9, 2007, the SEC published for comment proposed rule changes by the NASD and NYSE to implement certain recommendations made in the Joint Report relating to disclosure of conflicts, quiet periods, restrictions on review of research reports by non- research personnel and restrictions on personal trading by research analysts (the “Joint Report Proposal”). See SEC Release No. 34-55072. 8. On February 6, 2008, the SEC issued Release No. 34-57279 granting accelerated approval of a proposed rule change by FINRA to amend requirements regarding the review of third party research reports. The SEC also issued Release No. 34-57278 granting accelerated approval of a proposed rule change by FINRA to amend the exemption relating to foreign research analysts. 9. On October 14, 2008, as part of the process for developing FINRA’s new, consolidated rulebook,4 FINRA issued Regulatory Notice 08-55 seeking comment on proposed FINRA Rules 1223 and 2240 regarding research analyst conflicts of interest (the “October 2008 Proposal”). Although the October 2008 Proposal was not ultimately adopted, it served as the basis for FINRA’s later proposals regarding a consolidated rule to address equity research conflicts of interest. 10. On January 15, 2009, the SEC approved FINRA Rule 5280, which codifies with certain modifications NASD Interpretive Material (“IM”) 2110-4 (Trading Ahead of Research Reports) in the consolidated FINRA rulebook. 11. In March 2011, FINRA sought comment on a concept proposal to apply objectivity safeguards and disclosure requirements to the publication and distribution of debt research reports. See FINRA Regulatory Notice 11-11 (Mar. 2011). This proposal introduced the concept of a tiered approach that generally would provide retail debt research recipients with most of the same protections provided to recipients of equity research, while exempting from many of those requirements debt research provided solely to institutional investors. 12. In February 2012, following its review of comments to FINRA Regulatory Notice 11-11, FINRA published FINRA Regulatory Notice 12-09 seeking additional comments on a revised debt research conflicts rule proposal. 13. FINRA published a further revised proposal addressing debt research conflicts in October 2012 in response to comments received on the prior 4 The FINRA rulebook includes (1) FINRA Rules, (2) NASD Rules and (3) rules incorporated from the NYSE (“Incorporated NYSE Rules”). For more information about the FINRA rulebook consolidation process and the continuing applicability of NASD Rules and Incorporated NYSE Rules pending completion of the rulebook consolidation process, See Information Notice 3/12/08 and Information Notice 12/8/08. 3 proposal set forth in FINRA Regulatory Notice 12-09. See FINRA Regulatory Notice 12-42 (Oct. 2012). 14. On November 14, 2014, FINRA filed with the SEC a proposal to adopt NASD Rule 2711 (Research Analysts and Research Reports) as a FINRA rule, with several modifications; amend NASD Rule 1050 (Registration of Research Analysts) and Incorporated NYSE Rule 344 to create an exception from the research analyst qualification requirement; and re- designate NASD Rule 2711 as FINRA Rule 2241 in the consolidated FINRA rulebook (the “Equity Research Rule”). See SEC Release No. 34-73622 (the “Equity Rule Proposal”). At a substantive level, the new Equity Research Rule is largely in line with the Legacy Research Rules but significantly expands member firm obligations in certain key areas. Moreover, the Equity Research Rule combines a principle-based approach that allows member firms a certain degree of flexibility to design and implement policies and procedures specifically tailored to meet each such firm’s particular circumstances, but tempers that flexibility by mandating the inclusion of certain express prescriptive provisions that establish minimum standards. 15. On November 14, 2014, FINRA also filed with the SEC a proposal to adopt new FINRA Rule 2242, which would address, for the first time, conflicts of interest relating to the publication and distribution of debt research reports (the “Debt Research Rule”). See SEC Release No. 34-73623 (the “Debt Rule Proposal”). 16. On July 16, 2015, the SEC issued orders approving both the Equity Research Rule and the Debt Research Rule.
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