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89-28 Approval and Immediate Effectiveness of Amendment to Definition of ";Bona Fide Research" Under Article III, Section 24 of NASD Rules of Fair Practice

SUGGESTED ROUTING*

Senior Management
Legal & Compliance
Research

*These are suggested departments only. Others may be appropriate for your firm.

EXECUTIVE SUMMARY

The SEC has approved amendments to Article III, Section 24(b)(2) of the NASD Rules of Fair Practice and the Board of Governors' Interpretation thereunder that conform the definition of "bona fide research" to the standard previously announced by the Securities and Exchange Commission with respect to the meaning of "research" under Section 28(e) of the Securities Exchange Act of 1934, as amended. The text of the amendments follows this notice.

BACKGROUND

The Securities and Exchange Commission (SEC) recently approved amendments to Section 24(b)(2) of Article III of the NASD Rules of Fair Practice and the Board of Governor's Interpretation thereunder. (See Securities Exchange Act Release No. 26500, January 27, 1989.) The Amendments are intended to conform the definition of "bona fide research" to the standard announced by the SEC in 1986 with respect to the meaning of "research" under Section 28(e) of the Securities Exchange Act of 1934, as amended.

In October 1988, the NASD issued Notice to Members 88-72, which solicited a member vote on the amendment to Section 24(b)(2), and membership approval was subsequently obtained.

Section 24(a) of Article III of the NASD Rules of Fair Practice provides that, in connection with the sale of securities that are part of a fixed-price offering, no NASD member may grant selling concessions, discounts, or other allowances to anyone other than another broker-dealer for services rendered in distribution; provided, however, that nothing in the section prohibits any NASD member from selling any such securities to any person or account to which it has provided or will provide "bona fide research" if the stated public offering price is paid by the purchaser.1

The amendments change the definition of "bona fide research" contained in Section 24(b) of Article III of the NASD Rules of Fair Practice (Section 24(b) definition) and makes conforming changes to the Interpretation of the Board of Governors under Section 24, which interprets and explains the Section 24(b) definition (Interpretation). Prior to the amendments, the term "bona fide research" contained in Section 24(b)(2) was defined to exclude "products or services that are readily and customarily available and offered to the general public on a commercial basis...".

The prior definition was originally incorporated into the NASD rules as part of a larger package of new rules submitted by the NASD to the SEC regulating the granting by NASD members of selling concessions, discounts, and other allowances in connection with sales of fixed price offerings.2 The definition incorporated the SEC's original interpretation of the term "research" under Section 28(e)(3), which it had published in Securities Exchange Act Release No. 12251 (March 24, 1976) and which excluded as permissible "research" products or services that are readily and customarily available and offered to the general public on a commercial basis.3 The Board of Governors' Interpretation following Section 24 stated that for guidance concerning the meaning of "bona fide research" under Section 24(b), NASD members should refer to the 1976 SEC interpretation of the definition of "research."

However, on April 30, 1986, the SEC withdrew its 1976 standard and announced a revised standard to be used in determining what products and services shall be deemed protected "research" under Section 28(e).4 The SEC, in its 1986 release, stated that the controlling principle to be used to determine whether something is research under the statute is ". . .whether it provides lawful and appropriate assistance to the money manager in the performance of his investment decision-making responsibilities." The Commission stated that, under the revised standard, the fact that a product or service is readily and customarily available and offered to the general public on a commercial basis does not dictate the conclusion that the product or service is not "research", as was the case under its earlier 1976 standard.

Accordingly, the amendment changes Section 24(b)(2) of Article III of the NASD Rules of Fair Practice and the Board of Governors' Interpretation thereunder to eliminate the exclusion from the definition for products and services that are commercially available and to allow the standard established by the Commission in its most recent release to determine the parameters of "bona fide research."

The amendments also delete the reference to the SEC's 1976 release and substitute the SEC 1986 revised standard as well as any new interpretations that the SEC or its staff may issue in the future.

EFFECTIVENESS OF AMENDMENT

The amendment to the definition of "bona fide research" under Section 24(b) of Article III of the NASD Rules of Fair Practice and conforming amendments to the Board of Governors' Interpretation are effective immediately.

Questions concerning this notice may be directed to either Dennis C. Hensley, Vice President and Deputy General Counsel, at (202) 728-8245, or to John F. Mylod, Assistant General Counsel, at (202) 728-8288.

AMENDMENTS TO ARTICLE III, SECTION 24(b) OF NASD RULES OF FAIR PRACTICE AND BOARD OF GOVERNORS' INTERPRETATION

ARTICLE III, SECTION 24

(Note: Deleted language is bracketed; no new language is added.)

SELLING CONCESSIONS

In connection with the sale of securities which are part of a fixed price offering:

(a) A member may not grant or receive selling concessions, discounts, or other allowances except as consideration for services rendered in distribu tion and may not grant such concessions, dis counts or other allowances to anyone other than a broker or dealer actually engaged in the invest ment banking or securities business; provided, however, that nothing in this Section shall prevent any member from (1) selling any such securities to any person, or account managed by any person, to whom it has provided or will provide bona fide re search, if the stated public offering price for such securities is paid by the purchaser; or (2) selling any such securities owned by him to any person at any net price which may be fixed by him unless prevented therefrom by agreement.
(b) The term "bona fide research," when used in this Section, means advice, rendered either directly or through publications or writings, as to the value of securities, the advisability of investing in, purchasing, or selling securities, and the availability of securities or purchasers or sellers of securities, or analyses and reports concerning issuers, industries, securities, economic factors and trends, portfolio strategy, and performance of accounts; provided, however that [(1)] investment management or investment discretionary services [and (2) products or services that are readily and customarily available and offered to the general public on a commercial basis] are not bona fide research.

INTERPRETATION OF THE BOARD OF GOVERNORS

(Note: New language is underlined; deleted language is bracketed.)

BONA FIDE RESEARCH EXCLUSION

While Section 24 provides that a member may grant or receive selling concessions, discounts and other allowances only as consideration for services rendered in distribution and may grant such concessions, discounts or other allowances only to brokers or dealers actually engaged in the investment banking or securities business, that Section also states that a member is not prohibited by Section 24 from selling securities at the stated public offering price to persons to whom it provides bona fide research. Accordingly, nothing in Section 24 prohibits a member from providing bona fide research to a customer who also purchases securities from fixed price offerings from the member whether or not there is an express or implied agreement between the member providing the research and the recipient that the member will be compensated for the research in cash, brokerage commissions, selling concessions or some other form of consideration.

The definition of bona fide research is substantially the same as the definition of the term research in Subsection 28(e)(3) of the Securities Exchange Act of 1934, as amended, and as interpreted by the Securities and Exchange Commission. Members should refer to the Commission's interpretation[s] in Securities Exchange Act Release No. 23170 (April 30, 1986) concerning the definition of research under Section 28(e) for guidance as well as to any interpretations of the Commission or its staff thereafter issued. [For example, in Securities Exchange Act Release No. 12251 (March 24, 1976) the Commission indicated that items such as "newspapers, magazines and periodicals, directories, computer facilities and software, government publications, electronic calculators, quotation equipment, office equipment, airline tickets, office furniture and business supplies" are the type of products and services which are readily and customarily available and offered to the general public on a commercial basis. Accordingly, such services and products and other similar services and products are not bona fide research for purposes of Section 24.]

Moreover, while the provisions in the Section concerning bona fide research are intended to permit money managers to receive bona fide research from persons from whom securities are purchased, it is not intended to enable a money manager, who is also a member, to view its money management services as bona fide research. Accordingly, the performance of money management or investment discretionary services themselves are expressly excluded from the definition of bona fide research.

Another factor relating to bona fide research is that the research must be "provided by" the member who receives or retains the selling concession, discount or other allowance. Under Section 28(e) of the Securities Exchange Act of 1934, the Commission has stated that the "safe harbor" provided by Section 28(e) only extends to research that is "provided by" the broker to whom brokerage commissions are paid. In determining whether the exclusion for bona fide research under Section 24 is available in any given instance, members should refer to the interpretations of the Commission and its staff of the similar requirement applicable to Section 28(e). [In that regard, the Commission, in Securities Exchange Act Release No. 12251, stated that:

Section 28(e) might, under appropriate circumstances, be applicable to situations where a broker provides a money manager with research produced by third parties...]

Whether research is provided by the member will depend on all facts and circumstances surrounding the relationship of the member and the recipient of the research, relying upon interpretations by the Commission and staff with respect to similar questions under Section 28(e). See Securities Exchange Act Release 23170 (April 30, 1986).

INDIRECT DISCOUNTS

A member who, itself or through its affiliate, supplies another person with services or products [which are readily and customarily available and offered to the general public on a commercial basis] which fail to qualify as bona fide research, or which, in the case of services or products other than bona fide research, are provided by the member or its affiliate to such person or others for cash or for some other agreed upon consideration, and also retains or receives selling concessions, discounts or other allowances from purchases by that person or its affiliate of securities from a fixed price offering is improperly granting a selling concession, discount or other allowance to that person unless the member or its affiliate has been, or has arranged and reasonably expects to be, fully compensated for such services or products from sources other than the selling concession, discount or allowance retained or received on the sale.


1NASD Manual (CCH), ¶ 2174, pp. 2097-2098.

2.The rule package, including the provisions proposed to be amended by this filing, came to be known as the "Papilsky" rules and were approved by the Commission December 12,1980

3.Securities Exchange Act Release No. 12251 (March 24, 1976).

4Securities Exchange Act Release No. 23170 (April 30,1986).



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