[Federal Register: January 7, 2003 (Volume 68, Number 4)]
[Notices]
[Page 826-836]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07ja03-80]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47110; File No. SR-NYSE-2002-49; SR-NASD-2002-154]
Self-Regulatory Organizations: Notice of Filing of Proposed Rule
Changes by the New York Stock Exchange, Inc. Relating to Exchange Rules
344 (``Supervisory Analysts''), 345A (``Continuing Education for
Registered Persons''), 351 (``Reporting Requirements'') and 472
(``Communications With the Public'') and by the National Association of
Securities Dealers, Inc. Relating to Research Analyst Conflicts of
Interest
December 31, 2002.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is
hereby given that on October 9, 2002, the New York Stock Exchange, Inc.
(``NYSE'' or the ``Exchange''), and on October 25, 2002, National
Association of Securities Dealers (``NASD''), filed with the Securities
and Exchange Commission (``SEC'' or ``Commission'') the 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 December 4, 2002, NYSE submitted Amendment No. 1 to its
proposed rule change.\3\ On December 18, 2002, NASD submitted Amendment
No. 1 to its proposed rule change.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Letter from Darla Stuckey, Corporate Secretary, New York
Stock Exchange, Inc., to James A. Brigagliano, Assistant Director,
Division of Market Regulation (``Division''), Commission (December
4, 2002) (``NYSE Amendment No. 1''). NYSE Amendment No. 1 conformed
aspects of the proposed NYSE rules to those of NASD (See SR-NASD-
2002-154), and proposed effective dates for the various rule
provisions.
\4\ See Letter from Philip Shaikun, Assistant General Counsel,
NASD, to Katherine A. England, Assistant Director, Division of
Market Regulation, Commission (December 18, 2002) (``NASD Amendment
No. 1''). NASD Amendment No. 1 inserted language in proposed Rule
1050 to clarify that only research analysts who are directly
responsible for the preparation of research reports (as opposed to
indirect supervisors or others who are not directly responsible)
would be required to register with NASD and pass a qualification
examination. NASD Amendment No. 1 also conformed NASD's proposed
research analyst compensation provisions to comparable provisions in
the NYSE's research analyst rule amendments. NASD Amendment No. 1
also amended the definition of ``research report'' to conform it to
the requirements of the Sarbanes-Oxley Act of 2002. NASD Amendment
No. 1 also revised certain language that was contained in the
discussion of the proposed amendment concerning print media
interviews and articles.
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The Commission is publishing this notice to solicit comments on the
proposed rule changes from interested persons.
I. Self-Regulatory Organizations' Statement of the Terms of Substance
of the Proposed Rule Changes
The SROs propose to amend their rules to address research analyst
conflicts of interest. NYSE filed with the Commission proposed
amendments to Rule 472 (``Communications with the Public''). The
proposed amendments expand upon recently approved amendments to Rule
472 \5\ and will place further restrictions on associated persons'
(hereinafter referred to as research analysts) preparing research
reports, compensation and trading activities, as well as additional
disclosure requirements on research reports issued by members and
member organizations.
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\5\ See Securities Exchange Act Release No. 45908 (May 10,
2002), 67 FR 34968 (May 16, 2002).
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Proposed amendments to Rule 351 (``Reporting Requirements''), will
require members and member organizations to document the basis and
approval of a research analyst's compensation as required by Rule
472(h)(2) and include it in the annual written attestation that they
are required to submit to the Exchange.
Proposed amendments to Rule 344 (``Supervisory Analysts''), will
require a new registration category and qualification examination for
research analysts. Proposed amendments to Rule 345A (``Continuing
Education for Registered Persons''), will include research analysts and
supervisory analysts as covered persons subject to the Firm Element of
the Continuing Education Program to address applicable rules,
regulations, ethics and professional responsibility.
NASD filed with the Commission proposed amendments to NASD Rules
1120 and 2711, and a proposed rule change to create a new NASD Rule
1050, to expand upon recently approved rules that govern research
analyst conflicts of interest.
Below is the text of the proposed rule changes. Proposed new
language is in italics; proposed deletions are in [brackets].
A. NYSE's Proposed Rule Text
Rule 472 Communications With the Public
Approval of Communications and Research Reports
(a)(1) Each advertisement, market letter, sales literature or other
similar type of communication which is generally distributed or made
available by a member or member organization to customers or the public
must be approved in advance by a member, allied member, supervisory
analyst, or qualified person designated under the provisions of Rule
342(b)(1).
(2) Research reports must be [prepared or] approved, in advance, by
a supervisory analyst acceptable to the Exchange under the provisions
of Rule 344. Where a supervisory analyst does not have technical
expertise in a particular product area, the basic analysis contained in
such report may be co-approved by a product specialist designated by
the organization. In the event that the member organization has no
principal or employee qualified with the Exchange to approve such
material, it must be approved by a qualified supervisory analyst in
another member organization by arrangement between the two member
organizations.
Investment Banking, Research Department and Subject Company
Relationships and Communications
(b)(1) Research Department personnel or any associated person(s)
engaged in the preparation of research reports may not be subject to
the supervision or control of the Investment Banking Department of the
member or member organization. Research reports may not be subject to
review or approval prior to distribution by the Investment Banking
Department.
(2) Investment Banking personnel may check research reports prior
to distribution only to verify the accuracy of information and to
identify or to review for any potential conflicts of interest that may
exist, provided that:
(i) Any such written communication concerning the accuracy of
research reports between the Investment Banking and Research
Departments must be made either through the Legal or Compliance
Department or in a transmission copied to Legal or Compliance; and
(ii) Any such oral communication concerning the accuracy of
research reports between the Investment Banking and Research
Departments must be documented and made either with Legal or Compliance
personnel acting as intermediary or in a conversation conducted in the
presence of Legal or Compliance personnel.
(3) A member or member organization may not submit a research
report to the subject company prior to distribution, except for the
review of sections of a draft of the research report solely to verify
facts. Members and member organizations may not, under any
circumstances, provide the subject company sections of research reports
[[Page 827]]
that include the research summary, the research rating or the price
target.
(i) Prior to submitting any sections of the research report to the
subject company, the Research Department must provide a complete draft
of the research report to the Legal or Compliance Department.
(ii) If after submission to the subject company, the Research
Department intends to change the proposed rating or price target, the
Research Department must provide written justification to, and receive
prior written authorization from, the Legal or Compliance Department
for any change. The Legal or Compliance Department must retain copies
of any drafts and changes thereto of the research reports provided to
the subject company.
(iii) The member or member organization may not notify a subject
company that a rating will be changed until after the close of trading
in the principal market of the subject company one business day prior
to the announcement of the change.
(4) No associated person may issue a research report or make a
public appearance concerning a subject company if the associated person
engaged in any communication with the subject company in furtherance of
obtaining investment banking business prior to the time the subject
company entered into a letter of intent or other written agreement with
the member or member organization designating the member or member
organization as an underwriter of an initial public offering by the
subject company. This provision shall not apply to any due diligence
communication between the associated person and the subject company,
the sole purpose of which was to analyze the financial condition and
business operations of the subject company.
Written Procedures
(c) Each member and member organization must establish written
procedures reasonably designed to ensure that members, member
organizations and their associated persons are in compliance with this
Rule (see Rule 351(f) and Rule 472(h)(2) for attestations to the
Exchange regarding compliance).
Retention of Communications
(d) Communications with the public prepared or issued by a member
or member organization must be retained in accordance with Rule 440
(``Books and Records''). The names of the persons who prepared and who
reviewed and approved the material must be ascertainable from the
retained records and the records retained must be readily available to
the Exchange, upon request.
Restrictions on Trading Securities by Associated Persons
(e)(1) No associated person or member of the associated person's
household may purchase or receive an issuer's securities prior to its
initial public offering (e.g., so-called pre-IPO shares), if the issuer
is principally engaged in the same types of business as companies (or
in the same industry classification) which the associated person
usually covers in research reports.
(2) No associated person or member of the associated person's
household may trade in any recommended subject company's securities or
derivatives of such securities for a period of thirty (30) calendar
days prior to and five (5) calendar days after the member's or member
organization's issuance of research reports concerning such security or
a change in rating or price target of a subject company's securities.
(3) No associated person or member of the associated person's
household may effect trades contrary to the member's or member
organization's most current recommendations (i.e., sell securities
while maintaining a ``buy'' or ``hold'' recommendation, buy securities
while maintaining a ``sell'' recommendation, or effecting a ``short
sale'' in a security while maintaining a ``buy'' or ``hold''
recommendation on such security).
(4) The following are exceptions to the prohibitions contained in
paragraphs (1), (2), and (3):
(i) Transactions by associated persons and household members that
have been pre-approved in writing by the Legal or Compliance Department
that are made due to an unanticipated significant change in their
personal financial circumstances;
(ii) A member or member organization may permit the issuance of
research reports or permit a change to the rating or price target on a
subject company, regardless of whether an associated person and/or
household members traded the subject company's securities or
derivatives of such securities, within the thirty (30) calendar day
period described in paragraph (e)(2), when the issuance of such
research reports, or change in such rating or price target is
attributable to some significant news or events regarding the subject
company, provided that the issuance of such research reports, or change
in rating or price target on such subject company has been pre-approved
in writing by the Legal or Compliance Department;
(iii) Sale transactions by an associated person and/or household
member who is new to the member or member organization within thirty
(30) calendar days of such associated person's employment with the
member or member organization when such associated person and/or
household member had previously purchased such security or derivatives
of such security prior to the associated person's employment with the
member or member organization;
(iv) Sale transactions by an associated person and/or household
member within thirty (30) calendar days from the date of the member's
or member organization's issuance of research reports or changes to the
rating or price target on a subject company when such associated person
and/or household member had previously purchased the subject company's
securities or derivatives of such securities prior to initiation of
coverage of the subject company by the associated person;
(v) Transactions in accounts not controlled by the associated
person and for investment funds in which an associated person or
household member participates as a passive investor, provided the
interest of the associated person or household member in the assets of
the fund does not exceed 1% of the fund's assets, and the fund does not
invest more than 20% of its assets in securities of issuers principally
engaged in the same types of business as companies (or in the same
industry classification) which the associated person usually covers in
research reports. If an investment fund distributes securities in kind
to an associated person before the issuer's initial public offering,
the associated person must either divest those securities immediately
or refrain from participating in the preparation of research reports
concerning that issuer;
(vi) Transactions in a registered diversified investment company as
defined under Section 5(b)(1) of the Investment Company Act of 1940.
Restrictions on Member's or Member Organization's Issuance of Research
Reports and Participation in Public Appearances
(f)(1) A member or member organization may not issue research
reports regarding an issuer or recommend an issuer's securities in a
public appearance, for which the member or member organization acted as
manager or co-manager of an initial public offering within forty (40)
calendar days following the effective date of the offering.
(2) A member or member organization may not issue research reports
regarding an issuer or recommend an issuer's securities in a public
appearance, for
[[Page 828]]
which the member or member organization acted as manager or co-manager
of a secondary offering within ten (10) calendar days following the
effective date of the offering. This prohibition shall not apply to
research reports issued under Securities Act Rule 139 regarding issuers
whose securities are actively traded, as defined in Securities Exchange
Act Rule 101(c)(1) of Regulation M.
(3) A member or member organization may permit exceptions to the
prohibitions in paragraphs (f)(1) and (2) (consistent with other
securities laws and rules) for research reports that are issued due to
significant news or events, provided that such research reports are
pre-approved in writing by the member's or member's organization's
Legal or Compliance Department.
(4) No member or member organization which has acted as a manager
or co-manager of a securities offering may issue a research report or
make a public appearance within fifteen (15) days prior to or after the
expiration, waiver or termination of a lock-up agreement or any other
agreement that the member or member organization has entered into with
a subject company and its shareholders that restricts or prohibits the
sale of the subject company's or its shareholder's securities after the
completion of a securities offering. A member or member organization
may permit exceptions to the prohibitions in paragraph (f)(4)
(consistent with other securities laws and rules) for research reports
that are issued as a result of the development of significant news or
events, provided that such research reports are pre-approved in writing
by the member's or member organization's Legal or Compliance
Department.
(5) If a member or member organization withdraws its research
coverage of a subject company, notice of this withdrawal must be made.
Such notice must be made in the same manner as when research coverage
was first initiated by the member or member organization and must
include the member's or member organization's final recommendation or
rating.
Prohibition of Offering Favorable Research for Business
(g) No member or member organization may directly or indirectly
offer a favorable research rating or specific price target, or offer to
change a rating or price target, to a subject company as consideration
or inducement for the receipt of business or for compensation.
Restrictions on Compensation to Associated Persons
(h)(1) No member or member organization may compensate an
associated person(s) for specific investment banking services
transactions. An associated person may not receive an incentive or
bonus that is based on a specific investment banking services
transaction. However, a member or member organization is not prohibited
from compensating an associated person based upon such member's or
member organization's [person's] overall performance, including
[services provided to] the performance of the Investment Banking
Department (see Rule 472(k)(2) for disclosure of such compensation).
(2) An associated person's compensation must be reviewed and
approved at least annually by a committee which reports to the Board of
Directors or where the member or member organization has no Board of
Directors to a senior executive officer of the member or member
organization. Such committee may not include representatives from the
member's or member organization's Investment Banking Department. The
committee must, among other things, consider the following factors, if
applicable, when reviewing an associated person's compensation:
i. The associated person's individual performance, (e.g.,
productivity, and quality of research product);
ii. The correlation between the associated person's recommendations
and stock price performance;
iii. The overall ratings received from clients, sales force, and
peers independent of the Investment Banking Department, and other
independent rating services.
The committee may not consider as a factor in determining the
associated person's compensation, his or her contributions to the
member's or member organization's investment banking business.
The committee must document the basis upon which each associated
person's compensation was established. The annual attestation required
by Rule 351(f) must certify that the committee reviewed and approved
each associated person's compensation and has documented the basis upon
which such compensation was established.
General Standards for All Communications
(Formerly positioned at Supplementary Material .30)
(i) No change
Specific Standards for Communications
(Formerly positioned at Supplementary Material .40)
(j) No change (except for deletion of .40(2)).
Disclosure
(k)(1)Disclosures Required in Research Reports and Public Appearances
Disclosure of Member's, Member Organization's and Associated Person's
Ownership of Securities
(i) A member or member organization must disclose in research
reports and an associated person must disclose in public appearances:
a. If, as of the last day of the month before the publication or
appearance (or the end of the second most recent month if the
publication or appearance is less than ten (10) calendar days after the
end of the most recent month), the member or member organization or its
affiliates beneficially own 1% or more of any class of common equity
securities of the subject company. The member or member organization
must make the required beneficial ownership computation no later than
ten (10) calendar days after the end of the prior month. Computation of
beneficial ownership of securities must be based upon the same
standards used to compute ownership for purposes of the reporting
requirements under Section 13(d) of the Securities Exchange Act of
1934,
b. If the associated person or a household member has a financial
interest in the securities of the subject company, and the nature of
the financial interest, including, without limitation, whether it
consists of any option, right, warrant, futures contract, long or short
position, or
c. Any other actual, material conflict of interest of the member or
member organization, which the associated person knows, or has reason
to know, at the time the research report is issued or at the time the
public appearance is made.
Member, Member Organization and Affiliate Compensation
(ii) A member or member organization must disclose in research
reports if the member or member organization or its affiliates: a) Has
managed or co-managed a public offering of equity securities for the
subject company in the past twelve (12) months; b) has received
compensation for investment banking services from the subject company
in the past twelve (12) months; or c) expects to receive or intends to
seek compensation for investment banking
[[Page 829]]
services from the subject company in the next three (3) months.
When an associated person recommends securities in a public
appearance, the associated person must disclose if the subject company
is an investment banking services client of the member, member
organization, or one of its affiliates; when the associated person
knows or has reason to know of this relationship.
Disclosure of Associated Person's Affiliations With Subject Company
(iii) A member or member organization must disclose in research
reports, and an associated person must disclose in public appearances,
whether the associated person or member of the associated person's
household is an officer, director or advisory board member of the
recommended issuer.
(k)(2) Disclosures Specific to Research Reports
The front page of a research report either must include the
disclosures required under this Rule or must refer the reader to the
page(s) on which each such disclosure is found. Disclosures, and
references to disclosures, must be clear, comprehensive and prominent.
A member or member organization must disclose in research reports
if the associated person preparing such reports received compensation
that is based upon (among other factors) the member's or member
organization's overall investment banking revenues.
A member or member organization must disclose in research reports
that recommend securities:
(i) If it is making a market in the subject company's securities at
the time the research report is issued.
(i) The valuation methods used, and any price objectives must have
a reasonable basis and include a discussion of risks.
(iii) The meanings of all ratings used by the member or member
organization in its ratings system. (For example, a member or member
organization might disclose that a ``strong buy'' rating means that the
rated security's price is expected to appreciate at least 10% faster
than other securities in its sector over the next 12-month period).
Definitions of ratings terms also must be consistent with their plain
meaning. Therefore, for example, a ``hold'' rating should not mean or
imply that an investor should sell a security.
(iv) The percentage of all securities that the member or member
organization recommends an investor ``buy,'' ``hold,'' or ``sell.''
Within each of the three categories, a member or member organization
must also disclose the percentage of subject companies that are
investment banking services clients of the member or member
organization within the previous twelve (12) months. (See Rule 472.70
for further information.).
(v) A chart that depicts the price of the subject company's stock
over time and indicates points at which a member or member organization
assigned or changed a rating or price target. This provision would
apply only to securities that have been assigned a rating for at least
one year, and need not extend more than three years prior to the date
of the research report. The information in the price chart must be
current as of the end of the most recent calendar quarter (or the
second most recent calendar quarter if the publication date is less
than fifteen (15) calendar days after the most recent calendar
quarter).
When a member or member organization distributes a research report
covering six (6) or more subject companies for purposes of the
disclosures required in paragraph (k) of this Rule, such research
report may direct the reader in a clear and prominent manner as to
where they may obtain applicable current disclosures in written or
electronic format.
Other Communications Activities
(l) Other communications activities are deemed to include, but are
not limited to, conducting interviews with the media, writing books,
conducting seminars or lecture courses, writing newspaper or magazine
articles or making radio/TV appearances.
Members and member organizations must establish specific written
supervisory procedures applicable to members, allied members and
employees who engage in these types of communications activities. These
procedures must include provisions that require prior approval of such
activity by a person designated under the provisions of Rule 342(b)(1).
These types of activities are subject to the general standards set
forth in paragraph (i). In addition, any activity which includes
discussion of specific securities and/or industries is subject to the
specific standards in paragraph (j) and the disclosure requirements of
paragraphs (k)(1) and (k)(2)(i).
.10 Definitions
(1) Communication--The term ``Communication'' is deemed to include,
but is not limited to, advertisements, market letters, research
reports, sales literature, electronic communications, communications in
and with the press and wires and memoranda to branch offices or
correspondent firms which are shown or distributed to customers or the
public.
(2) Research Report--``Research report'' is generally defined as a
written or electronic communication which includes an analysis of
equity securities of individual companies or industries, and provides
information reasonably sufficient upon which to base an investment
decision. [and includes a recommendation].
For purposes of approval by a supervisory analyst pursuant to Rule
472(a)(2), research report includes, but is not limited to, reports
which recommend equity securities, derivatives of such securities,
including options, debt and other types of fixed income securities,
single stock futures products, and other investment vehicles subject to
market risk.
(3) Advertisement--``Advertisement'' is defined to include, but is
not limited to, any sales communications that is published, or designed
for use in any print, electronic or other public media such as
newspapers, periodicals, magazines, radio, television, telephone
recording, web sites, motion pictures, audio or video device,
telecommunications device, billboards or signs.
(4) Market letters--``Market letters'' are defined as, but are not
limited to, any written comments on market conditions, individual
securities, or other investment vehicles that are not defined as
research reports. They also may include ``follow-ups'' to research
reports and articles prepared by members or member organizations which
appear in newspapers and periodicals.
(5) Sales literature--``Sales literature'' is defined as, but is
not limited to, written or electronic communications including, but not
limited to, telemarketing scripts, performance reports or summaries,
form letters, seminar texts, and press releases discussing or promoting
the products, services and facilities offered by a member or member
organization, the role of investment in an individual's overall
financial plan, or other material calling attention to any other
communication.
.20 For purposes of this Rule, ``investment banking services''
includes, without limitation, acting as an underwriter in an offering
for the issuer; acting as a financial adviser in a merger or
acquisition; providing venture capital, equity lines of credit, PIPEs
(private investment, public equity transaction), or similar
investments; or serving as placement agent for the issuer.
[[Page 830]]
.30 For purposes of this Rule, the term ``Investment Banking
Department'' means any department or division of the member or member
organization, whether or not identified as such, that performs any
investment banking services on behalf of the member or member
organization.
.40 For purposes of this Rule, the term ``associated person''
includes a member, allied member, or employee of a member or member
organization responsible for, and any person who reports directly or
indirectly to such associated person in connection with, the
preparation of [making of the recommendation to purchase, sell or hold
an equity security in] research reports, or making recommendations or
offering opinions in public appearances or establishing a rating or
price target of a subject company's equity securities. For purposes of
this Rule, the term ``household member'' means any individual whose
principal residence is the same as the associated person's principal
residence. Paragraphs (e)(1), (2), (3); (4)(i), (ii), (iii), (iv) and
(v); (k)(1)(i)b., (k)(1)(iii) apply to any account in which an
associated person has a financial interest, or over which the
associated person exercises discretion or control, other than an
investment company registered under the Investment Company Act of 1940.
This term ``associated person'' also includes such ``other
persons,'' e.g., Director of Research, Supervisory Analyst, or member
of a committee, who have direct influence and/or control with respect
to (1) preparing research reports, or (2) establishing or changing a
rating or price target of a subject company's equity securities. Such
other persons are subject to the provisions of paragraph (e)(1)--(4) of
this Rule.
.50 For purposes of this Rule, the term ``public appearance''
includes, without limitation, participation in a seminar, forum
(including an interactive electronic forum), radio, [or] television or
print media interview, or other public appearance or public speaking
activity, or the writing of a newspaper article or other type of public
written medium in which an associated person makes a recommendation or
offers an opinion concerning any equity securities and/or industries.
.60 For purposes of this Rule, ``subject company'' is the company
whose equity securities are the subject of research reports.
.70 For purposes of Rule 472(k)(2)(iv), a member or member
organization must determine, based on its own ratings system, into
which of the three categories each of their securities ratings utilized
falls. This information must be current as of the end of the most
recent calendar quarter (or the second most recent calendar quarter if
the publication date is less than fifteen (15) calendar days after the
most recent calendar quarter). For example, a research report might
disclose that the member or member organization has assigned a ``buy''
rating to 58% of the securities that it follows, a ``hold'' rating to
15%, and a ``sell'' rating to 27%.
Rule 472(k)(2)(iv) requires members or member organizations to
disclose the percentage of companies that are investment banking
services clients for each of the three ratings categories within the
previous twelve (12) months. For example, if 20 of the 25 companies to
which a member or member organization has assigned a ``buy'' rating are
investment banking clients of the member or member organization, the
member or member organization would have to disclose that 80% of the
companies that received a ``buy'' rating are its investment banking
clients. Such disclosure must be made for the ``buy,'' ``hold'' and
``sell'' ratings categories as appropriate.
.80 For purposes of this Rule, the term ``Legal or Compliance
Department'' also includes, but is not limited to, any department of
the member or member organization which performs a similar function.
.90 For purposes of Rule 472(a), a qualified person is one who has
passed an examination acceptable to the Exchange.
.100 For purposes of this Rule, the term ``initial public
offering'' refers to the initial registered equity security offering by
an issuer, regardless of whether such issuer is subject to the
reporting requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, prior to the time of the filing of such issuer's
registration statement.
.110 For purposes of this Rule, a secondary offering shall include
a registered follow-on offering by an issuer or a registered offering
by persons other than the issuer involving the distribution of
securities subject to Regulation M of the Securities Exchange Act of
1934.
Reporting Requirements
Rule 351
(a)-(e) No change.
(f) Each member and member organization that prepares, issues or
distributes [communications to the public, (including but not limited
to,] research reports and whose associated persons make public
appearances [, media presentations and interviews]), is required to
submit to the Exchange annually, a letter of attestation signed by a
senior officer or partner that the member or member organization has
established and implemented procedures reasonably designed to comply
with the provisions of Rule 472. The attestation must also specifically
certify that each associated person's compensation was reviewed and
approved in accordance with the requirements of Rule 472(h)(2) and that
the basis for such approval has been documented.
* * * * *
.11 For purposes of Rule 351(f), the attestation must be submitted
by April 1 of each year.
.12 The term ``research report'' is defined in Rule 472.10 and the
term ``public appearance'' is defined in Rule 472.50.
Securities Analysts and Supervisory Analysts
Rule 344. Securities analysts and supervisory analysts must be
registered with, qualified by, and approved by the Exchange.
[Supervisory analysts required under Rule 472 shall be acceptable
to, and approved by, the Exchange.]
.10 For purposes of this Rule, the term ``securities analyst''
includes a member, allied member or employee who is directly
responsible for the preparation of research reports. Securities analyst
candidates must pass a qualification examination acceptable to the
Exchange.
.11 [.10] For purposes of this rule, the term ``supervisory
analyst'' includes a member, allied member or employee who is
responsible for approving research reports under Rule 472(a)(2). In
order to show evidence of acceptability to the Exchange as a
supervisory analyst, a member, allied member or employee may do one of
the following:
(1) Present evidence of appropriate experience and pass an Exchange
Supervisory Analysts Examination.
(2) Present evidence of appropriate experience and successful
completion of a specified level of the Chartered Financial Analysts
Examination prescribed by the Exchange and pass only that portion of
the Exchange Supervisory Analysts Examination dealing with Exchange
rules on research standards and related matters.
[In addition, if not a member, allied member or registered
representative, the candidate is subject to Exchange investigation of
character and conduct and should submit personal information on Form U-
4 for this purpose.]
The Exchange publishes a Study Outline for the Securities Analyst
Examination and the Supervisory
[[Page 831]]
Analysts Examination. [Examinations are requested and given under the
procedures described in Para. of 2345.15 for registered representative
examinations.]
Continuing Education for Registered Persons
Rule 345A.(a) Regulatory Element--No change.
(b) Firm Element
(1) Persons Subject to the Firm Element--The requirements of
Section (b) of this Rule shall apply to any registered person who has
direct contact with customers in the conduct of the member's or member
organization's securities sales, trading or investment banking
activities, and to the immediate supervisors of such persons, and to
registered persons who function as supervisory analysts, and securities
analysts as defined in Rule 344 (collectively, ``covered registered
persons'').
(2) Standards--No Change.
(3) Participation in the Firm Element--No Change.
(4) Specific Training Requirements--The Exchange may require a
member or member organization, either individually or as part of a
larger group, to provide specific training to its covered registered
persons in such areas the Exchange deems appropriate. Such a
requirement may stipulate the class of covered registered persons for
which it is applicable, the time period in which the requirement must
be satisfied and, where appropriate, the actual training content.
.10 For purposes of this Rule, the term ``registered person'' means
any member, allied member, registered representative or other person
registered or required to be registered under Exchange rules, but does
not include any such person whose activities are limited solely to the
transaction of business on the Floor with members or registered broker-
dealers. For purposes of the Regulatory Element required under Rule
345A(a), the term does not include persons registered as securities
analysts or supervisory analysts pursuant to Rule 344.
.20-.40 No Change.
.50 Pursuant to Rule 345A(b)(1), all persons registered as
securities analysts and supervisory analysts pursuant to Rule 344 must
participate in a Firm Element Continuing Education program that
includes training in applicable rules and regulations, ethics and
professional responsibility.
* * * * *
The Exchange is requesting the following implementation schedule
for the proposed amendments (all time periods are from the date that
the Commission approves the filing) in order to provide reasonable time
periods for members and member organizations to develop and implement
policies, procedures and systems to comply with the new requirements:
[sbull] NYSE Rule 345A(b) and .50--Implementation of a Firm Element
Continuing Education Program for Research Analysts--90 calendar days.
[sbull] All other provisions--60 calendar days.
In addition, the Exchange is proposing an effective date of 180
days after approval of the amendments to NYSE Rule 344.10 to provide
sufficient time for the Exchange to develop and implement a
qualification examination for research analysts.
B. NASD's Proposed Rule Text
Rule 1050. Registration of Research Analysts
All persons associated with a member who are to function as
research analysts shall be registered with NASD. Before their
registrations can become effective, they shall pass a Qualification
Examination for Research Analysts as specified by the Board of
Governors. For the purposes of this Rule 1050, ``research analyst''
shall mean an associated person who is directly responsible for the
preparation of research reports.
* * * * *
Rule 1120. Continuing Education Requirements
This Rule prescribes requirements regarding the continuing
education of certain registered persons subsequent to their initial
qualification and registration with the Association. The requirements
shall consist of a Regulatory Element and a Firm Element as set forth
below.
(a) Regulatory Element
(1)-(4) (No change.)
(5) Definition of Registered Person
For purposes of this Rule, the term ``registered person'' means any
person registered with [the Association] NASD as a representative,
principal, [or] assistant representative or research analyst pursuant
to Rule 1020, 1030, 1040, 1050 and 1110 Series.
(6) (No change.)
(b) Firm Element
(1) Persons Subject to the Firm Element
The requirements of this subparagraph shall apply to any person
registered with the member who has direct contact with customers in the
conduct of the member's securities sales, trading and investment
banking activities, and to the immediate supervisors of such persons,
and to any person registered as a research analyst pursuant to Rule
1050 (collectively, ``covered registered persons''). ``Customer'' shall
mean any natural person and any organization, other than another broker
or dealer, executing securities transactions with or through or
receiving investment banking services from a member.
(2) Standards for the Firm Element
(A) (No change.)
(B) Minimum Standards for Training Programs--Programs used to
implement a member's training plan must be appropriate for the business
of the member and, at a minimum must cover the following matters
concerning securities products, services, and strategies offered by the
member:
(i) General investment features and associated risk factors;
(ii) Suitability and sales practice considerations; [and]
(iii) Applicable regulatory requirements[.]; and
(iv) With respect to registered research analysts, training in
ethics, professional responsibility and the requirements of Rule 2711.
(3)-(4) (No change.)
* * * * *
Rule 2711. Research Analysts and Research Reports
(a) Definitions
For purposes of this rule, the following terms shall be defined as
provided.
(1)-(3) (No change.)
(4) ``Public appearance'' means any participation in a seminar,
forum (including an interactive electronic forum), radio, [or]
television or print media interview, or other public speaking activity,
or the writing of a print media article, in which a research analyst
makes a recommendation or offers an opinion concerning an equity
security.
(5) ``Research analyst'' means the associated person who is
principally responsible for, and any associated person who reports
directly or indirectly to such a research analyst in connection with,
preparation of the substance of a research report, whether or not any
such person has the job title of ``research analyst.'' Solely for
purposes of paragraph (g), the term ``research analyst'' also includes
such other persons as the director of research, supervisory analyst, or
[[Page 832]]
member of a committee who have direct influence or control with respect
to (A) the preparation of research reports, or (B) establishing or
changing a rating or price target of a subject company's equity
securities.
(6)-(7) (No change.)
(8) ``Research report'' means a written or electronic communication
which includes an analysis of equity securities or individual companies
or industries, and which provides information reasonably sufficient
upon which to base an investment decision [and includes a
recommendation].
(9) (No change.)
(b) (No change.)
(c) Restrictions on Review of a Research Report by the Subject Company
(1)-(3) (No change.)
(4) No research analyst may issue a research report or make a
public appearance concerning a subject company if the research analyst
engaged in any communication with the subject company in furtherance of
obtaining investment banking business prior to the time the subject
company entered into a letter of intent or other written agreement with
the member designating the member as an underwriter of an initial
public offering by the subject company. This provision shall not apply
to any due diligence communication between the research analyst and the
subject company, the sole purpose of which was to analyze the financial
condition and business operations of the subject company.
(d) [Prohibition of Certain Forms of] Restrictions on Research Analyst
Compensation
(1) No member may pay any bonus, salary or other form of
compensation to a research analyst that is based upon a specific
investment banking services transaction.
(2) A research analyst's compensation must be reviewed and approved
at least annually by a committee that reports to the member's board of
directors, or when the member has no board of directors, to a senior
executive officer of the member. This committee may not have
representation from the member's investment banking department. The
committee must consider the following factors when reviewing a research
analyst's compensation, if applicable:
(A) the research analyst's individual performance, including the
analyst's productivity and the quality of the analyst's research;
(B) the correlation between the research analyst's recommendations
and the stock price performance; and
(C) the overall ratings received from clients, sales force, and
peers independent of the member's investment banking department, and
other independent ratings services.
The committee may not consider as a factor in determining the research
analyst's compensation his or her contributions to the member's
investment banking business. The committee must document the basis upon
which each research analyst's compensation was established. The annual
attestation required by Rule 2711(i) must certify that the committee
reviewed and approved each research analyst's compensation and
documented the basis upon which this compensation was established.
(e) (No change.)
(f) [Imposition of Quiet Periods] Restrictions on Publishing Research
Reports and Public Appearances; Termination of Coverage
(1) No member may publish a research report regarding a subject
company or recommend a subject company's securities in a public
appearance for which the member acted as manager or co-manager of:
[(1)](A) an initial public offering, for 40 calendar days following
the date of the offering; or
[(2)](B) a secondary offering, for 10 calendar days following the
date of the offering; provided that:
[(A)](i) paragraphs (f)(1)(A) and (f)[(2)](1)(B) will not prevent a
member from publishing a research report concerning the effects of
significant news or a significant event on the subject company within
such 40- and 10-day periods, and provided further that the legal and
compliance department authorizes publication of that research report
before it is issued; and
[(B)](ii) paragraph (f)[(2)](1)(B) will not prevent a member from
publishing a research report pursuant to SEC Rule 139 regarding a
subject company with ``actively-traded securities,'' as defined in
Regulation M, 17 CFR 242.101(c)(1).
(3) No member that has acted as a manager or co-manager of a
securities offering may publish a research report or make a public
appearance concerning a subject company 15 days prior to and after the
expiration, waiver or termination of a lock-up agreement or any other
agreement that the member has entered into with a subject company or
its shareholders that restricts or prohibits the sale of securities
held by the subject company or its shareholders after the completion of
a securities offering. This paragraph will not prevent a member from
publishing a research report concerning the effects of significant news
or a significant event on the subject company within such period,
provided that the legal and compliance department authorized
publication of that research report before it is issued.
(4) If a member intends to discontinue its research coverage of a
subject company, notice of this withdrawal must be made in the same
manner as when research coverage was first initiated by the member and
must include the member's final recommendation or rating.
(g)-(i) (No change.)
II. Self-Regulatory Organization's Statements of the Purpose of, and
Statutory Basis for, the Proposed Rule Changes
In their filings with the Commission, the NYSE and NASD 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. The NYSE and NASD have prepared summaries,
set forth in Sections A, B, and C below.
A. Self-Regulatory Organizations' Statements of the Purpose of, and
Statutory Basis for, the Proposed Rule Changes
1. NYSE's Purpose
Background
NYSE believes that allegations regarding improprieties in
solicitation of investment banking business impugn the objectivity and
integrity of research analysts and the reports they prepare and have
continued to undermine investor confidence in the equity markets.
According to the NYSE, in discharging their duties as SROs, the NYSE
and NASD have been proactive in this regard and have passed sweeping
changes, described below, to their rules governing research analysts,
their member organizations and their communications with the public.
The proposed amendments described below are a continuation of this
process to restore integrity to the public equity markets.
Prior Amendments
On May 10, 2002, the SEC approved amendments to Exchange Rules 472
and 351 which significantly changed the manner in which members and
member organizations, their investment-banking departments and their
research analysts manage and disclose conflicts of interest between
their investment banking and research activities. The SEC also
[[Page 833]]
simultaneously approved comparable changes to NASD rules (new NASD Rule
2711--``Research Analysts and Research Reports''). NYSE believes that
these rule amendments are the result of the SROs working to develop
uniform industry rules.
The rule amendments generally restrict the relationship between
research and investment banking departments and the companies that are
the subject of research reports; require disclosure of a financial
interest in a subject company by an analyst or a member or member
organization; require disclosure of existing and potential investment
banking relationships with a subject company; impose quiet periods for
the issuance of research reports following the completion of a
company's securities offering; restrict personal trading by research
analysts in the stock of the companies covered by such analysts; and
generally require extensive disclosure in research reports of certain
important information to help customers monitor the correlation between
an analyst's rating and the stock's price movements.
The rule amendments have been phased-in incrementally to provide
members and member organizations time to develop and implement
policies, procedures and systems and hire additional personnel to
comply with the new requirements. The staggered implementation of the
Rules began July 9, 2002, with September 9, 2002 and November 6, 2002
as the effective dates for certain specified provisions. Implementation
dates for certain of the SRO rules have also been delayed for small
firms. As a result of numerous interpretive requests, on June 26, 2002,
the Exchange and the NASD issued a Joint Memo providing interpretive
guidance to certain rule provisions.\6\
---------------------------------------------------------------------------
\6\ NYSE Information Memo No. 02-26 (June 26, 2002), and NASD
Notice to Members 02-39 (July 2002).
---------------------------------------------------------------------------
According to NYSE, the Exchange, together with other regulatory
organizations and SROs, is currently examining members' and member
organizations' research practices to determine compliance with the new
SRO Rules.
According to the NYSE, some of the interpretive issues raised by
the industry and the preliminary findings from the recent examinations
have highlighted the need for certain additional changes to the
existing SRO Rules. NYSE believes that further amendments to the SRO
rules will also be required to comply with the mandate of the Sarbanes-
Oxley Act of 2002 (``SOA''), which requires the SEC, either directly or
indirectly through SROs, to adopt not later than one year after the
date of enactment of the Act (July 24, 2002), ``rules reasonably
designed to address conflicts of interest that can arise when
securities analysts recommend equity securities in research reports and
public appearances, in order to improve the objectivity of research and
provide investors with more useful and reliable information.''
According to the NYSE, certain of the disclosure requirements and
prohibitions that the SOA mandates have already been adopted in the new
NYSE Rules. In some cases, the SOA appears to impose more stringent
requirements. The NYSE is currently analyzing the differences between
the SOA and NYSE Rules, to determine the extent of additional
amendments to be made.
Proposed Amendments Regarding Research Analysts
The following proposed amendments to Exchange rules governing
communications with the public expand upon the recently approved rule
changes. The amendments generally provide for further restrictions on
research analysts' compensation and trading activities, and impose
additional disclosure requirements for research reports and associated
persons.
Proposed amendments to Rule 472 would further separate an analyst's
compensation from investment banking influence by requiring procedures
for review and approval of research analysts' compensation by a
Committee that reports to the Board of Directors or a senior executive.
Recently approved amendments prohibit an associated person from being
compensated for specific investment services transactions.
Such a Committee, at a minimum, would consider the following
factors: the associated person's individual performance (e.g., quality
of research product), correlation between a research analyst's
recommendations and stock prices, and overall ratings from various
internal or external parties exclusive of member or member organization
investment banking personnel.
Further, in determining an individual research analyst's
compensation, the Committee may not consider his or her contribution to
the firm's overall investment banking business. The basis for a
research analyst's compensation would have to be documented and an
annual attestation to the Exchange would certify that the Committee
reviewed and approved each associated person's compensation and
documented the basis for such approval (Rule 472(h)(1) and (2)).
Proposed Rule 472(b)(4) will prohibit a research analyst from
issuing a research report or making a public appearance concerning a
subject company if the research analyst engaged in any communication
with the subject company in furtherance of obtaining investment banking
business prior to the time the subject company entered into a letter of
intent or other written agreement with the member or member
organization designating the member or member rganization as an
underwriter of an initial public offering by the subject company.\7\
Prohibiting research analysts from issuing research reports or making
public appearances after participating in ``pitch'' meetings is
intended to prevent the use or promise of research as an influence or a
sales and marketing tool with prospective investment banking clients of
the member or member organization, and would cause subject companies to
choose a prospective investment banking firm based on the merits of its
underwriting capabilities, rather than its research coverage.\8\
---------------------------------------------------------------------------
\7\ Telephone conversation between NYSE and Division Staff on
December 30, 2002.
\8\ Telephone conversation between NYSE and Division Staff on
December 30, 2002.
---------------------------------------------------------------------------
Due diligence communications between the research analyst and the
subject company, the sole purpose of which is to analyze the financial
condition and business operations of the subject company, is not
subject to the prohibition. Recognizing the need for critical financial
analysis of a subject company during the period an issuer is preparing
to engage in a securities offering with the public, the rule allows
research analysts to participate in due diligence communications. In
doing so, the rule is intended to segregate legitimate research analyst
duties/functions, traditionally associated with their profession, from
the sales/marketing duties that they may have been called upon recently
to do by their firms.
Proposed amendments to Rule 472 would prohibit the issuance of
research reports by the manager or co-manager of a securities offering
for fifteen (15) days prior to and after the expiration time of any
``lock-up agreement'' (Rule 472(f)(4)). This provision is intended to
address situations where research analysts may issue positive research
reports or reiterated ``buy'' recommendations shortly before or just
after the expiration of a lock-up agreement. Through issuance or
reiteration of ``buy'' recommendations,
[[Page 834]]
shareholders of the subject company which were precluded from selling
shares in the immediate aftermarket for specified periods of time, may
be able to sell their shares at higher prices. Imposition of this
fifteen (15) day blackout period around the expirations of lockups is
intended to mitigate and/or eliminate the incentive for a research
analyst to issue positive research reports, and should permit real
market forces to determine the price at which such securities can be
sold after the expiration of such agreements.
Proposed amendments to Rule 472 would require notification to
customers when a member or member organization terminates research
coverage of a subject company and require that the final report include
a final recommendation or rating \9\ (assuming the member or member
organization had issued a prior rating or recommendation) \10\ (Rule
472(f)(5)). This provision is intended to address situations where
research analysts have discontinued following subject companies without
changing their ratings of such companies, even though ratings changes,
may have in many instances, been warranted. Thus, investors held the
securities of such companies, often while these companies were
deteriorating financially, without the benefit of guidance from the
firms from which they had purchased them. The recently approved
amendments to Rule 472 also address this issue, in part, by requiring
the disclosure of a price chart versus changes in ratings in order to
help investors track the correlation between a research analyst's
rating/recommendation and the stock's price performance. NYSE believes
that the proposed amendments would enhance this required disclosure by
providing investors with notice of termination of coverage as well as
any final rating the member or member organization has issued on the
subject company.
---------------------------------------------------------------------------
\9\ The Exchange requested that Commission Staff delete the
reference to a final recommendation or rating ``if any'' in order to
conform to changes made by NYSE Amendment No. 1.
\10\ Telephone conversation between NYSE and Division Staff on
December 30, 2002.
---------------------------------------------------------------------------
As proposed, the definition of research analyst (associated person)
would be amended to include research directors, supervisory analysts
and others e.g., committee members, who have direct influence, or
control the preparation of research reports and establishment or change
in ratings or price targets and thereby subject them to the trading and
ownership prohibitions of the Rule (Rule 472.40) as research analysts.
As proposed, the current ten (10) and forty (40) day quiet periods
for research analysts' issuance of research reports by managers and co-
managers of initial and secondary offerings would be extended to
include public appearances (Rule 472(f)(1) and (2)). Extending the
quiet periods to public appearances would preclude members and member
organizations from engaging in communications through public
appearances that they are otherwise prohibited from making in written
communications to the same standards. NYSE believes that subjecting all
types of appearances and written communications should further remove
any incentives for biased research recommendations in any potential
type of medium.
The definition of ``public appearance'' would be amended to include
research analysts'' making a recommendation in a newspaper article or
similar public medium (Rule 472.50). Extending the definition of public
appearance to recommendations in a newspaper article would require
research analysts to make the same disclosures that they are required
to make in other public appearances.\11\
---------------------------------------------------------------------------
\11\ The Exchange requested that Commission Staff delete the
reference to ``research reports.'' Telephone conversation between
NYSE and Division Staff on December 30, 2002.
---------------------------------------------------------------------------
Proposed amendments to Rule 344 (``Supervisory Analysts'') would
establish a new registration category and require a qualification
examination for research analysts (Rule 344). In addition, Rule 345A
(``Continuing Education for Registered Persons'') would be amended to
include research analysts and supervisory analysts as covered persons
subject to the Firm Element of the Continuing Education Program to
address applicable rules and regulations, ethics, and professional
responsibility (Rule 345A(b) and .50).
NYSE believes that research analysts as securities professionals
perform vital functions for their members or member organizations in
the public equity markets. As such, they should be subject to the
highest ethical and professional competency standards. Accordingly,
NYSE believes that establishing a new registration category with a
corresponding qualifying examination will raise such standards.
Further, including research and supervisory analysts as covered persons
in the Firm Element component of Continuing Education Programs would
place an obligation on members and member organizations to ensure that
they are receiving the requisite ethics and professional responsibility
training that NYSE believes they will require to properly conduct their
duties as research analysts.
The Exchange is making certain clarifying amendments to Rule 472
that would make it more uniform with the NASD rule and would bring it
into conformity with certain of the new requirements of the Act.
Rule 472 is being amended to require that the nature of a research
analyst's financial interest in a subject company's securities be
disclosed in research reports and public appearances, including whether
the interest consists of any option, right, warrant, futures contract,
or long or short position, etc. This would make NASD and NYSE rule
texts consistent with each other (Rule 472(k)(1)(i)(b).
Proposed amendments to Rule 472(l) with respect to specified
communications activities, including, interviews with the media,
writing books and newspaper/periodical articles etc., engaged in by
members, allied members or employees, would clarify the approval and
supervisory requirements for such activities.
As proposed, the term ``research report'' as it is currently
defined in the Rule 472 is being amended to conform to the Act's
definition by deleting the criterion of providing a recommendation from
the criteria that determines what constitutes a research report (Rule
472.10(2)). NYSE believes conforming the definition to the one required
by the SOA would help facilitate members' and member organizations'
future compliance with the SOA in the least disruptive manner.
2. NYSE's Statutory Basis
The NYSE believes that the proposed rule change is consistent with
Section 6(b)(5) of the Exchange Act \12\ which requires, among other
things, that the rules of the Exchange are 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.
---------------------------------------------------------------------------
\12\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
3. NASD's Purpose
Background
In May 2002, the SEC approved new NASD Rule 2711 and similar
amendments to existing New York Stock Exchange (``NYSE'') rules that
increased the regulation of research analysts and research reports.\13\
The new rules are intended to improve the objectivity of
[[Page 835]]
research and provide investors with more useful and reliable
information when making investment decisions. Most of the new rules'
provisions became effective on July 9, 2002, although some provisions
took effect on September 9, 2002, and one provision took effect on
November 6, 2002. Additionally, in July 2002, the SEC approved an NASD
rule proposal to delay until November 6, 2002 the effectiveness of
certain provisions for certain members with foreign affiliates, certain
research analysts that are divesting the securities of all subject
companies that they cover, and certain defined small firms.\14\
---------------------------------------------------------------------------
\13\ Supra note 5,m See also Securities Exchange Act Release No.
46402 (June 6, 2002), 67 FR 40361 (June 12, 2002)(correcting
language contained in rule 2711(h)).
\14\ See Securities Exchange Act Release No. 46165 (July 3,
2002), 67 FR 46555 (July 15, 2002).
---------------------------------------------------------------------------
In June 2002, NASD and the NYSE issued a joint memorandum that
provided members with the new rule language, as well as interpretive
guidance on a number of Rule 2711's provisions.\15\ NASD and the NYSE
also have been examining members' research practices to determine
compliance with the new research analyst rules.
---------------------------------------------------------------------------
\15\ See Notice to Members 02-39 (July 2002).
---------------------------------------------------------------------------
According to NASD, as a result of the examinations and further
discussions with the SEC staff, NASD and NYSE agreed that additional
rules governing members' research activities are necessary to protect
investors. This rule change proposal would effectuate those additional
safeguards. Generally, the proposed amendments would further separate
analyst compensation from investment banking influence, prohibit
analysts from issuing ``booster shot'' research reports, prohibit
analysts from participating in ``bake-off'' meetings with prospective
investment banking clients, require members to publish a final research
report when they terminate coverage of a subject company, impose
registration, qualification and continuing education requirements on
research analysts, and make certain other changes.
NASD believes that these amendments do not implement all of the
changes that may be required pursuant to the research analyst
provisions of the SOA. NASD anticipates filing additional proposed
amendments to Rule 2711 in the future to meet the requirements of SOA
after further discussions with NYSE and SEC staff.
A more detailed discussion of the proposed rule change follows.
1. Analyst Compensation
The proposed amendments would require members to further separate
analyst compensation from investment banking influence by imposing new
restrictions on the manner in which research analysts may be
compensated. The rule proposal would require members to employ a
compensation committee that reports to the member's board of directors
(or if the member does not have a board of directors, a senior
executive officer of the member) responsible for reviewing and
approving analyst compensation at least annually. The committee could
not have representation from the member's investment banking
department. In determining an analyst's compensation, the committee
would have to consider, if applicable, the research analyst's
individual performance, including the analyst's productivity and
research quality, the correlation between the analyst's recommendations
and stock price performance, and overall ratings of clients, sales
force, and peers independent of the member's investment banking
department. The committee could not consider the analyst's
contributions to the member's investment banking business.
The committee would be required to document the basis for
establishing the analyst's compensation. The member also would have to
attest annually to NASD that the committee reviewed and approved each
analyst's compensation and documented the basis upon which the
compensation was established.
2. Restrictions on Publishing Research Reports and Public Appearances
The proposed amendments would make several changes to current Rule
2711(f), which imposes ``quiet periods'' on members during which
members may not publish research reports following an initial or
secondary public offering of securities. First, the proposed amendments
would extend the quiet period prohibitions to public appearances by
research analysts as well as to the issuance of research reports.
Second, the proposed amendments would prohibit ``booster shot''
research reports or public appearances around the time of the
expiration, waiver or termination of a ``lock-up'' agreement. Members
often enter into lock-up agreements with subject companies or their
shareholders that restrict or prohibit the sale of a subject company's
or its shareholder's securities for a defined period after the
completion of a securities offering. This provision would prohibit
members from publishing a research report or making a public appearance
concerning a subject company for 15 days prior to or after the
expiration, waiver or termination of a lock-up agreement, thus helping
prevent members from publishing favorable research that is intended to
benefit the shareholders whose lock-up agreement is no longer in effect
by driving up the price of the issuer's shares. However, the rule
proposal includes an exception that would allow members to publish
research reports during this quiet period to comment on the effect of
significant news or a significant event on the subject company,
provided that the legal and compliance department authorizes the
publication of the report before it is issued. A similar exception
exists with respect to quiet periods in the current rule.
Third, the proposed amendments would require a member that decides
to terminate coverage of a subject company to publish a notice of this
termination, and to publish its final rating or recommendation of the
subject company's securities (assuming the member had issued a prior
rating or recommendation). This provision is intended to eliminate the
practice of dropping coverage of a subject company rather than lowering
a rating or recommendation.
3. Bake-Offs
The proposed amendments would prohibit a research analyst from
issuing a research report or making a public appearance concerning a
subject company if the research analyst communicated with the subject
company in furtherance of obtaining investment banking business before
the subject company had entered into a letter of intent or other
written agreement designating the member as an underwriter of an
initial public offering of the subject company. This provision would
not apply to due diligence communications between an analyst and a
subject company where the sole purpose is to analyze the financial
condition and business operations of the subject company. The purpose
of this provision is to prevent research analysts from attending
``bake-off'' meetings or otherwise communicating with a subject company
where the intention is to pitch the member's investment banking
services.
4. Registration, Qualification and Continuing Education of Research
Analysts
The proposed amendments would create new NASD Rule 1050, which
would require all persons associated with a member that function as
research analysts to register with NASD. For purposes of Rule 1050,
``research analyst'' would be defined as any associated person who is
directly responsible for the preparation of
[[Page 836]]
research reports. Before these persons' registrations could become
effective, they would be required to pass a qualification examination
for research analysts specified by NASD. The proposed amendments also
would amend Rule 1120 to require research analysts to participate in
the regulatory element and firm element of a member's continuing
education program. The firm element program would have to include
research analysts' training and education in ethics, professional
responsibility and the requirements of Rule 2711.
5. Definitions
The proposed amendments would revise the definition of ``research
analyst'' to include supervisors of research analysts, including
directors of research and members of supervisory committees. The
proposed expanded definition would apply only with respect to the
personal trading restrictions of Rule 2711(g). NASD believes the
amendment is necessary because these supervisory personnel review and
often greatly influence the content of and recommendation contained in
research reports and therefore should be subject to the same trading
restrictions, such as the prohibition on trading against the member's
recommendation. The other provisions of Rule 2711 that govern research
analyst conduct and disclosures would not apply to supervisors of
research analysts.
Additionally, the definition of ``public appearance'' would be
revised to include interviews with print media and the writing of a
print media article by a research analyst. In NASD's experience, the
opinions and recommendations by research analysts made in the print
media, specifically in opinion pieces, have created some of the same
concerns as those made in radio and television appearances, which are
covered by the current definition. NASD is modifying the guidance
discussed in NASD's Notice to Members 02-39 concerning the making of
the required disclosures in public appearances with media outlets. An
analyst would not violate the rule if the analyst makes the required
disclosures to the print, radio or television media in good faith, even
if the media outlet does not print or broadcast the information. NASD
thus recognizes the independent editorial discretion of the print,
radio and television media.
6. NASD's Statutory Basis
NASD believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) \16\ of the Act, which require, among
other things, that the NASD's rules 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. The NASD believes that this proposed rule change would
eliminate or expose conflicts of interest and thereby significantly
curtail the potential for fraudulent and manipulative acts. The 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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\16\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organizations' Statements on Burden on Competition
NYSE and NASD 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 Exchange Act.
C. Self-Regulatory Organizations' Statements on Comments on the
Proposed Rule Change Received From Members, Participants, or Others
NYSE and NASD has neither solicited nor received written comments
on the proposed rule change.
III. Date of Effectiveness of the Proposed Rule Changes and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding, or (ii) as to
which the SROs consent, the Commission will:
A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
The Commission notes that the NYSE and NASD have worked together to
develop these proposals. The Commission specifically requests comment
on the substance of the proposals, and whether there are any
differences between the NYSE and NASD proposals that present compliance
or interpretive issues. The Commission also specifically seeks comment
on the practicalities of making the required disclosures in print media
and other public appearances. The Commission requests comment on
whether the SROs should consider whether there are other effective
means (including abbreviated disclosures) to alert investors of
conflicts in the context of public media appearances that would take
into account possible space or time limitations.
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposals, 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. Comments also may be submitted electronically to the
following e-mail address: rule-comments@sec.gov. Electronically
submitted comments will be posted on the Commission's Web site (http://www.sec.gov
). All submissions should refer to File Nos. SR-NASD-2002-
154 and SR-NYSE-2002-49 and should be submitted by March 10, 2003.
Copies of the rule filings, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change 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 the rule filings and
amendments will also be available for inspection and copying at the
principal offices of the SROs and on the SROs' respective Web sites
(http://www.nyse.com and http://www.nasd.com).
(http://www.nyse.com and http://www.nasd.com).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\17\
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\17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-223 Filed 1-6-03; 8:45 am]
BILLING CODE 8010-01-P