NASD Issues Notice to Members Regarding Research Analyst Rules
On January 24, 2007, NASD issued Notice to Members (NTM) 07-04 regarding the amendments to NASD Rule 2711 that were filed with the SEC for immediate effectiveness on September 27, 2006. In large part, the amendments codify existing interpretive guidance that had been set forth in joint interpretive memoranda issued by NASD and NYSE. However, the amendments also included requirements regarding third-party research reports, which had not been included in the joint memoranda. NTM 07-04 provides guidance on the requirements regarding supervisory review and approval of third-party research reports, and it contains two additional interpretations of Rule 2711 relating to the prohibitions on research analysts from participating in the solicitation of investment banking business and road show presentations.
Supervisory Review and Approval of Third-Party Research
As amended, Rule 2711 now provides that all third-party research distributed by a member firm must be reviewed and approved (by signature or initial) by a designated principal (either a Series 24 or a Series 16 Supervisory Analyst) to determine (1) that the third-party disclosures required by Rule 2711, if applicable, are complete and accurate; and (2) that the content of the research report is consistent with all applicable standards regarding communications with the public.
NTM 07-04 states that a member firm is not considered to have "distributed" a research report when the member makes an "independent" third-party research report available to its customers either on request or through a member-maintained website. However, NASD also indicated that a member firm is considered to have distributed a research report prepared by an affiliate that is either requested by a customer or made available on a member-maintained website.
NASD stated further that member firms may not distribute any third-party research that the member knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading. To that end, NASD also stated that a member firm’s obligation to review the content of a third-party research report in this regard extends to any untrue statement of a material fact or any false or misleading information that (1) should be known from reading the report or (2) is known based on information otherwise possessed by the member. In addition, NASD stated that a member firm is not required to validate the preparing firm’s methodologies, analysis, or judgment, or, when the preparing firm is an NASD or NYSE member firm, to verify the completeness and accuracy of that firm’s disclosures. NASD also appears to have clarified that research-specific registration requirements (i.e., Series 86/87) apply only with respect to persons who approve a member firm’s own research reports, not to persons who approve third-party research reports.
NTM 07-04 also notes that the amendments to Rule 2711 do not incorporate guidance from the joint interpretive memoranda that excluded independent third-party research provided through a soft dollar arrangement from the third-party research rules. As amended, Rule 2711 treats soft dollar research the same as any other third-party research. NASD stated that it understands member firms that distribute independent third-party research through a soft dollar arrangement generally do so at a customer ’s request. As such, NASD maintains that the new language in Rule 2711 does not represent any practical change from the previous interpretation. However, NASD also stated that, in the event that arrangements exist where a member firm "distributes" research pursuant to a soft dollar arrangement, then the same obligations would apply as with any other third-party research.
Additional Interpretations of NASD Rule 2711
1. Solicitation of Investment Banking Business
NASD Rule 2711(c)(4) provides that research analysts may not participate in efforts to solicit investment banking business. In response, NASD indicated that it interprets the provision to prohibit in pitch materials any information about a member firm’s research capacity in a manner that suggests, directly or indirectly, that the member might provide favorable research coverage. For example, NASD stated that it would consider the publication in a pitch book or related materials of an analyst’s industry ranking to imply the potential outcome of future research because of the manner in which such rankings are compiled. However, NASD also stated that a member would be permitted to include in the pitch materials the fact of coverage and the name of the research analyst because such information alone does not imply favorable coverage.
2. Road Show Participation
NASD Rule 2711(c)(5) and (6) prohibit research analysts from participating in road shows related to investment banking transactions and from engaging in any communications regarding investment banking services transactions with current or prospective customers in the presence of investment banking personnel or company management. (Although NTM 07-04 states that the prohibition extends to research analysts’ communications with internal sales persons, the SEC has not yet approved that amendment to Rule 2711.) In addition, investment banking personnel are prohibited from directing a research analyst to engage in sales or marketing efforts or to engage in any communication with a current or prospective customer related to investment banking transactions. NASD stated that it interprets these provisions to permit research analysts to listen (in "listen-only" mode, without being identified as being present), or view a live webcast of a road show or other widely attended presentation to investors or the sales force, as long as access is from a remote location (i.e., not at the same address as investment banking, investors, or the sales force). Further, if the road show or other widely attended presentation to investors or the sales force is conducted at the firm’s offices, research personnel may listen from the same address as investment banking but may not be in the same room as investment banking personnel, investors, or the sales force.
Securities Industry FYI is a service of the Broker-Dealer Practice of Morgan Lewis. If you have any questions concerning these important legal developments, please contact one of the following Morgan Lewis attorneys:
John V. Ayanian
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