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07-04 Codification of Interpretations to Rule 2711; Implementation Date: September 27, 2006
Research Analysts and Research Reports
Legal & Compliance
Communications with the Public
NASD has filed for immediate effectiveness a proposed rule change to codify certain interpretations under Rule 2711 (Research Analysts and Research Reports). The interpretations include many that previously were set forth in two joint interpretive memoranda. The proposed rule changes also include additional interpretations regarding the definition of research report, the distribution of third-party research through soft-dollar arrangements, and the supervisory requirements with respect to the distribution of both member research and third-party research. This Notice also contains two additional interpretations of the Rule 2711 provisions that prohibit research analysts from participating in the solicitation of investment banking business and road show presentations.
Questions or comments concerning this Notice may be directed to Philip Shaikun, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8451.
Background and Discussion
On September 27, 2006, NASD filed for immediate effectiveness a proposed rule change to amend Rule 2711 (Research Analysts and Research Reports) to codify certain interpretations of the rule. Most of the interpretations had previously been set forth in two joint interpretive memoranda from NASD and the New York Stock Exchange (NYSE) (NASD Notices to Members 02-39 (July 2002) and 04-18 (March 2004)) and include those related to the definitions of "research report" and "public appearance" and disclosure requirements when distributing third-party research.
The rule change codifies an interpretation not contained in the joint interpretive memoranda that communications that constitute statutory prospectuses filed as part of the registration statement are not considered "research reports," even if they meet the definitional elements.
Additionally, the rule change does not incorporate language from previous interpretive guidance that exempted independent third-party research provided through a soft dollar arrangement from the third-party research rules. The new rule language treats such soft dollar research the same as any other third-party research. A member is not considered to have "distributed" such research where a member makes an independent third-party research report available to its customers either upon request or through a member-maintained Web site; however, this exception does not apply to non-member affiliate research that is either requested by a customer or made available on a member-maintained web site. NASD understands that generally member firms that distribute independent third-party research through a soft dollar arrangement do so only upon customer request. Thus, the new language does not represent any practical change from the previous interpretation. However, in the event that arrangements exist where a member "distributes" research pursuant to a soft dollar arrangement, then the same obligations would apply as with any other third-party research.
The rule change also clarifies the supervisory responsibilities when distributing thirdparty research. All third-party research distributed by a member must be reviewed by a designated principal (either a Series 24 or a Series 16 Supervisory Analyst) to determine that the third-party disclosures required by Rule 2711, if applicable, are complete and accurate. Consistent with Rule 2210(d)(1)(B), no member may distribute any third-party research that the member knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading. A member's obligation to review the content of a third-party research report in this regard extends to any untrue statement of a material fact or any false or misleading information that (1) should be known from reading the report or (2) is known based on information otherwise possessed by the member. A member is not required to validate the preparing firm's methodologies, analysis or judgment or, where the preparing firm is an NASD or NYSE member, to verify the completeness and accuracy of that firm's disclosures. For the purposes of this requirement, the term "distributed" has the same meaning as set forth above. Thus, the supervisory requirement does not apply to research reports prepared by an independent third party that the member makes available to its customers either upon request or through a member-maintained Web site.
There are separate requirements for those persons that approve a member's own research reports, depending on the scope of the review. Research reports prepared by a member still must be approved by an individual who has passed either (1) the Series 24 and the Series 87 or (2) the Series 16. A member may elect to have a Series 16 approve the content of research, and then a Series 24 principal who has also passed either the Series 87 or the Series 16 must supervise the conduct of both the Series 16 Supervisory Analyst and the research analyst. See Rule 1022(a)(5) and NASD Notice to Members 04-81 (November 2004). Similar to the approach set forth above regarding the approval of third-party research, NASD will permit any registered principal or a Series 16 Supervisory Analyst to supervise for compliance with the disclosure provisions (only) of Rule 2711. All other content of the research report must continue to be approved by an individual who has passed either the Series 24 and the Series 87, or the Series 16. NASD reminds members that in accordance with Rule 3010 (Supervision), all personnel reviewing both member and third-party research must be qualified by virtue of experience and training to carry out such review.
The new rule language is set forth in Attachment A to this Notice and became effective upon filing on September 27, 2006.
Additional Interpretations Not Contained in the Rule Filing
NASD also is setting forth two additional interpretations regarding the provisions of Rule 2711 that prohibit research analyst participation in the solicitation of investment banking business and road shows presentations.
Solicitation of Investment Banking Business
Rule 2711(c)(4) provides that "[n]o 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." Members have inquired whether this provision bans all research-related references in a pitch book or related presentation materials. NASD interprets the provision to prohibit in pitch materials any information about a member's research capacity in a manner that suggests, directly or indirectly, that the member might provide favorable research coverage. For example, NASD would consider the publication in a pitch book or related materials of an analyst's industry ranking to imply the potential outcome of future research because of the manner in which such rankings are compiled. On the other hand, a member would be permitted to include in the pitch materials the fact of coverage and the name of the research analyst because such information alone does not imply favorable coverage.1
Road Show Participation
Rule 2711(c)(5) and (6) prohibit research analysts from participating in road shows related to investment banking services transactions and from engaging in any communications regarding investment banking services transactions with current or prospective customers or internal sales personnel in the presence of investment banking personnel or company management. Investment banking personnel also are prohibited from directing a research analyst to engage in sales or marketing efforts or to engage in any communication with a current or prospective customer related to investment banking transactions.
NASD interprets this provision to permit research analysts to listen to (in "listen-only" mode, not identified as being present), or view a live webcast of a road show or other widely attended presentation to investors or the sales force, so long as access is from a remote location (i.e., not at the same address as investment banking, investors or the sales force). Further, if the road show or other widely attended presentation to investors or the sales force is conducted at the firm's offices, research personnel may listen from the same address as investment banking but may not be in the same room as investment banking, investors or the sales force.
1 Members must consider whether the facts and circumstances of any solicitation or engagement would warrant disclosure under Section 17(b) of the Securities Act of 1933.
New language is underlined; deletions are in brackets.
2711. Research Analysts and Research Reports
For purposes of this rule, the following terms shall be defined as provided.
If a research report contains a rating, [A] the member must define in [its] the research report[s] the meaning of each rating used by the member in its rating system. The definition of each rating must be consistent with its plain meaning.
If a research report contains either a rating or a price target, and the [A] member [must present in any research report concerning an equity security on which the member] has assigned [any] a rating or price target to the subject company's securities for at least one year, the research report must include a line graph of the security's daily closing prices for the period that the member has assigned any rating or price target or for a three-year period, whichever is shorter. The line graph must:
If a research report contains a price target, the [A] member must disclose in the research report[s] the valuation methods used to determine [a] the price target. Price targets must have a reasonable basis and must be accompanied by a disclosure concerning the risks that may impede achievement of the price target.
When a member distributes a research report covering six or more subject companies (a "compendium report"), for purposes of the disclosures required in paragraph (h), [such research] the compendium report may direct the reader in a clear manner as to where they may obtain applicable current disclosures [in written or electronic format]. Electronic compendium reports may include a hyperlink to the required disclosures. Paper-based compendium reports must provide either a toll-free number to call or a postal address to write for the required disclosures and may also include a web address of the member where the disclosures can be found.