Research Rules Frequently Asked Questions (FAQ)
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- Registration Requirements
- Separation Requirements
- Disclosure Requirements
- Exemption for Institutional Debt Research
- Applicability of Rule 5280 (Trading Ahead of Research Reports)
- Solicitation and Marketing
- Communications or Conduct by Issuers
- Q1. Is a debt research analyst required to register as a "research analyst" and take a qualification examination?
- A1. No. NASD Rule 1050 (Registration of Research Analysts) applies only to a research analyst who is primarily responsible for the preparation of the substance of an equity research report or whose name appears on an equity research report. FINRA is considering whether a similar requirement should apply to debt research analysts.
- Q1. Must there be physical separation between the debt research department and the sales and trading and principal trading departments when operating under the institutional debt research exemption?
- A1. The rule does not mandate physical separation between the debt research department and the investment banking, sales and trading and principal trading departments (or other persons who might seek to influence research analysts). As FINRA noted in its rule filing, however, FINRA would expect such physical separation except in extraordinary circumstances where the costs are unreasonable due to a firm's size and resource limitations. In those instances, a firm must implement written policies and procedures, including information barriers, to effectively achieve and monitor separation between debt research and investment banking, sales and trading and principal trading personnel.
The institutional debt exemption relieves firms of many of the separation requirements in the rule between debt research and sales and trading and principal trading personnel. FINRA notes, however, that even under the institutional debt exemption, a firm still must establish, maintain and enforce written policies and procedures reasonably designed to identify and manage debt research-related conflicts and establish information barriers or other institutional safeguards reasonably designed to ensure that debt research analysts are insulated from pressure by persons engaged in principal trading or sales and trading activities. Accordingly, a firm that does not impose physical separation between those departments must implement and document other policies and procedures to achieve compliance with the remaining applicable provisions of the rule.
- Q1. Must a member disclose in an equity or debt research report material conflicts of interest of a "person with the ability to influence the content of a (debt) research report"?
- A1. Rule 2241(c)(4)(I) requires a member to disclose "any other material conflict of interest of the research analyst or member that the research analyst or an associated person of the member with the ability to influence the content of a research report knows or has reason to know at the time of the publication or distribution of a research report." (emphasis added) Rule 2242(c)(4)(H) contains the same language as applied to debt research analysts and debt research reports.
As the emphasized rule text illustrates, these provisions require disclosure only of the material conflicts of the analyst or member that a person with the ability to influence the content of a (debt) research report knows or has reason to know. Thus, a research report must include disclosure of a material conflict that, for example, a supervisory analyst or research principal knows of that the research analyst is not aware of. However, under these provisions, a research report need not include disclosure of a personal conflict of interest of the supervisory analyst or research principal, unless it rises to the level of a conflict of the member.
Rules 2241.08 and 2242.07 describe an associated person with the ability to influence the content of a (debt) research report as an associated person who is required to review the content of the research report or has exercised authority to review or change the research report prior to publication or distribution. It does not include legal or compliance personnel who may review a report for compliance purposes but are not authorized to dictate a particular recommendation, rating or price target.
FINRA notes that other provisions in the rules may require management of those personal conflicts. For example, Rules 2241(b) and 2242(b) contain overarching requirements to establish, maintain and enforce policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to the preparation, content and distribution of research reports. In addition, Rules 2241(b)(2)(J)(i) and 2242(b)(2)(J)(i) require that a member's policies and procedures be reasonably designed to ensure that associated persons with the ability to influence the content of (debt) research reports do not benefit in their trading from knowledge of the content or timing of a research report before the intended recipients of such research have had a reasonable opportunity to act on the information in the (debt) research report.
- Q2. Must a member disclose in an equity or debt research report if the subject company has paid the member to prepare and distribute the equity or debt research report (sometimes called "issuer paid research")?
- A2. Yes. FINRA considers issuer paid research to be an actual material conflict of interest that must specifically be disclosed by the member pursuant to Rules 2241(c)(4)(I) and 2242(c)(4)(H).
A member will not have satisfied its disclosure obligations simply by complying with the disclosure requirements under Rule 2241(c)(4)(D) or (E) or Rule 2242(c)(4)(D) or (E). Rules 2241(c)(4)(D) and 2242(c)(4)(D) require disclosure if the member or its affiliates has received from the subject company compensation for products or services other than investment banking services in the previous 12 months. Rules 2241(c)(4)(E) and 2242(c)(4)(E) require disclosure if over the 12-month period preceding the date of publication or distribution of a research report the subject company has been a client of the member, and if so, the type of services provided to the company. It requires those services to be broadly characterized as either investment banking services, non-investment banking securities-related services or non-securities services. In general, these provisions are intended to provide more general disclosure of conflicts with less direct potential impact on the objectivity of a research report. Because of the magnitude of the conflict of issuer paid research, FINRA interprets the rules to require specific disclosure of that fact as an "other material conflict of interest." FINRA further notes that Rule 17(b) of the Securities Act of 1933 generally requires disclosing the receipt, whether past or prospective, and amount of consideration received from an issuer for issuing research on its securities.
Exemption for Institutional Debt Research
- Q1. Does the exemption for institutional debt research apply to the public appearance provisions of the Rule?
- A1. The express language of Rule 2242(j)(1) states only that the exemption applies to the "distribution of a debt research report." It would be inconsistent with the rationale of the institutional exemption—i.e., that all such recipients of debt research have sufficient sophistication to understand the conflicts of interest without the specific disclosures and other protections afforded retail debt research—to allow debt research analysts to make public appearances before an audience that could include retail investors.
- Q2. May firms rely on certifications obtained directly or through third-party vendors to establish elements of consent required by either Rule 2242(j)(1)(A) or (B) to distribute institutional debt research to an institutional investor?
- A2. The rule generally does not specify the means by which a firm must determine that an investor is eligible to receive institutional debt research by either negative or affirmative consent. As such, while a firm may use a certification, it is not required to do so. FINRA has not approved or endorsed any particular certification or third-party vendors that might create such certifications.
Rule 2242(j)(1)(A) incorporates and modifies elements of the institutional customer exemption in FINRA Rule 2111 (Suitability). To the extent that a firm intends to obtain negative consent pursuant to Rule 2242(j)(1)(A), it may wish to reference Questions 24-26 in Regulatory Notice 12-25 (May 2012) related to the Rule 2111 institutional customer exemption.
FINRA notes that Rule 2242(j)(1)(A)(ii) requires a qualified institutional buyer to affirmatively indicate that it is exercising independent judgment in evaluating the member's recommendations pursuant to Rule 2111 and that such affirmation cover transactions in debt securities. Therefore, any certification that is obtained or may have previously been used for the purposes of Rule 2111 must be broad enough to fairly encompass transactions in debt securities. Posted: 3/4/16
Applicability of Rule 5280 (Trading Ahead of Research Reports)
- Q1. Do the provisions of Rule 5280 apply to research reports that are produced outside of the research department, such as trading desk research?
- A1. No. Rule 5280(a) states that no member shall establish, increase, decrease or liquidate an inventory position in a security or derivative of such security based on non-public advance knowledge of the content or timing of a research report in that security. Rule 5280(b) requires a member to establish, maintain and enforce policies and procedures reasonably designed to restrict or limit the information flow between research department personnel, or other persons with knowledge of the content or timing of a research report, and trading department personnel, so as to prevent trading department personnel from utilizing non-public advance knowledge of the issuance or content of a research report for the benefit of the member or any other person.
In filings in connection with the proposal to establish Rule 5280, FINRA stated that the rule applies only to debt and equity research reports that are produced by personnel in the research department. The reference to "other persons with the knowledge of the content or timing of a research report" in Rule 5280(b) is not intended to capture persons outside of the research department, such as sales and trading personnel, who may produce research reports. Rather, that language is intended to refer to persons who may become aware of the content or timing of a research report emanating from the research department—for example, a committee that reviews initiations of coverage or changes in ratings or price targets.
As FINRA further noted in the Rule 5280 filings, because of the differing objective of Rule 5280, the definition of research report in the rule is intended to be broader than the definition of research report in the equity research rule and, by extension, the new debt research rule. Instead, it captures any written information from the research department that a reasonable person would expect to result in a transaction based on that information. Thus, for example, whereas Rules 2241 and 2242 exclude research reports distributed to fewer than 15 persons, those communications would be covered by Rule 5280.
View the filings associated with proposed Rule 5280.
Of course, trading ahead of customers based on non-public advance knowledge of research originating outside of the research department may raise issues under FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade), particularly where such trading is to the detriment of customers to which that research is ultimately directed. FINRA further notes that the SEC has charged violations of Section 15(g) of the Exchange Act where a broker-dealer failed to establish, maintain and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information concerning its research analysts' published research. See e.g., In the Matter of The Buckingham Research Group, Inc., Buckingham Capital Management, Inc., and Lloyd R. Karp, Release No. 34-63323 (Nov. 17, 2010).
Solicitation and Marketing
- Q1. Do NASD Rules 2711(c)(4) and 2711(e) prohibit a research analyst from meeting with an issuer while the issuer is engaged in the underwriter selection process for an offering?
- A1. NASD Rule 2711(c)(4) provides that no research analyst may participate in efforts to solicit investment banking business. Accordingly, no research analyst may, among other things, participate in any "pitches" for investment banking business to prospective investment banking clients, or have other communications with companies for the purpose of soliciting investment banking business. The rule contains an exception, which provides that the provision shall not prevent a research analyst from attending a pitch meeting in connection with an initial public offering (IPO) of an Emerging Growth Company (EGC), as defined in NASD Rule 2711(a)(11), 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.
NASD Rule 2711(e) states that no member may directly or indirectly offer favorable research, a specific rating or a specific price target, or threaten to change research, a rating or a price target, to a company as consideration or inducement for the receipt of business or compensation.
Whether a particular communication between a research analyst and an issuer violates one or both of these provisions will depend on the context and content of the communication. Of particular importance are the type and stage of an offering and the context created by the issuer. With respect to an IPO, FINRA sees three stages, with a sliding scale of attendant risks where an analyst communicates with an issuer: (1) a pre-IPO period; (2) a solicitation period; and (3) a post-mandate period. FINRA emphasizes that these periods serve only as guideposts for risk assessment purposes and do not create periods during which particular communications between an analyst and an issuer are absolutely prohibited or permitted.
FINRA considers communications by a research analyst with an issuer during a solicitation period, other than bona fide vetting or due diligence communications by the member, to carry significantly elevated risk. In general, FINRA believes that positive statements to an issuer by a research analyst during a solicitation period carry a high risk of constituting an impermissible promise of favorable research. FINRA recognizes that vetting and due diligence communications enable the research analyst to assess the issuer for underwriting commitment purposes, to gather or confirm information about the issuer to comply with the disclosure obligations of the federal securities laws, and to gather information on behalf of investors. Since those communications are for the purposes of obtaining information from the issuer in furtherance of the analyst’s research function, depending on the facts and circumstances, they carry lower risk than where a research analyst shares his or her views or valuations with an issuer. Of course, vetting or due diligence communications also must be managed carefully to avoid the risks discussed previously.
In FINRA’s view, these risk management considerations exist during a solicitation period, irrespective of who initiates a meeting or communication, or the setting. Thus, the same considerations would apply whether an issuer initiates a meeting at which it requests the analyst’s views as part of the issuer’s underwriter selection process or a research analyst initiates a meeting for bona fide due diligence purposes where the issuer then asks for the analyst’s views. Context is relevant to the degree of attendant risk. Thus, for example, FINRA would not expect a research analyst to refrain from sharing his or her industry views at a previously scheduled conference during a solicitation period where the issuer may be in attendance. In contrast, in circumstances where an issuer overtly or tacitly expresses that the selection of underwriters will be based in whole or in part on the views of a research analyst (including valuation), FINRA believes any subsequent sharing of those views by the member or the research analyst during the solicitation process would carry unmanageable risk.
In general, FINRA considers a solicitation period to begin when the issuer makes known that it intends to proceed with an IPO and ends when there is a bona fide awarding of the underwriting mandates. While typically a solicitation period will commence with a request for proposal from an issuer or other communication that will expressly indicate an intent to proceed with an IPO, firms must carefully assess the context and content of a request for information from an analyst by an issuer during an ostensible pre-IPO period to assess the risk of complying with the request. For example, where an analyst has indicia either from the type of information being requested by the issuer or from other reliable sources that the issuer has already determined to proceed with an IPO, the analyst should consult with legal and compliance personnel to make a reasonable determination whether a solicitation period has begun before complying with the information request. With respect to the end of a solicitation period, to the extent an issuer determines the deal participants on a rolling basis, a solicitation period would end for a particular firm when it is informed that it has been awarded a role in the offering or has been rejected for a role.
While the same risk management principles apply to follow on offerings, FINRA believes that, depending on the facts and circumstances, the risks associated with communications between an analyst and an issuer may be lower during a solicitation period than during an IPO. For example, where an analyst already covers an issuer and has no reason to know that the issuer intends to conduct a follow on offering, FINRA believes a firm could effectively manage the risk of violating the rules by maintaining effective information barriers to prevent the analyst from learning of the intended offering and by limiting the analyst’s post-IPO communications with the issuer to ordinary course communications for the benefit of the firm’s research customers. Where a firm has existing coverage and there is a post-IPO market valuation of the issuer, FINRA would not expect an analyst, in the ordinary course of discharging his or her research function, to share with the issuer a valuation or conclusions not contained in a published research report.
- Q2. Are there restrictions on research analyst communications with an issuer in a pre-IPO period?
- A2. While the prohibitions against participating in efforts to solicit investment banking business and promises of favorable research apply outside of a solicitation period and will depend on the particular facts and circumstances, FINRA believes the risk of violating these provisions in connection with communications between a research analyst and an issuer are lower during a pre-IPO period. As such, FINRA believes the risk of violating these provisions in connection with communications for purposes other than vetting or due diligence during a pre-IPO period can be effectively managed by a firm’s policies and procedures and could include, for example, discussions regarding the issuer’s competitors, the IPO market and an issuer’s readiness for an offering. However, FINRA cautions that a pre-IPO period is not a safe harbor for all analyst communications with an issuer. For example, answering questions from an issuer as to how an analyst would value or “position” the issuer would not only carry increased risk of violating these provisions even in a pre-IPO period, but the questions may also be indicia that the issuer has already determined to proceed with an IPO. Firm’s policies and procedures should address circumstances where issuer statements or questions suggest that an IPO determination has been made, including consultation with legal and compliance personnel.
- Q3. Are there restrictions on research analyst communications with an issuer in a post-mandate period? Does a solicitation period continue where an issuer has not fully resolved the specific roles or economics awarded to firms in the offering?
- Q3. FINRA believes that, depending on the facts and circumstances, the risks associated with communications between a research analyst and an issuer are lower during a post-mandate period, similar to a pre-IPO period. As such, FINRA believes policies and procedures can effectively manage the risk of violating NASD Rule 2711(c)(4) and (e) in a post-mandate period and that it would generally be appropriate for an analyst to communicate with the issuer his or her views about valuation, pricing and structuring of the transaction, even if the valuation or pricing assessment is positive.
FINRA understands that in awarding the mandates for a transaction, an issuer will not always finalize the roles or economics assigned to each firm that the issuer has determined will participate in the offering. Assuming the issuer has made a bona fide award of the underwriting mandates, FINRA believes the risks associated with subsequent communications between an analyst and issuer can be effectively managed, even where the issuer has not fully resolved the specific roles and economics for each firm.
However, FINRA notes that there is no safe harbor in a post-mandate period, and therefore firms must consider the context and issuer expectations in evaluating the permissibility of communications with the issuer. A firm’s policies and procedures should address circumstances that could give rise to impermissible promises of favorable research, such as where the issuer suggests the final roles or economics will be based on the highest valuation given by a firm’s research analyst.
- Q4. May investment banking consult with a research analyst about valuation or other views during a solicitation period?
- A4. Subject to applicable requirements (e.g., chaperones for a Global Settlement firm) and a firm’s policies and procedures to insulate research analysts from investment banking pressure, FINRA believes it would not be inconsistent with NASD Rule 2711(c)(4) and (e) for investment bankers to consult with analysts about valuation and other views during a solicitation period. However, bankers may not convey to the issuer that a valuation is either the research analyst’s valuation or a joint valuation of the bankers and research analyst. Moreover, absent a repudiation, bankers may not convey a valuation to an issuer where there has been a request from the issuer or tacit understanding that the valuation of the bankers and research analyst will be aligned or that any valuation presented will reflect the analyst’s views. Thus, consistent with Regulatory Notice 11-41, where an issuer creates an improper expectation that a firm’s valuation will reflect a research analyst’s view or analyst alignment with the investment bankers’ view, a firm that wishes to continue to compete for a role in the offering must repudiate the overture and explain that any valuation provided represents the bankers’ views only and that the firm cannot make any representations about the views of the research analyst. In such circumstances, a firm must document the repudiation. FINRA notes that any communications between investment bankers and research analysts during a solicitation period regarding valuation or the research analyst’s views present heightened risks that investment bankers will influence the research’s analyst’s views, and must be managed carefully.
- Q5. How, if at all, does application of the rules differ in the context of an IPO for an Emerging Growth Company?
- A5. Section 105(b) of the Jumpstart Our Business Startups Act (JOBS Act) permits research analysts to participate in any communication with the management of an EGC concerning an IPO that is also attended by any other associated person of a broker-dealer. SEC staff provided guidance on this provision in Question 4 (the SEC FAQ 4) of its JOBS Act Frequently Asked Questions About Research Analysts and Underwriters. SEC FAQ 4 states that the SEC staff interprets this provision as “primarily reflecting a Congressional intent to allow analysts to participate in emerging growth company management presentations with sales force personnel so that the issuer’s management would not need to make separate and duplicative presentations to analysts at a time when senior management resources are limited.”
FINRA understands SEC FAQ 4 to identify specific and narrow examples of permissible communications by a research analyst while in attendance at an EGC IPO pitch meeting or in other meetings during a solicitation period concerning an EGC IPO with issuer management that are also attended by other associated persons of a broker-dealer. Further, the SEC staff specifically stated in SEC FAQ 4 that while Section 105(b) permits analysts to attend pitch meetings, “Section 105(b) does not... permit analysts to engage in otherwise prohibited conduct in such meetings... for example, [it does not] affect SRO rules that otherwise prohibit an analyst from engaging in efforts to solicit investment banking business [like NASD Rule 2711(c)(4)].” SEC staff also expressly stated in footnote 179 of the order approving FINRA Rule 2241 that the examples in SEC FAQ 4 of permissible “ministerial statements” were not intended to permit otherwise impermissible activities solely because they were conducted via the ministerial examples given in the FAQ. FINRA views SEC FAQ 4 to be consistent with the risk management guidance set forth in Question 1 above, and does not view SEC FAQ 4 to create a safe harbor for sharing a research analyst’s views and valuations with an issuer during the underwriter selection process for either an EGC or non-EGC IPO or to change the risk management guidance set forth in Question 1 above, other than to allow attendance by a research analyst at a pitch meeting for an EGC IPO. Firms should contact SEC staff to the extent they have questions about the examples cited in SEC FAQ 4 or other particular communications by a research analyst during an EGC pitch meeting.
- Q6. May a member provide to an issuer during a solicitation period its previously published research reports?
- A6. FINRA believes that it would not be inconsistent with NASD Rule 2711(c)(4) and (e) for a member’s investment bankers or other non-research personnel to provide (or arrange for others, including research personnel, to provide) to an issuer during a solicitation period a firm’s previously published research reports (or electronic access to those reports), upon request by the issuer, provided that the request is unsolicited and the research reports have been previously published and generally made available to investing clients of the firm. If the investment banker or other non-research personnel were to provide only its selection of reports or to comment on the reports, these actions would carry an elevated risk of being viewed as impermissible.
There is no absolute prohibition against a research analyst or other research personnel providing (or arranging for others to provide) to an issuer during a solicitation period a firm’s previously published research reports (or electronic access to those reports). However, consistent with the risk management guidance in Question 1, responding to a direct request from an issuer to a research analyst or other research personnel during the solicitation period for previously published research carries additional risk. To the extent that the request from the issuer is unsolicited and the research reports have been previously published and generally made available to investing clients of the firm, FINRA views the risk of a research analyst or other research personnel complying with the direct request to be commensurate with the risk of bona fide vetting or due diligence communications during the solicitation period; i.e., it must be carefully managed. If the research analyst or other research personnel were to provide only its selection of research reports or to comment on the reports, these actions would carry significantly elevated risk of being viewed as impermissible.
Communications or Conduct by Issuers
- Q1. Do FINRA rules govern inappropriate communications or conduct by issuers?
- A1. FINRA rules apply only to FINRA members. While the conduct of most issuers is not governed by FINRA’s rules, some FINRA members may from time to time issue securities or function as advisor to an issuer in connection with an offering. While NASD Rule 2711 does not specifically address conduct by a member when acting as issuer or an advisor to an issuer, FINRA expects members acting in those capacities to be respectful of the regulatory obligations of other members participating, or competing to participate, in an offering. Depending on the particular facts and circumstances, FINRA believes it could be inconsistent with just and equitable principles of trade for a member acting in those capacities to request, induce or pressure another member to engage in conduct that, if acquiesced to, would result in a violation of Rule 2711.