[Federal Register: December 11, 2002 (Volume 67, Number 238)]
[Notices]
[Page 76202-76205]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11de02-61]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-46949; File Nos. SR-NASD-2002-161; SR-NYSE-2002-60]
Self-Regulatory Organizations; Notice of Filing and Immediate
Effectiveness of Proposed Rule Change and Amendment No. 1 Thereto by
the National Association of Securities Dealers, Inc. and Notice of
Filing and Immediate Effectiveness of Proposed Rule Change by the New
York Stock Exchange, Inc. Relating to Establishing Effective Dates for
Certain Provisions of NASD Rule 2711, Research Analysts and Research
Reports and Certain Provisions of NYSE Rule 472, Communications With
the Public
December 4, 2002.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on November 5, 2002, the National Association of Securities Dealers,
Inc. (``NASD''), and on November 8, 2002, the New York Stock Exchange,
Inc. (``NYSE'' or ``Exchange''), filed with the Securities and Exchange
Commission (``SEC'' or ``Commission'') proposed rule changes as
described in Items I, II, and III below, which Items have been prepared
by the respective self-regulatory organizations (``SROs''). On November
26, 2002, NASD filed amendment No. 1 to the proposed rule change.\3\
The SROs have designated the proposed rule changes as constituting a
stated policy, practice, or interpretation with respect to the meaning,
administration, or enforcement of an existing rule series under
paragraph (f)(1) of Rule 19b-4 under the Act,\4\ which renders the
proposals effective upon filing with the Commission. The Commission is
publishing this notice to solicit comments on the proposed rule
changes, as amended, from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Philip Shaikun, Assistant General Counsel,
NASD, to Katherine A. England, Assistant Director, Division of
Market Regulation, Commission, dated November 26, 2002 (``Amendment
No. 1'').In Amendment No. 1, NASD established a further condition
for delaying the implementation of NASD Rules 2711(b) and (c) until
May 5, 2003 for members that over the previous three years, on
average per year, have participated in 10 or fewer investment
banking transactions or underwritings as manager or co-manager and
generated $5 million or less in gross investment banking revenues
from those transactions. Amendment No. 1 requires that those firms
that meet the eligibility requirements outlined above must maintain
records of communications that would otherwise be subject to the
gatekeeper provisions of Rules 2711(b) and (c). In Amendment No. 1,
NASD also corrected a technical error that appeared in its original
filing.
\4\ 17 CFR 240.19b-4(f)(1).
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I. Self-Regulatory Organizations' Statement of the Terms of Substance
of the Proposed Rule Change
A. NASD
NASD is filing with the Commission a proposed rule change to
establish May 5, 2003 as the effective date for NASD Rules 2711(b) and
(c) for members that over the previous three years, on average, have
participated in 10 or fewer investment banking transactions as manager
or co-manager and generated $5 million or less in gross investment
banking revenues from those transactions. NASD Rules 2711(b) and (c),
when effective, will prohibit a research analyst from being subject to
the supervision or control of any employee of a member's investment
banking department, and will further require legal or compliance
personnel to intermediate certain communications between the research
department and either the investment banking department or the company
that is the subject of a research report or recommendation (``subject
company'').
B. NYSE
The NYSE is filing with the SEC a proposed rule change that would
change the effective date for certain provisions of Rule 472
(``Communications with the Public'') for certain members and member
organizations.
II. Self-Regulatory Organizations' Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In their filings with the Commission, NASD and the NYSE included
statements concerning the purpose of and basis for the proposed rule
changes. The text of these statements may be examined at the places
specified in Item IV below. NASD and the NYSE have prepared summaries,
set forth in Sections A, B, and C below.
A. Self-Regulatory Organizations' Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. NASD's Purpose
NASD is filing the proposed rule change to establish May 5, 2003 as
the effective date for NASD Rules 2711(b) and (c) for members that over
the previous three years, on average per year, have participated in 10
or fewer investment banking transactions as manager or co-manager and
generated $5 million or less in gross investment banking revenues from
those transactions. Pursuant to the SEC's approval of SR-NASD-2002-
87,\5\ NASD Rules 2711(b) and (c) as applied to this class of members
otherwise would go into effect on November 6, 2002. NASD seeks to delay
implementation of these provisions for this limited set of members to
allow NASD to continue to explore with the SEC the appropriate
treatment of small firms under NASD Rule 2711 and the recently-enacted
Sarbanes-Oxley law (``Sarbanes-Oxley''). Smaller members often are the
sole or primary source of underwriting and research coverage for some
smaller companies; therefore, NASD continues to consider ways to
preserve this important role served by these firms, to the extent
consistent with the requirements and objectives of Sarbanes-Oxley and
NASD Rule 2711.
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\5\ See Securities Exchange Act Release No. 46165 (July 3,
2002), 67 FR 46555 (July 15, 2002).
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On May 10, 2002, the Commission approved new NASD Rule 2711, which
governs conflicts of interest when research analysts recommend equity
securities in research reports and during public appearances.\6\ The
Commission approved a staggered implementation period for the rule.
Most provisions of the rule became effective on July 9, 2002, including
those that restrict supervision and control of research analysts by the
investment banking department. The ``gatekeeper'' provisions, described
below, became effective September 9, 2002. The remaining provisions of
the Rule become effective on November 6, 2002, including two provisions
that were delayed pursuant to approval of SR-NASD-2002-87: (1)
Provisions that require disclosure of investment banking compensation
received by foreign affiliates and (2) prohibitions against trading
against a member's recommendation for those members that have
instituted a ban on ownership of securities covered by an analyst and
that have instituted a specific, periodic divestiture schedule.
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\6\ See Securities Exchange Act Release No. 45908, 67 FR 34968
(May 16, 2002).
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NASD Rule 2711(b) contains provisions that generally restrict the
relationship between the research and investment banking departments,
including ``gatekeeper'' provisions that require a legal or compliance
person to intermediate certain communications between the research and
investment banking departments. NASD Rule 2711(b)(1) prohibits a
research analyst from being under the control or supervision of any
employee of the investment banking department. NASD Rule 2711(b)(2)
prohibits employees in
[[Page 76203]]
the investment banking department from reviewing or approving any
research reports prior to publication. NASD Rule 2711(b)(3) creates an
exception to (b)(2) to allow investment banking personnel to review a
research report prior to publication to verify the factual information
contained therein and to screen for potential conflicts of interest.
Any permissible written communications must be made through an
authorized legal or compliance official or copied to such official.
Oral communications must be made through, or in the presence of, an
authorized legal or compliance official and must be documented.
Similarly, NASD Rule 2711(c) restricts communications between a
member and the subject company of a research report, except that a
member may submit sections of the research report to the company to
verify factual accuracy and may notify the subject company of a ratings
change after the ``close of trading'' on the business day preceding the
announcement of the ratings change. Submissions to the subject company
may not include the research summary, the rating or the price target,
and a complete draft of the report must be provided beforehand to legal
or compliance personnel. Finally, any change to a rating or price
target after review by the subject company must first receive written
authorization from legal or compliance.
As the Commission noted in its approval order of NASD Rule 2711,
several commenters argued that the gatekeeper provisions would impose
significant costs, especially for smaller firms that would have to hire
additional personnel. Commenters also noted that personnel often wear
multiple hats in smaller firms, thereby causing a greater burden to
comply with the restriction on supervision and control by investment
banking personnel over research analysts. These comments raised the
prospect that the rules might force some firms out of business or
reduce important sources of capital and research coverage for smaller
companies and companies of regional or local interest.
NASD shares the concern raised by these commenters. To that end,
NASD has been exploring with the SEC possible exemptions or
accommodations that can be made while preserving the purposes of the
rule. In SR-NASD-2002-87, NASD sought comment on whether the parameters
set forth above to be eligible for delayed implementation of Rules
2711(b) and (c) should be made permanent or whether another approach
should be considered. Moreover, in July 2002, NASD issued Notice to
Members 02-44, which similarly sought comment on whether certain
members should be exempted from certain provisions of the Rule and what
criteria should be employed to fashion such an exemption. NASD received
10 comments in response to the Notice to Members.\7\ Generally, the
comments emphasized the financial and administrative burdens imposed by
NASD Rule 2711 to implement the gatekeeper provisions and to structure
firms so that research personnel are not subject to supervision by
investment banking personnel. Commenters argued that the conflicts
addressed by NASD Rule 2711 are less pronounced with respect to smaller
firms and that the burdens of compliance could force firms to
discontinue their research business.
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\7\ Letter from David Amster, CRT Capital Group, dated August
19, 2002; Letter from Peter V.B. Unger, Fulbright & Jaworski, LLP,
dated August 30, 2002; Letter from First Analysis Securities Corp.,
dated August 30, 2002; Letter from Scott Cleland and John Eade,
Investorside Research Association, dated August 29, 2002; Letter
from W. Gray Medlin, The Carson Medlin Co., dated August 29, 2002;
Letter from Cathryn Streeter, BioScience Securities, Inc., dated
August 28, 2002; E-mail from James Nelson, Minnesota Valley
Investments, dated July 31, 2002; E-mail from Joe B. Kercheville,
Kercheville & Company, dated August 28, 2002; E-mail from Ray Chin,
DBS Vickers Securities (USA) Inc., dated July 29, 2002; Letter from
Stuart J. Kaswell, Securities Industry Association, dated August 30,
2002.
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According to NASD, the enactment of Sarbanes-Oxley has further
complicated the picture with respect to small firms. NASD believes
that, while the provisions of Sarbanes-Oxley related to analyst
conflicts closely parallel NASD Rule 2711 in many respects, they also
require the SEC or self-regulatory organizations, such as NASD and
NYSE, to promulgate additional--and sometimes more burdensome--rules on
firms to further limit the influence of investment banking on research
and increase analyst accountability. Notably, Sarbanes-Oxley makes no
explicit exception for small firms. NASD is currently assessing, with
the SEC and NYSE, the implications of Sarbanes-Oxley generally and its
impact on small firms, specifically.
Meanwhile, compliance with NASD Rules 2711(b) and (c) continues to
pose financial and administrative challenges for certain smaller firms.
As such, NASD believes it appropriate to extend the effective date of
those provisions for the limited class of members cited above, so that
NASD may fully explore with the SEC the treatment of small firms that
is consistent with the mandates of Sarbanes-Oxley, the purposes of NASD
Rule 2711 and the best interests of the markets and the investing
public. Therefore, NASD proposes to delay the effective date of NASD
Rules 2711(b) and (c) until May 5, 2003 for those members that over the
previous three years, on average per year, have participated in 10 or
fewer investment banking transactions or underwritings as manager or
co-manager and generated $5 million or less in gross investment banking
revenues from those transactions.
As a further condition for the delayed implementation date, those
firms that meet the eligibility requirements outlined above would be
required to maintain records of communications that would otherwise be
subject to the gatekeeper provisions of Rules 2711(b) and (c).
2. NASD's Statutory Basis
NASD believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\8\ which requires, among
other things, that NASD's rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. NASD believes that this proposed rule change would
reduce or expose conflicts of interest and thereby significantly
curtail the potential for fraudulent and manipulative acts. NASD
further believes that the proposed rule change will provide investors
with better and more reliable information with which to make investment
decisions.
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\8\ 15 U.S.C. 78o-3(b)(6).
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3. NYSE's Purpose
The Exchange is filing the proposed rule change to establish May 5,
2003, as the effective date for: NYSE Rules 472(b)(1), (2) and (3),
subject to certain conditions, for members and member organizations
that over the previous three years, on average, have participated in
ten or fewer underwritings as manager or co-manager and generated $5
million or less in gross investment banking revenues from those
transactions.
On May 10, 2002, the Commission approved amendments to NYSE Rules
351 (``Reporting Requirements'') and 472, which place prohibitions and/
or restrictions on Investment Banking Department, Research Department
and Subject Company relationships and communications and impose new
disclosure requirements on members and member organizations and their
associated persons.\9\ At the same time, the Commission also approved a
[[Page 76204]]
staggered implementation period for the Rules. Most provisions of the
Rules became effective on July 9, 2002, including those that restrict
supervision and control of associated persons by the investment banking
department and those that require disclosure of investment banking
compensation received from a subject company. The ``gatekeeper''
provisions, described below, became effective September 9, 2002.
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\9\ See Securities Exchange Act Release No. 45908, 67 FR 34968
(May 16, 2002).
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On July 9, 2002, the Exchange filed, for immediate effectiveness,
SR-NYSE-2002-23 \10\ that extended the effective date of September 9,
2002 for certain provisions of NYSE Rule 472. Specifically, November 6,
2002 was established as the effective date for NYSE Rules 472(b)(1),
(2) and (3) (``Gatekeeper Provisions'') for members or member
organizations that over the previous three years, on average, have
participated in 10 or fewer investment banking transactions as manager
or co-manager and generated $5 million or less in gross investment
banking revenues from those transactions.
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\10\ See Securities Exchange Act Release No. 46182 (July 11,
2002), 67 FR 47013 (July 17, 2002).
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Small Firm Relief
NYSE Rule 472 contains provisions that generally restrict the
relationship between the research and investment banking departments,
including ``gatekeeper'' provisions that require a legal or compliance
person to intermediate certain communications between the research and
investment banking departments. NYSE Rule 472(b)(1) prohibits an
associated person (also referred to throughout this filing as a
``research analyst'') from being under the control or supervision of
any employee of the investment banking department.
NYSE Rule 472(b)(1) also prohibits the investment banking
department from reviewing or approving any research reports prior to
distribution. NYSE Rule 472(b)(2) creates an exception to the
prohibition of (b)(1) to allow investment banking personnel to review a
research report prior to publication to verify the factual information
contained therein and to screen for potential conflicts of interest.
Any permissible written communications must be made through an
authorized legal or compliance official or copied to such official.
Oral communications must be made through, or in the presence of, an
authorized legal or compliance official and must be documented.
Similarly, NYSE Rule 472(b)(3) restricts communications between a
member or member organization and the subject company of a research
report, except that a member or member organization may submit sections
of the research report to the subject company to verify factual
accuracy and may notify the subject company of a ratings change after
the ``close of trading'' on the business day preceding the announcement
of the ratings change. Submissions to the subject company may not
include the research summary, the rating or the price target, and a
complete draft of the research report must be provided beforehand to
legal or compliance personnel. Finally, any change to a rating or price
target after review by the subject company must first receive written
authorization from a legal or compliance official.
As the Commission noted in its approval order,\11\ several
commenters argued that the ``gatekeeper'' provisions would impose
significant costs, especially for smaller firms that may have to hire
additional personnel to comply with the requirements. Commenters also
noted that personnel often wear multiple hats in smaller firms, thereby
causing a greater burden to comply with the restriction on supervision
and control by investment banking personnel over research analysts.
These comments raised the prospect that the Rules might force some
firms out of the investment banking or research business and/or reduce
important sources of capital and research coverage for smaller
companies.
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\11\ See Securities Exchange Act Release No. 45908 (May 10,
2002), 67 FR 34968 (May 16, 2002).
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In order to provide time to review those issues, the Exchange is
proposing to delay implementation of NYSE Rules 472(b)(1), (2), and (3)
until May 5, 2003 for members and member organizations that over the
previous three years, on average, have participated in 10 or fewer
underwritings as manager or co-manager and generated $5 million or less
in gross investment banking revenues from those transactions.
Those members or member organizations that meet the eligibility
requirements outlined above for the delayed implementation date, would
be required to disclose in research reports that they are delaying
implementation of this Rule provision until May 5, 2003. Further, they
would also be required to maintain records of communications that would
otherwise be subject to the gatekeeper provisions of NYSE Rules
472(b)(2)(i) and (ii).
The Exchange believes it appropriate to extend until May 5, 2003,
the effectiveness of this provision for small firms that meet the
requirements described above. The Exchange believes that for these
members and member organizations, provided they comply with the
conditions described, the temporary relief from these provisions will
not adversely impact the spirit or intent of the Rule initiative.
4. NYSE's Statutory Basis
The Exchange believes that the statutory basis for the proposed
rule change is Section 6(b)(5) of the Exchange Act \12\ which requires,
among other things, that the rules of the Exchange be designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade and in general to protect investors
and the public interests.
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\12\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organizations' Statement on Burden on Competition
NASD and the NYSE do not believe that the proposed rule changes
will result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act, as amended.
C. Self-Regulatory Organizations' Statement on Comments on the Proposed
Rule
NASD and the NYSE have neither solicited nor received written
comments on the proposed rule changes.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
The proposed rule changes have been filed by NASD and NYSE as
stated policies, practices, or interpretations with respect to the
meaning, administration, or enforcement of an existing rule series
under Rule 19b-4(f)(1) under the Act.\13\ Consequently, they have
become effective pursuant to Section 19(b)(3)(A) of the Act and Rule
19b-4(f)(1) thereunder.
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\13\ 17 CFR 240.19b-4(f)(1).
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At any time within 60 days of this filing, the Commission may
summarily abrogate these proposals if it appears to the Commission that
such action is necessary or appropriate in the public interest, for the
protection of investors, or otherwise in furtherance of the purposes of
the Act.\14\
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\14\ For SR-NASD-2002-161, the 60-day period would run from the
date of filing of Amendment No. 1.
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing,
[[Page 76205]]
including whether the proposed rule changes, as amended, are consistent
with the Act. Persons making written submissions should file six copies
thereof with the Secretary, Securities and Exchange Commission, 450
Fifth Street, NW., Washington, DC 20549-0609. Copies of the submission,
all subsequent amendments, all written statements with respect to the
proposed rule changes that are filed with the Commission, and all
written communications relating to the proposed rule changes between
the Commission and any person, other than those that may be withheld
from the public in accordance with the provisions of 5 U.S.C. 552, will
be available for inspection and copying in the Commission's Public
Reference Room. Copies of such filings will also be available for
inspection and copying at the principal offices of the NASD and NYSE.
All submissions should refer to the file numbers SR-NASD-2002-161 and
SR-NYSE-2002-60 and should be submitted by January 2, 2003.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-31199 Filed 12-10-02; 8:45 am]
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